ECONOMICS 0281

         SUPPLEMENTARY READINGS QUESTIONS-PART 2

 

1. In Catherine England's article "Agency Costs and Unregulated Banks: Could Depositors Protect Themselves?":

 

a. Briefly explain the incentives of stockholders, depositors, and managers for a bank and how creditor-stockholder conflicts might be resolved.

b. Briefly explain how the three control mechanisms work to restrain bank managers from engaging in excessively risky activities. Specifically:

(1) What kind of information sources might evolve in the absence of regulation? (If depositors can hold auditors responsible for inaccurate reports how will this affect the quality of the auditors report? If depositors cannot hold government examiners responsible for inaccurate reports how will this affect the quality of their reports?)

 
(2) What kind of third party monitors would evolve in the absence of regulation?

(3) What kind of contractual terms would help assure depositors that their agents were not jeopardizing their deposits? (More capital, extended liability, subordinated debt, delayed requests for liquidity, mutual fund banking are some of the possibilities: choose a few and explain them.)

c. Why would the failure of a bank (or banks) cause other bankers to organize a system of mutual support? Why would depositors of other banks learn to differentiate banks from one another in the absence of regulation? What effects would this have on bank panics?

d. What kind of historical support exists for England's ideas? (For example: What did the Scottish banks do to calm depositors? What role did the 19th century clearinghouses play in the US [exclude Timberlake's example]? What was the Suffolk system and why was it successful? Why is unlimited liability important to depositors? )

2. In Charles Calomiris's article "Runs on Banks and the Lessons of the Great Depression":

 

a. Why will otherwise solvent banks fail when an information asymmetry exists between depositors and bank managers? (Calomiris refers to this as the problem of the rational depositor with imperfect information.)

b. In the pre-Depression US what conditions made the banking system more vulnerable to panics? How did this fact affect the ability of banks to form coalitions designed to reduce the effect of panics?

c. From the Chicago study, what factors lead Calomiris to conclude that "although many solvent banks experienced some withdrawals of deposits during the panic, only the weakest banks failed"? Explain the implications of this finding.

d. What role did the Chicago Clearinghouse play during the panic?

e. Would deposit insurance solve the information asymmetry problem?

3. In Jith Jayaratne and Philip Strahan’s article “The Benefits of Branching Deregulation”:

a. Explain some of the developments that contributed to the removal of geographic barriers to bank expansion.

b. Why were large banking organizations important in the relaxation of restrictions on branching?

c. Do banks perform better when branching restrictions are relaxed? What is the evidence on loan losses, non-interest expenses, and loan rates?

d. Has deregulation of banking led to increased concentration and increased market power? Explain carefully.

 

 

4. In William Shughart’s article “A Public Choice Perspective on the Banking Act of 1933”:

 

a. What is the public interest justification for enacting Glass-Steagall?

b. Briefly explain how commercial banks became involved in securities activities before 1933.

c. How were banks affected by the panic of 1929-33 and how well did banks with securities affiliates do compared with banks in general?

d. What alternative explanation to the public interest theory does Shughart propose?

e. What interests did the commercial and investment bankers as well as the Treasury have in separating commercial from investment banking?

5. In Loretta Mester’s article “Repealing Glass-Stegall: The Past Points to the Future”:

 

a. Why was Glass-Steagall established?

b. What are the arguments for and against repealing Glass-Steagall?

c. What is the empirical evidence on conflict of interest and what does it imply about repealing Glass-Steagall?

d. What is the empirical evidence on organizational structure and how is that relevant to the issue of repeal of Glass-Steagall?

6. In Nicholas Economides, R. Glenn Hubbard, and Darius Palia's article "Federal Deposit Insurance: Economic Efficiency or Politics?":

 

a. Why was deposit insurance established?

b. How does the statistical evidence from state experience with deposit insurance and role call votes on branching restrictions support the authors' hypothesis?

c. What events occurred during the 1920s and early thirties that threatened the survival of small banks? What did they do?

d. Why did strong banks oppose the deposit insurance provisions of the Banking Act of 1933?

e. Is government deposit insurance an effective way to reduce the problem of financial crises?

7.  In Catherine England's article "The Savings and Loan Debacle":

 

a. How did prior regulation of the S&Ls (tax incentives, interest-rate ceilings, asset portfolios limited to regions of operation, and fixed rate mortgages) lay the foundation of the crisis?

b. How did rising costs and stagnant earnings create an industry that was insolvent by $100 billion in 1980?

c. How did government policies make this bad situation even worse? Why did policymakers attempt to save the S&Ls? Explain.

d. Why would policymakers act differently from private creditors?

e. How did the government's response to the insolvent S&Ls undermine the solvent S&Ls?

 8. In George Kaufman’s article "The U.S. Banking Debacle of the 1980s: A Lesson in Government Mismanagement":

 

a. Why was deposit insurance introduced in 1934?

 

b. What role did deposit insurance and other regulatory restrictions play in the banking debacle of the 1980s?

 

c. What is Structured Early Intervention and Resolution (SEIR)? Has it been effective? Why? (Hint: Use public choice ideas here.)

 

 

d. What is the lesson to be learned from the banking debacle? Can government solve the principal-agent problem and the associated problem of asymmetric information that plagues political institutions?

 

9.  In Arnold Kling’s article “Not What They Had in Mind”:

 

a. What three lessons did regulators learn from the S&L Crisis and how did these lessons/solutions contribute to the current crisis? (pp. 10-13)

 

b. Kling argues that “from the 1960s to the early 1980s, mortgage securitization was driven largely by anomalies in accounting treatment and regulation.” Explain what he means here. (Hints: Explain what mortgage securitization is; an anomaly is a deviation from a common practice.) (See pp. 16-18)

 

c. Why did mortgage lending standards deteriorate and why didn’t regulators stop this trend? (See pp. 17-19)

 

d. How did the Basel Accord capital regulations create an advantage for securitized mortgages? (See p. 23)

 

e. Briefly explain how CDOs (private label mortgage securities) and SIVs aided regulatory capital arbitrage (helped to lower the actual capital held by financial institutions, thereby increasing their leverage). (Be sure you know what Kling means by regulatory capital arbitrage. See p. 23.)

 

f. A key modification of the Basel regulations went into effect in 2002. Explain what its main (deleterious) effects were.

 

g. What role did the off balance sheet entities play in creating the crisis?

 

h. Can financial regulation prevent (future) financial crises? Explain Kling’s answer briefly.