Capital forbearance and thrifts: Examining the costs of regulatory gambling

✍ Scribed by Ramon P. Degennaro; James B. Thomson

• Book ID: 104625686
• Publisher: Springer
• Year: 1996
• Tongue: English
• Weight: 871 KB
• Volume: 10
• Category: Article
• ISSN: 0920-8550
• DOI: 10.1007/bf00114084

✦ Synopsis

This article estimates losses embedded in the capital positions of the 996 FSLIC-insured savings and loan institutions that did not meet capital standards on December 31, 1979. We compare the estimated cost of resolving the insolvencies of these institutions in 1980 with the actual failure-resolution costs for those that were closed by August 31, 1994. Our most conservative estimates, considering only the direct costs associated with delayed closure of only the 372 thrifts that were subsequently closed as independent institutions, show that these costs exceed estimates of the cost of prompt resolution by over 16 billion 1979-dollars.

The initial policy response to the insolvency of the thrift industry at the beginning of the 1980s was capital forbearance (Kane, 1989;White, 1991). Both the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and the Garn-St. Germain Act of 1982 aimed at providing relief for the thrift industry. These two pieces of legislation combined with regulatory efforts to permit a dramatic reduction in thrift capital requirements. Explicit capital requirements were lowered from 5 to 3 percent of assets, and regulatory accounting principles (RAP) were introduced to mask the true insolvency of the industry. 1 Rather than deal with the insolvency of the thrift industry at the end of 1979, policy makers placed a bet that unexpectedly lower interest rates or more diversified assets would restore these institutions to health and took actions to conceal emerging problems in the industry.

To assess this regulatory gamble, we construct a sample of FSLIC-insured thrifts that failed to meet book-accounting-based minimum capital standards at the end of 1979.