Capital Forbearance and Thrifts: An Ex Post Examination of Regulatory Gambling

Abstract

This paper studies at the forbearance bet taken by policy makers at the end of the 1970s. We define forbearance as the failure of regulators to enforce book capital standards at the end of 1979. By comparing the cost of prompt regulatory intervention (defined here as closure or reorganization of capital-deficient thrifts in 1980) with the estimated resolution cost at the time of closure for thrifts closed from January 1, 1981 through December 31, 1992 we find that forbearance was a bad bet for taxpayers. Moreover, a more complete accounting for losses would include the costs associated with supervisory mergers and the embedded losses in yet-to-be-resolved forbearance thrifts. This result is in contrast to those in Benston and Carhill (1992), which suggest that forbearance was not costly.

This paper provides direct evidence that forbearance contributed to the ultimate loss to taxpayers from the resolution of the thrift insurance mess. In fact, taxpayer losses grew despite the dramatic downturn in interest rates after 1982, which was a necessary event for taxpayers to win the forbearance bet. Moreover, our measure of the cost of forbearance does not include important secondary costs of forbearance. Work by Kane (1989), Hendershott and Kane (1991), the Congressional Budget Office (1992), and Shoven, Smart, and Waldfogel (1992) suggest that these secondary costs are economically significant.

Keywords: forbearance, capital standards, FSLIC, thrift insurance

JEL Classification: G21