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Meltzer, Allan. 1981. The Thrift Industry in the Reagan Era. In Managing Interest Rate Risk in the Thrift Industry: Proceedings o the Seventh Annual Conference, 5f

13. San Francisco: Federal Home Loan Banks.

Moe, Terry M. 1985a. Control and Feedback in Economic Regulation: The Case of the NLRB. American Political Science Review 79:1094-1116.

. 1985b. The Politicized Presidency. In New Directions in American Politics, edited by John E. Chubb and Paul E. Peterson. Washington, D.C.: Brookings.

. 1989. The Politics of Bureaucratic Structure. In Can Government Govern?, edited by John E. Chubb and Paul E. Peterson. Washington, D.C.: Brookings.

Ogul, Moms S., and Bert A. Rockman. 1990. Overseeing Oversight: New Departures and Old Problems. Legislative Studies Quarterly 155-24.

Pilzer, Paul Zane, with Robert Dietz. 1989. Other People’s Money: The Inside Story of the S&L Mess. New York: Simon & Schuster.

Political Foundations of the Thrift Debacle Pizzo, Stephen P., Mary Fricker, and Paul Muolo. 1989. Inside Job: The Looting o f America’s Savings and Loans. New York: McGraw-Hill.

Poole, Keith T., and Howard Rosenthal. 1991. Patterns of Congressional Voting.

American Journal o Political Science 35 (February): 228-78.

f Romer, Thomas, and Howard Rosenthal. 1978. Political Resource Allocation, Controlled Agendas, and the Status Quo. Public Choice 33(4):27-43.

. 1987. Modem Political Economy and the Study of Regulation. In Public Regulation: New Perspectives on Institutions and Policies, edited by E. E. Bailey, 73Cambridge, Mass.: MIT Press.

Scott, Kenneth E. 1989a. Deposit Insurance and Bank Regulation. Business Lawyer 44:907.

. 1989b. Never Again: The S&L Bailout Bill. Stanford University School of Law. Typescript.

Sinclair, Barbara. 1989. House Majority Leadership in the Late 1980s. In Congress Reconsidered, 4th ed. Edited by Lawrence C. Dodd and Bruce I. Oppenheimer.

Washington, D.C.: Congressional Quarterly Press.

Starobin, Paul. 1989. Will the Banks Be Next? National Journal. December 30.

Weicher, John C. 1988. The Future of the Housing Finance System. In Restructuring Banking & Financial Services in America. Edited by William S. Haraf and Rose Marie Kushmeider, 296-342. Washington, D.C.: American Enterprise Institute.

Weingast, Barry R. 1984. The Congressional-Bureaucratic System: A Principal-Agent Perspective (with Applications to the SEC). Public Choice 44: 147-91.

Weingast, Barry R., and Mark J. Moran. 1983. Bureaucratic Discretion or Congressional Control? Regulatory Policymaking by the Federal Trade Commission. Journal o Political Economy 91:765-800.

f Woerheide, Walter J. 1984. The Savings andLoan Industry. Westport, Conn.: Quorum Books

Comment Robert E. Litan

Thomas Romer and Barry R. Weingast join the growing industry of economists, journalists, and now political scientists who have been attempting to explain the worst financial crisis since the 1930s: the thrift disaster of the 1980s. The entry of political scientists into this fray is welcome. For Romer and Weingast are correct when they argue that the fundamental causes of the thrift mess are political rather than economic or criminal.

Not that economics or flagrant abuse of the law have not mattered, because they have. The lifting of the deposit insurance ceiling from $40,000 to $100,000 in 1980 contributed to the massive risk-taking in the thrift industry that occurred thereafter. The flat-rate feature of deposit insurance pricing, which allowed the drunk drivers of the system to pay no more for their insurance then the safe drivers, also played a part. And the number of books and articles on the rampant insider abuses and fraud among thrift owners and managers clearly demonstrate that criminal activity played a role as well.

Robert E. Litan is a senior fellow and the Director of Economic Progress and Employment at the Brookings Institution, Washington, D.C.

