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Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium

  • John B. Shoven
  • Scott B. Smart
  • Joel Waldfogel

Real interest rates shifted upwards by four or five percentage points in approximately 1980. The question is why. In this paper we review some of the more popular explanations and point out that they are somewhat inconsistent with the facts. We then present a new explanation which may partially account for the dramatic increase. We suggest that the upward shift in rates may be directly connected with the decade-long crisis in the savings and loan industry and the federal government's handling of that crisis. Owners and managers of troubled thrifts responded to the incentives provided by underpriced deposit insurance by offering higher and higher rates in an attempt to attract new funds. Depositors, anticipating that the government would protect their investments, actively sought out higher yields in local and national markets. The end result was that the rates offered by Treasury securities rose to compete with these quasi-risk-free substitutes sold by savings and loans. This added (and, indeed, continues to add) significantly to the federal government's borrowing costs. We calculate this increased cost under various assumptions about the effect of the S&L crisis on real interest rates.

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Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 6 (1992)
Issue (Month): 1 (Winter)
Pages: 155-167

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Handle: RePEc:aea:jecper:v:6:y:1992:i:1:p:155-67
Note: DOI: 10.1257/jep.6.1.155
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  1. Edward J. Kane, 1985. "The Gathering Crisis in Federal Deposit Insurance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262611856, June.
  2. Frederic S. Mishkin, 1988. "Understanding Real Interest Rates," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 70(5), pages 1064-1072.
  3. Mishkin, F.S., 1988. "Understanding Real Interest Rates," Papers fb-_88-40, Columbia - Graduate School of Business.
  4. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  5. Plosser, Charles I., 1987. "Fiscal policy and the term structure," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 343-367, September.
  6. Evans, Paul, 1987. "Do budget deficits raise nominal interest rates? : Evidence from six countries," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 281-300, September.
  7. Bernheim, B Douglas & Bagwell, Kyle, 1988. "Is Everything Neutral?," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 308-38, April.
  8. Kane, Edward J, 1990. " Principal-Agent Problems in S&L Salvage," Journal of Finance, American Finance Association, vol. 45(3), pages 755-64, July.
  9. Poterba, James M. & Summers, Lawrence H., 1987. "Finite lifetimes and the effects of budget deficits on national saving," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 369-391, September.
  10. Evans, Paul, 1987. "Interest Rates and Expected Future Budget Deficits in the United States," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 34-58, February.
  11. Kane, Edward J, 1989. "The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 31-47, Fall.
  12. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  13. Bernheim, B Douglas & Shleifer, Andrei & Summers, Lawrence H, 1986. "The Strategic Bequest Motive," Journal of Labor Economics, University of Chicago Press, vol. 4(3), pages S151-82, July.
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