The impact of federal deposit insurance on savings and loan failures: reply.

• Author: Cebula, Richard J.
• Position: Response to Ira S. Saltz, this issue, p. 253

1. Introduction

   My recent study [2] finds, within a variety of models based extensively on Barth [1], that raising the ceiling level of federal deposit insurance acts to raise the savings and loan (S&L) failure rate. This finding (which is based on OLS estimates using the Cochrane-Orcutt correction for first-order autocorrelation) is obtained whether the ceiling level on federal deposit insurance is expressed in current or constant dollars.

   It is alleged by Saltz [4] that there is an econometric flaw in my analysis. In particular, it has been suggested that there exists a simultaneity bias in my basic model involving the average S&L cost of funds, which is a statistically significant variable in my study [2]. Further, it is argued that, after allowing for this problem (alleged problem), the conclusion in my empirical study that federal deposit insurance affects S&L failures is invalidated.

   This study examines the simultaneity issue within the context of my model. First, I describe the original basic model. Then, I expressly address the possibility of simultaneity bias involving explanatory variables in the model. It is shown that (1) there is no simultaneity problem involving the S&L cost of funds variable, (2) there is evidence of a possible simultaneity involving the S&L mortgage portfolio yield, but (3) once the latter is appropriately allowed for, the conclusions in my original study [2] remain unchanged. The comment [4] is useful, nevertheless, for its pointing out the need to allow formally for the possibility of simultaneity.

2. The Model

   The most basic model estimated in Cebula [2] is the following reduced-form equation:

   [PSL.sub.t] = a + b [RINS.sub.t-2] + c [VOL.sub.t] + d [RP.sub.t-2] + e [COST.sub.t-2] + f [MORT.sub.t] + g [CAP.sub.t-2] + u (1)

   where:

   [PSL.sub.t] = the percentage of federally insured S&Ls that failed in year t;

   a = constant;

   [RINS.sub.t-2] = the FSLIC insurance ceiling per account on deposits at S&Ls in year t - 2, expressed in thousands of 1982 dollars;

   [VOL.sub.t] = the variance in year t of the yield on new home mortgages (FHLBB series);

   [RP.sub.t-2] = the average price per barrel of imported crude oil in year t - 2, expressed in 1982 dollars;

   [COST.sub.t-2] = the average cost of funds to S&Ls in year t - 2, expressed as a percent per annum;

   [MORT.sub.t] = the average S&L mortgage portfolio yield in year t, expressed as a percent per annum;

   [CAP.sub.t-2] = the average required S&L capital-to-asset ratio in year...