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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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( I j The ThriJt Industry A key feature of the economic developments in the industry over the 1981period is the growing disparity between the healthy thrifts and those that were not doing well. Table 6.3 shows that the gap between the worstperforming institutions (those in the 5th and 10th percentiles of the industry, as measured by after-tax income) and the ones doing best (those in the 90th and 95th percentiles) widened enormously from 1983 to 1987.

As figures 6.1 and 6.2 show, there was also a geographical segmentation of the industry, with some regions having particularly heavy concentrations of insolvent thrifts.24By 1986, concern about the thrift industry would be more 189 Political Foundations of the Thrift Debacle

–  –  –

Source: Barth and Bradley (1988, chart 3).

relevant generally. But, perhaps more important, figure 6.2 reveals that the immediacy of the concern would be manifest more clearly to legislators in the southwest and parts of the farm belt than to those in other parts of the country.

These effects eventually led to a divergence of interests within the industry, but in a way that had both segments of the industry supporting only limited help for FSLIC.

Troubled Thrifts. Troubled S&Ls would seem to be the most likely source of active support for legislation to resolve the problems in the industry. There was indeed active support-but not for increased regulatory activity. Instead, these thrifts, and especially the U.S. League of Savings Institutions, argued for continued forbearance, so that weak and insolvent thrifts could grow out of their current problems, much as they were claimed to have done in 1983.

They were opposed to increasing deposit insurance levies to generate more funds for the FSLIC. Generally, they supported a limited recapitalization for FSLIC. This would provide the insurance fund with some resources to handle the worst cases, but not allow it to move aggressively against many insolvent institutions.

Healthy Thrifts. These firms recognized that allowing FSLIC to fail would create depositor uncertainty that would harm even the healthy thrifts, so they preferred some recapitalization over doing nothing. Obviously, healthy thrifts would have liked to shift to taxpayers as much of the cost of resolving failed institutions as possible.25But they also recognized that to expect a recapitalization totally financed by taxpayers was unrealistic. At least initially, increases in FSLIC capital would have to be financed in large measure by increased assessments on the industry. If the sick thrifts did not get better, these assessments would have to be borne by the segment of the industry that had a positive cash flow. The larger the FSLIC recapitalization, the larger the cost to Thomas Romer and Barry R. Weingast

–  –  –

Fig. 6.2 Percentage of thrifts insolvent in 1986 the currently healthy firms-except in the highly unlikely event that many of the zombies were indeed resurrected. A recapitalization large enough to cover all likely losses by zombie thrifts, if borne by the healthy members of the industry, would wipe out most of the healthy thrifts’ profits and a substantial portion of their net worth. So, from the healthy thrifts’ viewpoint, a large Political Foundations of the Thrift Debacle recapitalization, drawing mostly on industry funds, was not necessarily better than doing nothing. This group was therefore inclined to support a modest recapitalization on the order of $5 billion.

(2) Depositors The clear preference of account holders was to ensure that the various guarantee schemes-thrifts backed by FSLIC and FSLIC backed by the government-worked as promised. This system of pledges removed the incentives for this group to monitor the institutions that held their deposits. While depositors were likely to react quite strenuously if these pledges were threatened, they were unlikely to play an active role in the choice among different alternatives for honoring the pledges.

Where there were relatively heavy concentrations of failing thrifts, the immediacy of the problem would be more apparent to depositors. In such areas, the concerns of depositors could be strong enough to register on the political seismograph. This effect would pull a congressman’s preferences toward a higher FSLIC capitalization, providing a countervailing force against the interests of the troubled thrifts.

(3) Taxpayers Taxpayers, of course, were the most diffuse constituency. Because of this diffusion, only a few issues ever become sufficiently salient to play a role in the mass politics of taxation. In the short run, this group simply prefers lower taxes. While in principle it may have an interest in spending more money today to avoid spending much more money tomorrow, in practice politicians can act on this principle only if they can credibly claim credit for actually having saved the money tomorrow. Such claims typically look like rationalizations for boondoggles for some other group and are usually avoided by politicians. Prior to the crisis becoming common knowledge, therefore, it was unlikely that politicians could claim credit for saving future taxes by big appropriations today.

While there is a clear overlap between the last two groups, their interests are not identical. Not all taxpayers have significant deposits at thrift institutions. Because depositors are a subset of all taxpayers, they prefer policies that secure their deposits while spreading the costs over the much larger group of taxpayers. For depositors, especially large ones, the benefits in making deposits more secure outweigh their share of the increase in taxes.

This discussion suggests that there was little initial support, outside of a small group of experts, for developing a legislative solution that covered the full scope of the thrift problem. While in late 1985 the problem was big enough to demand some attention, it was not recognized to be large enough to generate sufficient public attention that there were large political rewards from a major new, expensive policy. A recapitalization that would have given FSLIC sufficient resources to resolve all current and expected insolvencies Thomas Romer and Barry R. Weingast would, by late 1986, have required a $50 billion program. This level of funding was totally outside the scope of anything that could be financed from assessments on the industry. It would require a significant commitment of taxpayer resources.26 It must be emphasized that, while regulators and a small group of experts were warning of dire things to come, no significant group was mobilized to support a large-scale recapitalization. Congressmen were faced with a situation in which the lineup of interests was largely against the high levels of recapitalization called for by some regulators. In such a situation, congressmen did not need elaborate rationalizations to follow their legislative preferences and side with their constituents.

6.3.5 Committee Jurisdictions and Other Interests In the Senate, the jurisdiction over thrifts is assigned to the Committee on Banking, Housing, and Urban Affairs, while in the House the similarly named Committee on Banking, Finance, and Urban Affairs deals with these matters.