Thomas Romer and Barry R. Weingast But each of these explanations raises still additional questions. Take deposit insurance, for example. While I have been among those who have argued that the banking industry is in poorer health than reported either by the banks themselves or by the Federal Deposit Insurance Corporation (FDIC) (Brumbaugh and Litan 1990), no responsible observer claims that the cost of actual or hidden bank failures has been even close in magnitude to the costs of resolving the thrift crisis. Yet the deposit insurance system for banks and thrifts has been identical (but for a somewhat higher differential in the flat-rate insurance premium for thrifts since 1985). How then can deposit insurance be the sole cause of the thrift problem, as certain would-be reformers of deposit insurance implicitly, if not explicitly, claim.?

Meanwhile, although fraud and insider abuse appears to have contributed to many, if not most, thrift insolvencies, there are no reliable estimates to indicate what portion of the cleanup cost is due to criminal activity. My own guess-and it is just that-is that the figure is 20% or below. Others certainly will have different intuitions.

But the exact figure does not matter because, in my opinion, there is a more fundamental reason why so much criminal or near-criminal activity apparently took place, as well as why deposit insurance for thrifts in particular turned out to be so disastrous. That reason was the virtual abandonment of capital standards by thrift regulators who not only formally lowered required capital-to-asset ratios in the early 1980s, but who also introduced new regulatory accounting principles (RAP) that effectively allowed failed thrifts to hide their insolvency. Romer and Weingast, as well as others, are also correct to point to the utterly senseless refusal by the Office of Management and Budget in the mid-1980s to increase the number of thrift supervisors precisely when they were needed most: that is, after the congressional decision in 1982 to broaden thrift asset powers. This action, too, had the effect of abolishing capital regulation for many thrifts.

It is now well recognized that the decision to let thrift operators play with federally insured deposits, but with little of their own money, was like throwing a lighted match into a pool of gasoline.' But it is less well understood that, by abandoning meaningful capital regulation, thrift regulators virtually invited high rollers and crooks into the industry. Had capital standards been enforced, few of the Donald Dixons (Vernon Savings and Loan of Texas), Charles Keatings (Lincoln Savings and Loan of Arizona), and David Pauls (Centrust Savings and Loan of Florida) would have ever bought thrifts.

In short, capital deregulation in my view lies at the bottom of the thrift disaster. But, then, this explanation too simply leads to another question.

Why did thrift regulators, but not their bank counterparts, effectively gut

1. This point has now been so heavily discussed that one hesitates to single out any particular authors who have advanced it. Nevertheless, a small sample of the literature includes: Benston and Kaufman (1990), Brumbaugh, Carron, and Litan (1989), and Barth et al. (1985).

211 Political Foundations of the Thrift Debacle preexisting capital standards? Or, to put the question in somewhat more political terms, why did regulators and Congress wait for so long to put insolvent institutions out of business?

Romer and Weingast tells us that the answer is simple: Congress was behaving in a business-as-usual mode by encouraging regulatory forbearance, not only in now-celebrated particular cases (the Vernon and Lincoln S&Ls, for example) but in a systemic fashion by denying FSLIC sufficient funds to clean the insolvent institutions out of the industry.

Stripped to its essentials, the Romer/Weingast story is one we find over and over again in public policy circles. A narrow constituency, in this case the thrift industry, strongly wants a policy outcome, the costs of which are widely diffused throughout the economy. Congress then adopts the policy, in this case forbearance, largely by ignoring the problem and entrusting its resolution to its own narrow specialists, members of the banking committees.

Of course, Romer and Weingast tell a fuller story, embellishing it with an interesting econometric demonstration of the important role played not only by insolvent thrifts, who of course wanted forbearance in their own particular cases, but also by healthy thrifts, who feared that they would have to pay for the cleanup and thus encouraged their legislators to deny the thrift insurance fund of all the resources it required.

