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«Volume Title: Politics and Economics in the Eighties Volume Author/Editor: Alberto Alesina and Geoffrey Carliner, editors Volume Publisher: ...»

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Frequently, one can find good evidence of congressional influence by comparing agency proposals with what actually happens, whether through legislation or an agency's implementing a revised proposal. An example is useful here. In studying the 1960s policy initiatives of the Securities and Exchange Commission (SEC), many scholars provided explanations in terms of the agency itself, focusing especially on the preferences of new SEC leaders.I5 Weingast (1984) showed that, in fact, the SEC had been proposing these apparently new policies as early as the 1940s. These proposals fell on deaf Thomas Romer and Barry R. Weingast presidential and congressional ears and went nowhere. Only when new officials in the White House and on the relevant Senate committee began to favor these initiatives were they actually implemented. l6 Fourth, the lineup of constituency interests facing congressmen on the relevant committees, members on the floor, and the president is an important foundation for regulatory policy choice. When only one interest is active, it tends to dominate policy choice, often at the expense of a much larger group of inactive individuals. When several constituencies are relevant, policy tends to be a compromise among them. But here, too, such compromises often come at the expense of inactive interests.

Fifth, presidential action can provide a counterweight to the congressional tendency to favor narrow but active constituencies. Such action typically comes only when it is consistent with the overall administration agenda (and does not significantly conflict with the interests of constituencies that form an important part of the president’s support). Because his resources are limited, a president usually plays this role only when issues of the highest priority are involved.

Sixth, when policy initiatives backfire, politicians often blame bureaucrats.

This rhetoric is part of the system itself. Because the influence of Congress on the bureaucracy is subtle and not readily known, Congress can rail against the very bureaucracy it created (Fiorina 1981). Moreover, as Kane (1989b) emphasizes, legislation is often constructed so as to give politicians considerable scope to obscure the lines of authority to the bureaucracy. Since the public holds regulators responsible for a host of policy problems, the bureaucracy becomes a convenient whipping boy.

6.3 The Thrift Problem and the Relevant Constituency Interests

6.3.1 Background of the Regulatory Environment To put the events of the eighties in proper perspective, a brief sketch of the political setting of the thrift industry is useful. Many thrift institutions were formed between the world wars by real estate, construction, and development companies as a natural adjunct to their other activities. The regional Federal Home Loan Bank system was established in 1932 to provide for thrift institutions the services that commercial banks obtained through the Federal Reserve System. The Federal Savings and Loan Insurance Corporation (FSLIC) was established in 1934 as part of a political compromise to gain the support of thrift institutions for Roosevelt’s National Housing Act. The FSLIC was placed under the supervision of the FHLB Board.

The linkage between the housing industry and the thrift industry was a politically potent force in the decades following World War 11. Much of the argument for the special status of thrifts was based on the premise that a strong housing industry required strong thrift institutions, and that these institutions, Political Foundations of the Thrift Debacle in turn, required favorable treatment to assure a healthy market for residential mortgages.l9 The geographic dispersion of the thrift industry-with firms in nearly every congressional district-has meant that when the industry required congressional attention, it could usually get it. Through the 1970s, the industry was quite homogeneous in its interests. Consequently, its trade association, the U.S. League of Savings Associations (later renamed the U.S. League of Savings Institutions), was able to marshal considerable agreement on policy matters and to “speak with one voice” to regulators and politicians. Indeed, the league was so effective in making its views known that its name was nearly always accompanied in newspaper accounts by the adjectives “powerful” and “influential.” The relative homogeneity of the industry also worked to its direct advantage with the relevant congressional committees and hence with the industry’s chief federal regulator, the FHLBB. Forces tending toward “capture” of a regulatory agency by the industries it regulates are magnified when the regulated interests are themselves not in conflict. The absence of conflict among constituents led to an FHLBB that in many ways has looked like the paradigmatic captured agency: responsive for the most part to thrift industry interests, promulgating regulations that would increase industry rents, staving off competition from unwelcome poachers from commercial banking. Congress supported these policies both with active legislation, and-more generallysimply by not opposing them.*O As a response to the straitened economic circumstances faced by the industry at the beginning of the 1980s, the Garn-St Germain Act of 1982 loosened restrictions on thrifts’ activities. This helped to provide the industry with greater scope to make investments and compete for deposits. As the adverse interest-rate environment of the early 1980s receded, the apparent health of the industry improved. Encouraged by spokesmen for the thrift industry, most members of Congress were ready to believe that legislation in 1982, coupled with regulatory actions from then on, had succeeded in handling the problems that had surfaced at the beginning o the decade.

f During this time, there is little evidence that the FHLBB disagreed with the policy of forbearance. Indeed, a case can be made that warning signs about the looming losses embedded in many thrift balance sheets were systematically downplayed, both by industry groups and by the regulators.2’The accounting rules adopted by FHLBB pursuant to the guidelines of the Garn-St Germain Act made this possible. The gambles of insolvent thrifts, made with at least tacit regulatory approval, were backed by congressional mandate.

6.3.2 The Administration and the Emerging Thrift Crisis The administration’s domestic policy stance centered on reducing the scope of government activity, including an emphasis on holding down nondefense spending. As far as the thrift industry was concerned, this had three important Thomas Romer and Barry R. Weingast implications. First, the administration strongly supported the deregulatory components of the 1982 legislation. It looked at thrift regulators with a somewhat jaundiced eye, at least when it came to the question of bank examination and supervision. Second, to the extent that dealing with the thrift problem required infusions of government funds, the administration preferred not to acknowledge the problem. In part, this reflected the administration’s desire to avoid any explicit new revenue requirements. In part, it was due to the recognition that any attempt by the administration to gain revenue for one purpose would require compromise with administration opponents seeking funds for their own favored programs. Third, by late 1986, deferring action on the full scope of the thrift problem allowed the administration to focus on other policy goals as the Reagan presidency approached its end.

