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The capital crunch in New England

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  • Joe Peek
  • Eric S. Rosengren

Abstract

The increase in real estate lending was a major reason for the rapid expansion of New England banks during the 1980s. When nominal real estate prices began to decline in New England, collateral became impaired and many loans stopped performing. The consequent increased provision for expected loan losses (loan loss reserves) caused a rapid deterioration in bank capital throughout the region. ; Having just lost a significant proportion of their capital, many banks tried to satisfy their capital/asset ratio requirements by shrinking their institutions. This article discusses why banks facing binding capital constraints will shrink more than unconstrained banks when an adverse capital shock occurs. It shows that New England banks with low capital/asset ratios are in fact shrinking their institutions faster than better capitalized institutions, and that this behavior has been particularly apparent in those liability categories that are marginal sources of funds for most banks.

Suggested Citation

  • Joe Peek & Eric S. Rosengren, 1992. "The capital crunch in New England," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 21-31.
  • Handle: RePEc:fip:fedbne:y:1992:i:may:p:21-31
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    File URL: http://www.bostonfed.org/economic/neer/neer1992/neer392b.pdf
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    References listed on IDEAS

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    1. Ben S. Bernanke, 1992. "The bank credit crunch," Proceedings 369, Federal Reserve Bank of Chicago.
    2. Allan D. Brunner & Diana Hancock & Mary M. McLaughlin, 1992. "Recent developments affecting the profitability and practices of commercial banks," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jul, pages 459-483.
    3. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    4. John R. Walter, 1991. "Loan loss reserves," Economic Review, Federal Reserve Bank of Richmond, vol. 77(Jul), pages 20-30.
    5. King, Stephen R, 1986. "Monetary Transmission: Through Bank Loans or Bank Liabilities?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 290-303, August.
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    1. Chakraborty, Suparna & Allen, Linda, 2007. "Revisiting the Level Playing Field: International Lending Responses to Divergences in Japanese Bank Capital Regulations from the Basel Accord," MPRA Paper 1805, University Library of Munich, Germany.
    2. Matthew Baron & Emil Verner & Wei Xiong, 0. "Banking Crises Without Panics," The Quarterly Journal of Economics, Oxford University Press, vol. 136(1), pages 51-113.
    3. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
    4. Cathcart, Lara & El-Jahel, Lina & Jabbour, Ravel, 2015. "Can regulators allow banks to set their own capital ratios?," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 112-123.
    5. Houston, Joel & James, Christopher & Marcus, David, 1997. "Capital market frictions and the role of internal capital markets in banking," Journal of Financial Economics, Elsevier, vol. 46(2), pages 135-164, November.
    6. Brunner, Allan D & Kamin, Steven B, 1998. "Bank Lending and Economic Activity in Japan: Did 'Financial Factors' Contribute to the Recent Downturn?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 3(1), pages 73-89, January.
    7. Joe Peek & Eric S. Rosengren, 1996. "Bank Regulatory Agreements and Real Estate Lending," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(1), pages 55-73, March.
    8. Cara S. Lown & Stavros Peristiani & Kenneth J. Robinson, 1999. "What was behind the M2 breakdown?," Staff Reports 83, Federal Reserve Bank of New York.
    9. Robert Tannenwald, 1993. "How dependent are New England's mid-sized firms on the region's largest bank holding companies?," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 35-48.
    10. Mark Hooker & Michael Knetter, 1994. "Unemployment Effects of Military Spending: Evidence from a Panel of States," NBER Working Papers 4889, National Bureau of Economic Research, Inc.
    11. Charles W. Calomiris & Athanasios Orphanides & Steven A. Sharpe, 1994. "Leverage as a State Variable for Employment, Inventory Accumulation, andFixed Investment," NBER Working Papers 4800, National Bureau of Economic Research, Inc.
    12. David C. Wheelock, 2006. "What happens to banks when house prices fall? U.S. regional housing busts of the 1980s and 1990s," Review, Federal Reserve Bank of St. Louis, vol. 88(Sep), pages 413-430.
    13. Pecchenino, Rowena A., 1998. "Risk averse bank managers: Exogenous shocks, portfolio reallocations and market spillovers," Journal of Banking & Finance, Elsevier, vol. 22(2), pages 161-174, February.

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    Keywords

    Capital; New England;

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