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Political Foundations of the Thrift Debacle Eventually, however, the toxic effects of the thrift spill became too large for even healthy thrifts and banks to ignore. Of course, by then the cleanup costs were also too large for them to pay, so with a free conscience they could presumably advocate a massive cleanup effort. But it is far from clear that this was why the Bank Board and then the new Bush administration finally began to attack the thrift problem with vigor. My simple-minded explanation is that eventually the press became convinced that the economists who had been warning about the immense magnitude of the problem had been right all along, which helped force the new administration into doing something major, at least after the 1988 Presidential election was over. In addition, by extending roughly $40 billion in government guarantees to buyers of failed thrifts in the 1988, Danny Wall (the chairman of the FNLBB at the time) also helped force Congress and the new administration confront the mess. The size of the expenditure, coupled with the off-budget way in which it was made, literally embarrassed both branches of government into going about the cleanup in a more straightforward way. As a reader I would have liked to have seen Romer and Weingast spend a little more time explaining why they think Congress and the administration backed off forbearance when they did.

Finally, I would have liked to see Romer and Weingast attempt to apply their logic to both predicting how, if at all, Congress will attempt to reform the system to prevent future “thrift spills.” At a minimum, their paper persuasively suggests the broad outlines of what should be done.

We now know what happens when business-as-usual politics confronts a major crisis: defenders of the status quo will prevent an immediate solution to the problem as long as no one feels the costs of not addressing it (or the costs of not doing so are diffused broadly throughout the population). Armed with this knowledge, it surely makes sense to develop mechanisms for forcing much earlier action to be taken when depository institutions get into trouble, but before they become insolvent.* One possible approach is to require regulators to intervene early and to base their judgment on more realistic marketbased measures of the financial condition of institutions (Benston et al., 1989). A supplement, or alternative, is to rely more heavily on market mechanisms, whether discipline by depositors, holders of subordinated debt, or private deposit insurers.

I realize this is not the forum in which to debate the relative strengths and weakness of these alternative proposals. The concluding question that I would like to raise here is, What do Romer and Weingast believe their political analysis has to say about which, if any, are likely to be adopted? My own forecast,

2. Earlier action would surely mitigate losses to the insurance funds. In the 1980s the FDIC lost approximately 12 cents per dollar of recorded assets on failed banks. Since 1986, the thrift insurance fund (first the FSLIC and then later the Savings Association Insurance Fund of the FDIC) has lost more than 30 cents per dollar. These loss figures demonstrate that, by the time the capital of a depository institution, measured at book value, falls below zero, the market value of the institution is far less than that.

Thomas Romer and Barry R. Weingast based on my inside-the-Beltway knowledge and intuition, is that, first, given the huge dimensions of the thrift problem and the certainty that more money will have to be authorized to solve it, Treasury will recommend and in 1991 or 1992 that Congress adopt significant reforms in deposit insurance. These will include: (1) authority for the FDIC to introduce risk-sensitive pricing of deposit insurance premiums; (2) some variation of the American Bankers Association proposal requiring mandatory “haircuts” on uninsured deposits; and (3) authorization for regulators to assume conservatorship of troubled depositories before they become insolvent.

Without discussing the merits of any specific proposal, I believe that, in combination, the set of reforms I have just described would force regulators to act much earlier than they do now to assume conservatorship or to force the merger of troubled depositories. I hope that Romer and Weingast in their future work lend their considerable talents to forecasting whether the political system that brought us the thrift crisis can ever help prevent another, and, if so, how.

References Barth, James R., R. Dan Brumbaugh, Daniel Sauerhaft, and George K. Wang. 1985.

Thrift Institution Failures: Causes and Policy Issues. In Proceedings of a Conference on Bank Structure and Competition, 184-216. Chicago: Federal Reserve Bank.

Benston, George J., and George G. Kaufman. 1990. Understanding the Savings-andLoan Debacle. The Public Interest no. 99 (Spring), 79-95.

Benston, George J., et al. 1989. Blueprint for Restructuring America’s Financial Institutions. Washington, D.C.: Brookings.

Brumbaugh, R. Dan, Andrew S. Carron, and Robert E. Litan. 1989. Cleaning up the Depository Institutions Mess. Brookings Papers on Economic Activity, no. 1, 349Brumbaugh, R. Dan, and Robert E. Litan. 1990. The Banks Are Worse Off Than You Think. Challenge (January-February), 4-12.

Kane, Edward J. 1989. The High Cost of Incompletely Funding the FSLIC’s Shortage of Explicit Capital. Journal of Economic Perspectives (Fall) 3 1-48.

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