《货币银行学》课程教学资源（文献资料）Understanding Financial Crisis.pdf_P16-P20

job properly. An example of this occurred in the United States and helped lead a regulatorybreakdown inthe savingsand loan(S&L)industryin the198Os.Oneaspect ofthederegulationwave of the early 1980s was the passage of legislation in 1980 and 1982 that deregulated theS&L industry and opened up many lines of business for these institutions.These thriftinstitutions, which had been restricted almost entirely to making loans for home mortgages, nowwere allowed to have up to 40% of their assets in commercial real estate loans, up to 30% inconsumer lending,and up to 10% in commercial loans and leases.In the wake of thislegislation, savings and loans regulators allowed up to 10% of assets to be in junk bonds or indirect investments (common stocks, real estate, service corporations, and operating subsidiaries).Three problems arose from these expanded powers for S&Ls. First many S&L managersdid not have the required expertise to manage risk appropriately in these new lines of business.Second, the new powers meant that there was a rapid growth in new lending, particularly to thereal estate sector. Even if the required expertise was available initially, Iapid credit growth mayoutstrip the available information resources of the banking institution,resulting in excessive risktaking. Third, these new powers of the S&Ls and lending boom meant that their activities wereexpanding in scope and were becoming more complicated, requiring an expansion of regulatoryresources to appropriately monitor these activities. Unfortunately, regulators of the S&Ls attheFederal Savings and Loan Insurance Corporation (FSLIC) neither had the expertise nor wereprovided with additional resources which would have enabled them to sufficiently monitor thesenew activities.Given the lack of expertise in both the S&L industry and the weakening of theregulatory apparatus, it is no surprise that S&Ls took on excessive risks, which helped lead tomassivelosses totheAmericantaxpayer.The scenario described above in the United States was not unique and has occurred inother developed countries. A striking example occurred in the Nordic countries -- Norway,Sweden and Finland --when they deregulated their financial markets in the early 1980s.9 Thelack of expertise in both the banking industry and its regulators to keep risk taking in check,particularly when bank credit growth was very high as a result of a lending boom, resulted inmassive losses to banks loan portfolios when real estate prices collapsed in the late 198Os.The'SeeDreesandPazarbasioglu (1995)14

job properly. An example of this occurred in the United States and helped lead a regulatory breakdown in the savings and loan (S&L)industry in the 1980s. One aspect of the deregulation wave of the early 1980s was the passage of legislation in 1980 and 1982 that deregulated the S&L industry and opened up many lines of business for these institutions, These thrift institutions, which had been restricted almost entirely to making loans for home mortgages, now were allowed to have up to 40% of their assets in commercial real estate loans, up to 30% in consumer lending, and up to 10% in commercial loans and leases. In the wake of this legislation, savings and loans regulators allowed up to 10% of assets to be in junk bonds or in dirmt investments (common stocks, rd estate, service corporations, and operating subsidiaries). Three problems arose from these expanded powers for S&Ls. First many S&L managers did not have the required expertise to manage risk appropriately in these new lines of business. Second, the new powers meant that there was a rapid growth in new lending, particularly to the real estate sector. Even if the required expertise was available initially, rapid credit growth may outstrip the available information resources of the banking institution, resulting in excessive risk taking. Third, these new powers of the S&Ls and lending boom meant that their activities were expanding in scope and were becoming more complicated, requiring an expansion of regulatory resources to appropriately monitor these activities. Unfortunately, regulators of the S&Ls at the Federal Savings and Loan Insurance Corporation (FSLIC) neither had the expertise nor were provided with additional resources which would have enabled them to sufficiently monitor these new activities. Given the lack of expertise in both the S&L industry and the weakening of the regulatory apparatus, it is no surprise that S&Ls took on excessive risks, which helped lead to massive losses to the American taxpayer. The scenario described above in the United States was not unique and has occurred in other developed countries. A striking example occurred in the Nordic countries - Norway, Sweden and Finland - when they deregulated their financial markets in the early 1980s,9 The lack of expertise in both the banking industry and its regulators to k~p risk taking in check, particularly when bank credit growth was very high as a result of a lending boom, resulted in massive losses to banks loan portfolios when rd estate prices collapsed in the late 1980s. The ‘See Drees and Pa.zarbasioglu(1995). 1.4

