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

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

Abstract

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.

Suggested Citation

  • John B. Shoven & Scott B. Smart & Joel Waldfogel, 1992. "Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 155-167, Winter.
    • 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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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.6.1.155
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    11. 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.
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    Cited by:

    1. Ramon P. DeGennaro & James B. Thomson, 1992. "Capital forbearance and thrifts: an ex post examination of regulatory gambling," Working Papers (Old Series) 9209, Federal Reserve Bank of Cleveland.
    2. Sebastian Fleitas & Matthew Jaremski & Steven Sprick Schuster, 2023. "The U.S. Postal Savings System and the collapse of building and loan associations during the Great Depression," Southern Economic Journal, John Wiley & Sons, vol. 89(4), pages 1196-1215, April.
    3. Der‐Yuan Yang, 1999. "A Cooperative Perspective On Sovereign Debt: Past And Present," Contemporary Economic Policy, Western Economic Association International, vol. 17(1), pages 44-53, January.
    4. Hendricks, Torben W. & Kempa, Bernd, 2009. "The credit channel in U.S. economic history," Journal of Policy Modeling, Elsevier, vol. 31(1), pages 58-68.
    5. Harold M. Somers, 1992. "Deficits and Interest Rates," UCLA Economics Working Papers 645, UCLA Department of Economics.
    6. Russell W. Cooper & Jonathan L. Willis, 2010. "Coordination of expectations in the recent crisis: private actions and policy responses," Economic Review, Federal Reserve Bank of Kansas City, vol. 95(Q I), pages 5-39.
    7. Jorge A. Chan-Lau & Zhaohui Chen, 1998. "Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis," International Finance 9804001, University Library of Munich, Germany, revised 22 Sep 1998.
    8. Tzavalis, Elias & Wickens, M. R., 1996. "Forecasting inflation from the term structure," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 103-122, May.
    9. Kane, Edward J. & Yu, Min-Teh, 1996. "Opportunity cost of capital forbearance during the final years of the FSLIC mess," The Quarterly Review of Economics and Finance, Elsevier, vol. 36(3), pages 271-290.
    10. Edward J. Kane & Min-Teh Yu, 1994. "How Much Did Capital Forbearance Add to the Cost of the S&L Insurance Mess," NBER Working Papers 4701, National Bureau of Economic Research, Inc.
    11. Ben-David, Itzhak & Palvia, Ajay A. & Spatt, Chester S., 2015. "Banks' Internal Capital Markets and Deposit Rates," Working Paper Series 2015-16, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    12. Sim, Khai Zhi, 2023. "Monetary and fiscal coordination in preventing bank failures and financial contagion," Journal of Macroeconomics, Elsevier, vol. 75(C).
    13. M Ball, 1994. "The 1980s Property Boom," Environment and Planning A, , vol. 26(5), pages 671-695, May.
    14. Guo, Lin, 2003. "Inferring market information from the price and quantity of S&L deposits," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2177-2202, November.
    15. Bartholdy, Jan & Boyle, Glenn W. & Stover, Roger D., 2003. "Deposit insurance and the risk premium in bank deposit rates," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 699-717, April.
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    18. Hendrickson, Jill M., 2000. "The impact of bank failures on local bank pricing decisions," The Quarterly Review of Economics and Finance, Elsevier, vol. 40(3), pages 401-416.

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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