Capital Forbearance and Thrifts: Examining the Costs of Regulatory Gambling
Ramon P. DeGennaro
University of Tennessee, Knoxville - Department of Finance
James B. Thomson
University of Akron
Bank Structure and Competition: FDICIA: An Appraisal, Federal Reserve Bank of Chicago, pp. 406-420, 1993
We define forbearance as the failure of regulators to enforce mandated capital standards at the end of 1979, and calculate the outcome of the forbearance bet taken by policymakers at the end of the 1970s. By comparing the cost of prompt regulatory intervention 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 added at least $16 billion (in 1979 dollars) to the eventual cost. 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.
Our results are in contrast to Benston and Carhill (1992), which suggests that forbearance was not costly to taxpayers, but are consistent with Kane and Yu (1994), which concludes that each year of forbearance added about $8 billion to the ultimate clean-up costs. Both of these studies examine only the latter half of our sample, after the dramatic downturn in interest rates in 1982, which was a necessary event for taxpayers to win the forbearance bet. Despite capturing the gains provided by the unexpected decline in interest rates, our results show that forbearance contributed to the ultimate loss to taxpayers. Finally, our estimated cost of forbearance does not include important secondary costs which Kane (1989), Hendershott and Kane (1991), and the CBO (1992) suggest are economically significant.
Keywords: forbearance, deposit insurance, thrifts, savings and loan
JEL Classification: G21Accepted Paper Series
Date posted: June 26, 1998
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