result was a government bailout of the banking industry in those countries which was similar inscale relative to GDP to that which occurred in the United States.The Japanese banking crisisthat has been unfolding in recent years also shares common elements with the episode in theNordic countries. Deregulation of the financial system in Japan in the 198Os was followed byincreased Japanese bank lending,especially to the real estate sector, which resulted in huge loanlosses when thereal estate sector collapsed.The second reason why regulators may not do their job properly is explained byunderstanding that the relationship between voters-taxpayers and the regulators and politicianscreates a particular type of moral hazard problem, the principal-agent problem. The principal-agent problem occurs when the agent has different incentives than the person he works for (theprincipal) and so acts in his own interest rather than in the interest of his employer. Regulatorsand politicians are ultimately agents for voters-taxpayers (principals) because in the final analysistaxpayers bear the cost of any losses when the safety net is invoked.The principal-agentproblem occurs because the agent (a politician or regulator)may not have the same incentivesto minimize costs to the economy as the principal (the taxpayer).Indeed, the principal-agenproblem stems from asymmetric information because the principal does not have sufficientinformation about what the agent is doing to make sure that the agent is operating in theprincipal's interest.A classic example of this principal-agent problem occurred in the United States duringthe savings and loan debacle of the 1980s. By the late 1970s, many savings and loans in theUnited States were actually insolvent because most of their assets were tied up in fixed-rate longterm mortgages whose rates had been fixed at a time when interest rates were quite low. Wheninterest rates rose in the 1970s and early 1980s, the cost of funds for these institutions rosedramatically,while their fixed-rate mortgages did not produce higher income.The result wasthat the economic net worth of the S&Ls plunged dramatically.In addition, the 1981-1982recession and the collapse in the prices of energy and farm products hit the economies of certainparts of the country such as Texas very hard, with the result that there were defaults on manyS&Ls' loans. Losses for savings and loan institutions mounted to $10 billion in 1981--1982, andby some estimates over half of the S&Ls in the United States had a negative net worth and werethus insolvent bytheend of1982.15

result was a government bailout of the banking industry in those countries which was similar in scale relative to GDP to that which occurred in the United States. The Japanese banking crisis that has been unfolding in recent years also shares common elements with the episode in the Nordic countries. Deregulation of the financial system in Japan in the 1980s was followed by increased Japanese bank lending, especially to the real estate smtor, which resulted in huge loan losses when the rd estate sector collapsed. The second reason why regulators may not do their job properly is explained by understanding that the relationship between voters-taxpayers and the regulators and politicims creates a particular type of moral hazard problem, the principal-agent problem. The pnncipalagent problem occurs when the agent has different incentives than the person he works for (the principal) and so acts in his own interest rather than in the interest of his employer. Regulators and politicians are ultimately agents for voters-taxpayers (principals) because in the final analysis taxpayers bear the cost of any losses when the safety net is invoked. The principal-agent problem occurs because the agent (a politician or regulator) may not have the same incentives to minimize costs to the economy as the principal (the taxpayer). Indeed, the principal-agent problem stems from asymmetric information because the principal does not have sufficient information about what the agent is doing to make sure that the agent is operating in the principal’s interest. A classic example of this principal-agent problem occurred in the United States during the savings and loan debacle of the 1980s. By the late 1970s, many savings and loans in the United States were actually insolvent because most of their assets were tied up in fixed-rate longterm mortgages whose rates had been fixed at a time when interest rates were quite low. When interest rates rose in the 1970s and early 1980s, the cost of funds for these institutions rose dramatically, while their fixed-rate mortgages did not produce higher income. The result was that the economic net worth of the S&Ls plunged dramatically. In addition, the 1981-1982 recession and the collapse in the prices of energy and farm products hit the economies of certain parts of the country such as Texas very hard, with the result that there were defaults on many S&Ls’ loans. Losses for savings and loan institutions mounted to $10 billion in 1981-1982, and by some estimates over hdf of the S&Ls in the United States had a negative net worth and were thus insolvent by the end of 1982. 15

