Barth's analysis of the savings and loan debacle: an empirical test.

• Author: Cebula, Richard J.
• Position: James Barth - Communications

1. Introduction

   The failure rate of F.S.L.I.C. insured savings and loan associations (S&Ls) in the United States during recent years has assumed unprecedented proportions. For the period from 1934 through 1941, a total of 33 F.S.L.I.C. insured S&Ls failed. Over the period from 1942 through 1962, a total of 15 F.S.L.I.C. insured S&Ls failed. The number of failed so-insured S&Ls rose to 82 for the period from 1963 through 1979. However, since 1980, the annual number of failed F.S.L.I.C. insured S&Ls has reached unprecedented levels. Indeed, according to Barth |1, 29~, over the period 1980 through 1989, a total of 525 F.S.L.I.C. insured insolvent S&Ls failed (were liquidated or sold at an enormous cost). A similar conclusion is observed when considering the percentage of the total number of F.S.L.I.C. insured S&Ls that failed: the percentage that failed during the 1980-1989 period far exceeded any prior experience. These alarming facts are discussed in detail in a recent book by James Barth |1~.(1) Based on his experience and knowledge, Barth |1~ describes and interprets the underlying causes of the S&L debacle in great detail.

   In this brief paper, we seek to empirically evaluate whether Barth's contentions are valid.(2) Section II of this paper essentially summarizes Barth's basic arguments and conclusions. Section III provides the empirical test. It is shown that through the use of a reduced-form, distributed lag model, Barth's contentions are remarkably accurate. Concluding remarks are presented in the final section of the paper.

2. The Analytical Framework

   Following Barth |1~ and others |6; 10~, the basis premise of the present analysis is that the diminishing profit margin resulting from the changes in economic conditions prior to deregulation and the increased competition brought about by deregulation are primary causes of the S&L failures in the last decade.(3) Specifically, the increase in the variability in the S&L profitability and thus the increased incidence of failure are the results of: (1) long periods of regulation which not only protected but also adversely constrained the S&Ls since the 1930s; (2) the changes in economic conditions over the last two or three decades and the lack of regulatory response to these changes, and (3) the subsequent deregulation of the financial services industry in the 1980s: a period of time with volatile economic conditions.(4)

   Whereas at one time regulation and supervision of S&Ls on the federal and state levels contributed to a stable housing and housing-financed industry and may have protected the managers from the consequences of their mistakes, regulations have also adversely affected the revenue and cost conditions of the thrift institutions, thereby limiting their profit potentials. As discussed by Barth |1~, a perhaps more serious problem is that for years regulation has inhibited and discouraged S&Ls from adapting to changes in the market forces.(5) As a result, they were relatively less prepared for the adverse economic conditions in the 1980s and the newly deregulated competitive environment; thus, they were hard hit.

   On the cost side, while regulation Q provided a stable and low-cost supply of mortgage funds to S&Ls, the maximum interest rates on savings deposits also limited their ability to compete for funds with other depository institutions. The exodus of funds (disintermediation) has been evidenced by the periods of credit crunch in 1966, 1969, 1974-1975, and 1979-1980.(6) The problem has become particularly serious in the late 1970s and early 1980s, when the nominal interest rates...