My only significant quarrel with Romer and Weingast is that by focusing so heavily on congressional and regulatory forbearance in the mid- 1980s they provide an incomplete analysis of their topic-the “political foundations of the thrift debacle.” In fact, there were two stages to the thrift debacle of the 1980s, which, as Edward Kane (1989) has demonstrated, can be usefully analogized to a massive oil spill. Like the Exxon spill that dumped millions of barrels of oil onto the Alaska coastline, the first stage of the thrift crisis occurred when doubledigit interest rates in the early 1980s caused thrifts to spill billions of dollars of red ink onto the financial landscape-by several estimates, over $100 billion in present value. But unlike the relatively rapid cleanup of the oil spill, the administration and the regulators did not ask for the funds, nor did the Congress voluntarily supply the funds, for cleaning up the initial thrift spill.


Romer and Weingast do not directly answer this question-prefemng instead to concentrate on later stages of the crisis in the mid-eighties-but the answers are straightforward. To have “cleaned up” the initial thrift spill would not only have cost far more money than anyone at the time was willing to spend, but it would have required the liquidation or assisted merger of most thrifts. At that time, few believed that effective substitutes for financing home ownership existed. The mortgage-backed securities market was growing, but it was not then as well developed as it eventually has become. In any event, even if all new mortgages could then have been securitized, it is highly doubtful that without some institutions dedicated primarily to buying those mortThomas Romer and Barry R. Weingast gages that they would have been fully absorbed by other buyers (pension funds, insurance companies and banks). All of these reasons help explain why Congress and regulators essentially chose to gamble on interest rates coming down, which eventually they did, rather than either shrinking the industry or, less radically, not permitting it to grow.

Nor do Romer and Weingast discuss in detail the political foundations of why the first thrift spill happened in the first place. Part of the answer, of course, lies in the Regulation Q deposit interest ceilings, whose origins could have been usefully explored. But Regulation Q applied to banks first, and, as I have already noted, banks did not get into nearly as deep a mess as thrifts in the 1980s. The reason, of course, is that banks have been free to invest in assets of varying maturities as well as to lend at floating rates.

In contrast, thrifts have been locked into long-term mortgages, which, until the early 1980s, had to be at fixed rates (except for certain state-chartered thrifts, such as those in California, that were permitted to extend adjustable rate mortgages in the 1970s). One of the great policy mistakes of the 1970s that Romer and Weingast should have given more emphasis was that Congress essentially refused to consider thrift industry proposals (as well as those of the industry’s regulator, the Federal Home Loan Bank Board) to permit the extension of adjustable-rate mortgages: this would have dramatically reduced the magnitude of the initial thrift crisis of the early 1980s. By the logic advanced in the RomedWeingast paper-wherein thrifts always get their way-this should not have happened. But it did because of heavy opposition from consumer groups.

The strength of the Romer and Weingast paper, as I have said, is that it focuses on what happened after the first thrift spill, or, using the oil spill analogy, why Congress and the regulators delayed cleaning up the initial thrift spill even after the “oil” turned toxic. Not only did thrifts have a singleminded interest in forbearance, but politicians could reasonably assume that there would be no immediate or near-term (two years for a Representative, or even six years for a Senator) costs to a forbearance policy. After all, depositors were protected against all losses, both by the formal deposit insurance system and, in the case of the larger thrift institutions, by the “too big to fail” doctrine implicitly developed by federal regulators when they protected uninsured depositors of Continental Illinois Bank in 1984. During the 1984-88 period, given the administration’s adamant opposition to higher taxes, there also was little immediate or even intermediate-run prospect that taxpayers would suffer from forbearance. Finally, politicians could ignore warnings by the few economists, and eventually by FHLBB Chairman Ed Gray, that the FSLIC fund was effectively bankrupt by arguing that the problems thrifts were experiencing would be temporary. After all, had not the doomsayers who had pointed to the $100 billion-plus market value insolvency of the industry in.the early 1980s been proved wrong by the subsequent drop in interest rates, which seemingly restored many thrifts to financial health?

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