As our analysis earlier indicates, the incentives to engage in risk-taking moral hazardincreased dramatically for these insolvent institutions because they now had little to lose and alot to gain by taking on excessive risks.Clearly, it was essential that prompt corrective actionbe enforced and these institutions be closed down. Instead, S&L regulators loosened capitalrequirements and restrictions on risky asset holdings and pursued regulatory forbearance. Oneimportant incentive for regulators that explains this phenomenon is their desire to escape blamefor poor performance by their agency.By loosening capital requirements and pursuing regulatoryforbearance, regulators hide the problem of an insolvent bank and hope that the situation willimprove. Such behavior on the part of regulators is described by Edward Kane of Ohio StateUniversity as"bureaucratic gambling."1oAnother important incentive for regulators is that they want to protect their careers byaccedingto pressures fromthepeople who most influence their careers.Thesepeople arenotthe taxpayers but the politicians who try to keep regulators from imposing tough regulations oninstitutions that are major campaign contributors. Members of Congress have often lobbiedregulators to ease up on a particular S&L that contributed large sums to their campaigns.In addition, both the U.S. Congress and the presidential administration promoted bankinglegislation in 1980 and 1982 that made it easier for savings and loans to engage in risk-takingactivities. After the legislation passed, the need for monitoring the S&L industry increasedbecause of the expansion of permissible activities.The S&L regulatory agencies needed moreresources to carry out their monitoring activities properly, but Congress (successfully lobbiedby the S&L industry) was unwilling to allocate the necessary funds. As a result, the S&Lregulatory agencies became so short on personnel that they actually had to cut back on their on-site examinations, just when they were most needed. In the period from January 1984 until July1986,for example, several hundred S&Ls werenot even examined once.Even worse, spurredon by the intense lobbying efforts of the S&L industry, Congress was only willing to passlegislation in 1987 (the Competitive Banking Equality Act) which provided a totally inadequateamount ($15 billion) to close down the insolvent S&Ls. Only when the crisis had reachedmassive proportions requiring a bailout on the order of s150 billion in present value terms did10SeeEdwardKane (1989).16

As our analysis earlier indicates, the incentives to engage in risk-taking moral hazard increased dramatically for these insolvent institutions because they now had little to lose and a lot to gain by taking on excessive risks. Clearly, it was essential that prompt corrective action be enforced and these institutions be closed down. Instead, S&L regulators loosened capital requirements and restrictions on risky asset holdings and pursued regulatory forbearance. One important incentive for regulators that explains this phenomenon is their desire to escape blame for poor performance by their agency. By loosening capital requirements and pursuing regulatory forbearance, regulators hide the problem of an insolvent bank and hope that the situation will improve. Such behavior on the part of regulators is described by Edward Kane of Ohio State University as “bureaucratic gambling. “1° Another important incentive for regulators is that they want to prottit their careers by acceding to pressures from the people who most influence their careers. These people are not the taxpayers but the politicians who try to keep regulators from imposing tough regulations on institutions that are major campaign contributors. Members of Congress have often lobbied regulators to ease up on a particular S&L that contributed large sums to their campaigns. In addition, both the U.S. Congress and the presidential administration promoted banking legislation in 1980 and 1982 that made it easier for savings and loans to engage in risk-taking activities. After the legislation passed, the need for monitoring the S&L industry increased because of the expansion of permissible activities. The S&L regulatory agencies needed more resources to carry out their monitoring activities properly, but Congress (successfully lobbied by the S&L industry) was unwilling to allocate the necessary funds. As a result, the S&L regulatory agencies became so short on personnel that they actually had to cut back on their onsite examinations, just when they were most needed. In the period from January 1984 until July 1986, for example, several hundred S&Ls were not even examined once. Even worse, spurred on by the intense lobbying efforts of the S&L industry, Congress was only willing to pass legislation in 1987 (the Competitive Banking Equality Act) which provided a totily inadequate amount ($15 billion) to close down the insolvent S&Ls. Only when the crisis had reached massive proportions requiring a bailout on the order of $150 billion in present value terms did ‘“See Edward Kane (1989). 16

