1 / 17

Banking Crises

Banking Crises. Regulation & Performance Economics 102 Winter 2002. Early Regulation. Scams, Bank failures ==> bank licensing from early 1800s Minimum capital requirements Attempt to exclude criminals But US had 20,000+ banks In much of midwest, branch banking prohibited

tudor
Download Presentation

Banking Crises

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Banking Crises Regulation & Performance Economics 102 Winter 2002

  2. Early Regulation • Scams, Bank failures ==> bank licensing from early 1800s • Minimum capital requirements • Attempt to exclude criminals • But US had 20,000+ banks • In much of midwest, branch banking prohibited • Interstate banking prohibited • Federal Reserve System from 1913 • Smooth interest rate swings • Support faith in money, quell banking panics • Foster national market

  3. Great Depression • Big swings in prices: deflation • Debtors hurt, many default • Real GDP fall likewise leads to defaults • Banking “panic” • Fears lead to bank runs • 9755 banks failed in 1929-33 • FDR declared bank holiday in March 1933 to stop panic • Sum • Illiquidity issues • Insolvency issues

  4. Regulation • Promote “sound” banking practice • More below... • Depositor insurance (FDIC, 1933) • Restores confidence • But insurance has side effects • Moral hazard • Encourages risk taking • Heads I win … tails you lose

  5. Safe Banking • Sound practice • Glass-Steagall (1933): segment services • Insurance - banking - securities - underwriting • NOW DEFUNCT cf. Enron issues • Bank supervision (gradual from 1800s, state & federal) • Inspection • Case study: Bank of Tokyo NY, 1979 • Regulation Q (1933) • Prevent competition for deposits • Help guarantee margins

  6. Banking Crises • Structural change is the enemy of sound banking • Managing risk is undermined • Mix of products / operations undermined

  7. 1970s shifts • 1970s • Inflation rose ==> disintermediation • MMMFs developed • Donahue and money market [mutual] funds • Incentive to pull money from term savings accounts • Also could buy bonds directly …. such as I did. • Regulation Q broke down [for S&Ls from 1982] • Banks were freed to pay market interest rates

  8. S&Ls • Savings & Loan Institutions • State-chartered banks (initially) • Restricted to local residential real estate ca. 1936 • No geographic or industry diversification • Typical product fixed-rate 30 year mortgage • Core of business • Borrow short • Lend long • “Maturity transformation”

  9. Demise of S&Ls • 30 year mortgages • Collecting 4% • Short-term deposits • Paying 10% • Entire sector rendered insolvent

  10. Further deregulation • So rechartered as federal institutions • Freed S&Ls to lend to new business • Allowed to enter new, more profitable types of lending, such as commercial real estate development in other states

  11. S&Ls in the New Age • But the same old regulators - and understaffed • And the same old bankers • In a brave new world • California S&Ls in Texas … ….. Dentists as Bankers?! • No ability to practice or assess sound banking • Outright fraud • Ex: Over $1 billion in fraud at one S&L in Colorado • Chs Keating bought 5 US Senators to protect himself, with $2 billion in losses and (for him) a brief stint in jail

  12. Bottom Line • Initial $250 billion cost to taxpayers • Liquidation of real estate recouped $90 bil thereof • Lots of bad assets • Lots of unmitigated waste • Local business cycle accentuated (Tx, Fl, La) • Ultimate total elimination of S&L segment • Commercial banks alternatives • floating rate mortgages [undermined S&Ls in their latter days] • so it’s still possible to finance a home purchase

  13. More recent crises • Japan • Traditional business disappeared • Growth slowed from 10% pa to 5% pa • Less Investment • business borrowing fell by 10% of GDP • savings (deposits) continued to rise • So need new business • Small firms (60% of economy) • Real estate (good collateral, prices always rise)

  14. Japan’s Crisis • New business plan a failure • Good small businesses already had bankers • Real estate prices could fall, too • Began shift in a boom, hiding bad practices • Banking crisis from 1992 • Real estate prices fell • Stock-market based financing backfired • Japan in 2001 is back in recession, with only one year of good growth since 1990.

  15. Thailand, Argentina • A supposedly fixed foreign exchange rate • But domestic interest rates high! • Answer? • Borrow in US $ from foreign / offshore banks • But the exchange rate depreciated • Suddenly instead of owing B20,000 you owe B40,000 • And interest payable doubles too • Widespread defaults / bankruptcies

  16. Tomorrow’s crisis? • Citigroup gone awry? • Home mortgage loans in a falling real estate market? • Etc .. ? • Why worry? • Structural change • but management change? • Expansion in up cycle when hard to lose money • Mistakes now coming home to roost

  17. Summary • Leverage: • a little is very powerful • Try to move too much and something will snap - or spring back and slap you • Institutional change: both regulators & lenders find hard to handle • Regulation • Regulations generate side effects • Moral hazard • Heads I win, Tails you lose • Adverse selection: if you try to expand quickly, you have to lower standards, and (like grade inflation) those rejected by conservative banks will seek you out! Losses always prove worse than average!

More Related