A minority voice within the administration recognized the problems inherent with the system of deposit insurance in a deregulated environment. The 1984 Economic Report o the President contained a recommendation by the f Council of Economic Advisers (CEA) that the deposit insurance system be reformed because of the adverse incentives it created. The 1986 Economic Report o the President, published in February, devoted a chapter to “The f Federal Role in Credit Markets,” which gave a succinct explanation of the thrift problem as of late 1985-including the risks posed by “gambling for resurrection.” The CEA also sounded a warning that FSLIC’s problems could turn into a potential liability for taxpayers and again called for deposit insurance reform.

The economists’ position was not reflected in the administration’s policy.

The president continued to support further deregulation of financial markets, but there were no initiatives to deal specifically with the problems of the thrifts.22 A policy of forbearance was consistent with the three factors we listed above. Any other path would have been in conflict with the administration’s highest priorities. From the perspective of 1985 and 1986, the stakes in the thrift issue did not appear substantial enough to compromise those priorities. The administration thus withheld support from thrift regulators not only when they attempted to enforce capital requirements but also for new revenue that might have provided an early and much smaller recapitalization of the thrift insurer than would prove necessary later on. Action by the Office of Management and Budget (OMB) to limit FHLBB budget requests (see below) was consistent with this stance.

6.3.3 Regulators and the Emerging Crisis While the scope of thrifts’ lending activities-and hence their asset-risk exposure-increased, the resources devoted to monitoring thrifts’ health stayed constant or actually declined. Table 6.2 shows that FHLBB examination and thrift supervisory budgets were roughly constant from 1982 through 1984, whether measured in numbers of people or dollars. Yet, during this time, industry assets grew by 50%. Arguing that the growth in the industry 187 Political Foundations of the Thrift Debacle

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1,282 41.0 1979 568.1 49.8 1980 1,308 620.6 1981 1,385 52.8 658.5 57.3 1982 1,379 686.2 62.5 1983 1,368 813.8 67.0 1984 977.5 1,337 1,990 108.8 1985 1,070.0 2,986 168.5 1,163.8 297.6 3,258 1,250.8 Source: Barth and Bradley (1988, table 8).

”Staffing figures are based on full-time-equivalent personnel engaged in examination or supervision at both the Bank Board and the district Home Loan Banks.

bBudget figures are. budget or actual expenditures, as available, on examination or supervision at both the Bank Board and the district Home Loan Banks.

required greater regulatory resources, the FHLBB requested a significantly increased budget for 1985. This was rejected by the Office of Management and Budget as unjustified, given the administration’s overall stance on regulation as well as its desire to limit government spending.

Even peering through the distorting lenses of regulatory accounting practices, it was becoming apparent to the regulatory agency in 1985 that the gambles of many insolvent thrifts would probably result in heavy losses for FSLIC. A report by FHLBB economists in July 1985 estimated that the present value of the costs associated with dealing with resolving thrifts that were insolvent at the end of 1984 would be over $15 billion. At the time, FSLIC had assets of $5.5 billion. At a Senate Banking Committee hearing, Edwin Gray “emphasized that [the report] painted a worst-case scenario which was very unlikely to occur.” Senators Jake Garn (R-Utah, the committee chairman) and William Proxmire (D-Wisconsin, ranking minority member) concurred.23 The FHLBB did take some steps to increase its regulatory resources. Having been rebuffed by OMB, the agency decided in mid-1985 to decentralize its examination activities by shifting personnel to the district Federal Home Loan Banks. This ploy allowed the FHLB budget to increase, since the district banks’ budgets were not subject to OMB review. The last three years’ entries in table 6.2 reflect this administrative shift by the agency.

By the fall of 1985, thrift insolvencies were mounting at a rate that alarmed even the FHLBB. Edwin Gray’s announcement in October 1985 that FSLIC needed about $15 billion in new capital to handle insolvent thrifts provided a Thomas Romer and Barry R. Weingast clear signal of a change in regulatory position. Gray’s change from his stance earlier was driven to a large extent by knowledge within the agency that disaster was impending-FSLIC was clearly going broke. If nothing were done, Gray and the agency would be blamed. Blame might be avoided if the problem were urgently brought to public attention. The FHLBB chairman testified to Congress that were the board to resolve cases immediately, the deposit insurance fund would run out of money within a year.

6.3.4 Congressional Response The Reagan administration’s decision to remain in the background on the thrift issue left Congress as the major player. In looking at congressional response to these developments, two elements should be emphasized. First, it is not unusual for an agency to cry ‘‘wolf‘’-a crisis is emerging-and claim that if its budget is not increased dramatically, life as we know it cannot go on. Why, in a given instance, would congressmen believe the alarm? For the case of the S&Ls, had not the 1982 legislation fixed the problem? In what sense was there a new problem? Even congressmen without a special-interest axe to grind may well rationally react with skepticism to the new tune being sung by regulators.

The second element relevant to the emerging crisis was the fiscal austerity of the mid-1980s. In times of budgetary constraint, nearly all congressmen had to face constituents who wanted funds for existing programs increased, without the political wherewithal for added revenues. To the extent that new resources for the FSLIC or the FHLBB were to come in the form of newly funded budget authority, these resources would probably have to come at the expense of competing programs. To refuse valued, long-term constituents while creating a large new program would be politically difficult. Congressmen (and the president) would thus be reluctant to address any problem with big fiscal requirements unless there were large political rewards to be gained.

Since the nature and potential proportions of the problem were not well known, these rewards were likely to be small.

To understand the nature of the political costs and benefits associated with new legislation, we turn to the lineup of interests on this issue.

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