ON THE WEALTH EFFECTS OF THE SUPERVISORY GOODWILL CONTROVERSY

• DOI: http://doi.org/10.1111/j.1475-6803.1999.tb00715.x
• Date: 01 March 1999
• Published date: 01 March 1999
• Author: Donald R. Fraser,Asghar Zardkoohi,Leonard Bierman

The Journal of Financial

Research.

Vol. XXII,

NO.1.

Pages 69-81 • Spring 1999

ON THE WEALTH EFFECTS

OF THE SUPERVISORY GOODWILL CONTROVERSY

Leonard Bierman, Donald R. Fraser, and Asghar Zardkoohi

Texas

A&M

University

Abstract

We provide evidence on the potential wealth effects

of

the 1996 U.S.

Supreme Court decision that the U.S. government had violated contractual

obligations when, in 1989, it passed legislation prohibiting- savings and loan

associations from counting"supervisorygoodwill" as capital. The SupremeCourt

decision produced large wealth gains for the savings and loan plaintiffs, as did

prior court decisions in favor

of

these savings and loans. However, little evidence

exists to suggest negative market responses to important events surrounding the

1989 legislation.

I. Introduction

On July 1, 1996, the U.S. SupremeCourt in a 7-2 decision (U.S. v. Winstar)

ruled that the U.S. government had violated contractual obligations through the

1989 passage

of

the Financial Institutions Reform, Recovery, and Enforcement Act

(FIRREA). FIRREA mandated new regulatory capital accounting for depository

institutions (especially relevant to savings and loans (SLAs)) and provided for the

rapid phase-out

of

"supervisory goodwill" as a component

of

capital. As a result,

numerous thrifts became undercapitalized. Many

of

these thrifts were closed, while

others resorted to massive portfolio changes designed to shrink their balance sheets

and to restore adequate capital. I

The Supreme Courtdecision culminated a series oflawsuitsinvolving both

surviving and defunct institutions. Estimates

of

the damages due from the U.S.

government to the harmed institutions range from $10 billion to $20 billion (Wall

We appreciate theinsightful comments

of

the reviewer, which contributed to significant improvements

in the paper. We also appreciate the helpful comments of Darius Miller. Naturally, all remaining errors are

the responsibility

of

the authors. Asghar Zardkoohi would like to thank the Private Enterprise Research

Center at Texas A&M University for providing financial support for this project.

'The U.S. General Accounting Office reported that 300 SLAs (of2,285) held supervisory goodwill

as

of

March 1991. These institutions, which composed 50. I percent

of

the industry's assets, reported $4.7

billion in supervisory goodwill (General Accounting Office, October 15,1991).

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