As their names suggest, the domain of these committees is extensive, and includes a large variety of issues beyond the S&L industry. Not only were other financial markets and regulatory agencies within their realms, but so too were such diverse policies as housing and even some aspects of international development. A common occurrence in the legislative process is that members of committees with legislative interests in one policy area must negotiate with other members of the committee whose interests lie elsewhere, often in policy issues that are logically unrelated except that they come under the purview of the same committee. This politically induced interdependence among issues may have a strong effect on legislation aimed at a particular problem because the fate of one policy may be tied to political circumstances involving other, possibly unrelated issues.

An ongoing matter of concern for both of these committees throughout the 1980s was the question of deregulation of commercial banks. A particularly contentious issue involved the entry into banking of nonbanking institutions, such as Sears and American Express. The regulation of such “nonbank banks” did not directly involve most of the problems confronting the thrift industry.

But, in a larger sense, a case could be made that the health of the thrift industry was linked to the overall competitive environment of the banking sector.

In any event, over the 1986-87 period, these issues became linked in the political process.

6.4 The Politics of Legislative Delay and Forbearance, 1986-87 In this section we examine the legislative consideration of a response to the regulators’ signal that all was not well and that a major change in policy would be needed. The conjunction of constituent interests and the institutional strucPolitical Foundations of the Thrift Debacle ture of congressional decision making provides a road map through the events of the two years following Gray’s October 1985 testimony. The trail to follow in this narrative is the one laid out by our framework: attention to players at key veto points and their role in structuring the legislative agenda.

6.4.1 The 1986 Stalemate The reaction by the two committee chairmen to the emergence of a new thrift problem differed in ways that foretold conflict: St Germain (D-Rhode Island, chairman of the House committee) called for extension of the 1982 legislation and opposed further financial deregulation. In contrast, Senate committee chairman G r announced that he was “vitally committed” to an broad financial deregulation. He planned to use the yet undrafted bill to strengthen the FSLIC system as a vehicle for banking deregulation. As will become clear, Garn was not alone in this sentiment. Thus, St Germain, at least initially, sought a bill that focused on the thrift problem. Garn’s interest focused on deregulation of the financial system and saw the legislation on the thrifts as a potential vehicle.

In the early spring of 1986, a plan emerged to finance the recapitalization of FSLIC. The FHLBB proposed to tighten regulations concerning thrift investments and accounting standards, arguing that half a decade of permissiveness had done much harm. The new rules would require thnfts, among other things, to double their capitalization to 6% of assets in six years and to replace the current accounting conventions that, according to the board, had obscured the emerging problems. By early May, the proposed plan would raise sufficient funds to cover deposits in the (then) estimated 216 failing thrifts.

Proceedings in the Senate began when G r introduced an omnibus bankan ing bill that included provisions for dealing with thrifts and other problems.

Shortly thereafter, however, he dropped the additional provisions as his committee passed a bill with FSLIC provisions nearly identical to those in the House. Nonetheless, William Proxmire, ranking minority member of the committee, threatened to filibuster unless other, unrelated aspects of bank regulation-especially the issue of the nonbank banks-were dealt with at the same time. In late September, the House committee joined this measure with political alternatives of its own, especially additional authorization for some housing programs, hoping to use the FSLIC recapitalization as a vehicle to move other legislation.

Before a vote on the House floor could be taken, however, majority leader Jim Wright of Texas (who would soon succeed Tip O’Neill as Speaker) removed the bill from the House calendar. Texas bankers and real estate developers had complained to Wright that regulators were restricting real estate loans and refusing to restructure bad loans. The bill was not rescheduled until Edwin Gray met with Wright and assured him that regulators would cooperate with ailing thrifts in Texas. By holding the legislation sought by regulators Thomas Romer and Barry R. Weingast hostage, this intervention compelled an agreement by the regulators not to enforce their own rules against ailing thrifts-assuring an expanded de fact0 policy of forbearance, at least for politically favored institutions.

Shortly thereafter (October 1986), the House passed its measure. The house bill created a new financing corporation with the authority to borrow up to $15 billion over three years, to be used to fund FSLIC. Only a limited amount of new FSLIC resources would come from extra assessments on thrifts. Like the regulators, legislators also proposed changes in the regulatory restrictions.

But instead of increasing the stringency with which insolvent thrifts were regulated, legislators weakened the position of regulators vis-2-vis the zombies.

Regulators were given expanded powers, not to force failing banks to close, but to keep them open until new owners could be found or the hoped-for resurrection took place.

On the Senate side, the final bill called for only $3 billion in FSLIC recapitalization and did not include housing provisions that St Germain strongly favored. St Germain had earlier indicated that he would not accept any compromise that excluded the housing issues. At this point a stalemate occurred.

None of the policies preferred by House members at key veto points (i.e., policies calling for funds for FSLIC and housing, but without provisions dealing with commercial bank regulation) were acceptable to key veto players in the Senate (who supported lower FSLIC recapitalization without the housing provisions but with the commercial banking matters) and vice versa. With the congressional session ending before the 1986 elections, there was insufficient time to resolve the differences between the Senate and House versions. Both bills died.27 The end-of-the-session rush combined with strategies by several politicians to link the thrift issue to other issues. Even a partial resolution of the growing thrift problem was thereby delayed for nearly a year. P r of the explanation at for the intransigence of the relevant committee members in both chambers is that those with strong constituency interests were inclined toward lax regulation. Since, for the most part, thrifts were arguing for forbearance, delay would ensure greater laxity by forcing the regulators to wait for needed funds.

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