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Bush's Banking Reforms: Will They Work?
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18543 |
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Section : |
CURRENT ISSUES
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| Issue
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4 / 1991 |
1,933 Words |
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Thomas R. Saving
Thomas R. Saving is chairman of the Economics Department at
Texas A&M University. |
As the U.S. economy moves inexorably toward recession, the pundits are nearly unanimous in forecasting a crisis in the banking industry. The signs are here in the failure of the Bank of New England and the earnings news from the other major banks. Many predict that the magnitude of the problem will dwarf the S&L crisis, the final cost of which is yet to be determined and whose estimated cost grows exponentially as the months pass.
Right in the middle of this problem is the Federal Deposit Insurance Corporation (FDIC). We have all seen the magic words deposits insured by the Federal Deposit Insurance Corporation for so long that we barely notice them. We've taken for granted the ability of the FDIC to meet bank failures for so long that its predicted vulnerability is almost impossible to contemplate, even after the total collapse of the Federal Savings and Loan Insurance Corporation (FSLIC) and the assumption of its assigned task of insuring the S&L industry by the FDIC. The root cause of the FSLIC failure in light of the S&L crisis is there in the FDIC's handling of the banking industry.
In response to the potential banking crisis, the Bush administration has proposed banking reforms. Although the suggested reforms are contained in a 500-page document, the guts of the proposed changes can be outlined in a page or less. Essentially, the administration proposes to reduce the FDIC's exposure to loss by a series of changes that are designed to increase the capitalization of the banks while reducing the total volume of deposits insured. Clearly, both of these changes reduce the potential of loss to the FDIC, but can they solve the problem? Can we ever return to the halcyon days of the 1970s?
To evaluate the potential for the administration reforms to solve the banking crisis, we must understand the source of that problem. Then each administration proposal can be evaluated as to its contribution to the solution of the problem. In very simple terms, the problem with the banking system is that the incentives in the system encourage bankers to invest your money and mine in loans and investments that are too risky. The benefits of these risky investments, when they pay off, accrue entirely to the bankers. But what if the investments don't pay off? If the dice come up snake eyes, don't the bankers lose? Yes, but since the banks have very little capital when compared to their deposits, most of the losses are borne by depositors.
To illustrate the effect of incentives on the industry, think of the problem this way. You're in Las Vegas or Atlantic
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