A financial crisis thus results in the inability of financial markets to function efficiently, whichleads to a sharp contraction in economic activityFactors Leading to Banking and Financial CrisesIn order tounderstand why banking and financial crises occur and more specifically howthey lead to contractions in economic activity, we need to outline what factors lead to bankingand financial crises.There are four categories of factors that promote financial crises: increasesin interest rates, increases in uncertainty,asset market effects on balance sheets,and bankpanics.Increases inInterestRates.AsdemonstratedbyStiglitzandWeiss(1981),asymmetricinformation and the resulting adverse selection problem can lead to credit rationing in whichsome borrowers are denied loans even when they are willing to pay a higher interest rate.Thisoccurs because individuals and firms withtheriskiest investmentprojects areexactly those whoare willing to pay the highest interest rates since if the high-risk investment succeeds, they willbe the main beneficiaries.Thus a higher interest rate leads to even greater adverse selection;that is, it increases the likelihood that the lender is lending to a bad credit risk. If the lendercannot discriminate among the borrowers with the riskier investment projects, it may want tocut down the number of loans it makes, which causes the supply of loans to decrease with thehigher interest rate rather than increase.Thus, even if there is an excess demand for loans, ahigher interest rate will not be able to equilibrate the market because additional increases in theinterest rate will only decrease the supply of loans and make the excess demand for loansincreaseevenfurther.1212Jaffee and Russell (1976)have demonstrated a second type of credit rationing in which lenders makeloans but limit their size to less than theborrower may want.This occurs because the larger the loanthe greater are moral hazard incentives for the borrower to engage in activities that make it less likelythattheloanwill berepaid.18

A financial crisis thus results in the inability of financial markets to function efficiently, which leads to a sharp contraction in economic activity. Factors Leading to Banking and Financial Crises In order to understand why banking and financial crises occur and more specifically how they lead to contractions in economic activity, we need to outline what factors lead to banking and financial crises, There are four categories of factors that promote financial crises: increases in interest rates, increases in uncertainty, asset market effects on balance sh=ts, and bank panics. Increases in Interest Rates. As demonstrated by Stiglitz and Weiss (1981), asymmetric information and the resulting adverse selection problem can lead to credit rationing in which some borrowers are denied loans even when they are willing to pay a higher interest rate. This occurs because individuals and firms with the riskiest investment projects are exactly those who are willing to pay the highest interest rates since if the high-risk investment succeeds, they will be the main beneficiaries. Thus a higher interest rate leads to even greater adverse selection; that is, it increases the likelihood that the lender is lending to a bad credit risk. If the lender cannot discriminate among the borrowers with the riskier investment projects, it may want to cut down the number of loans it makes, which causes the supply of loans to decrease with the higher interest rate rather than increase. Thus, even if there is an excess demand for loans, a higher interest rate will not be able to equilibrate the market because additional increases in the interest rate will only decrease the supply of loans and make the excess demand for loans increase even further. 12 ‘2Jaffeeand Russell (1976) have demonstrated a second type of credit rationing in which lenders make loans but limit their size to less than the borrower may want. This occurs because the larger the loan, the greater are moral hazard incentives for the borrower to engage in activities that make it less likely that the loan will be repaid. 18