Some of the issues that motivated bank bailouts in the 1970s and early 1980s, particularly worries about banking concentration, are still relevant today, say Cleveland Fed researchers
According to George C. Nurisso and Edward Simpson Prescott, researchers at the Federal Reserve Bank of Cleveland, most of the too–big–to–fail bailouts of the 1970s and early 1980s arose because the preferred way of dealing with a failing bank, an assisted merger, was not possible due to banking concentration and state branching restrictions. The end of branching restrictions in 1994 expanded the pool of banks able to acquire a troubled bank. However, since then, there has been an enormous amount of consolidation in the banking industry.
“At the end of 2016, the market share of the four largest commercial banks in the United States is 45 percent, a figure that is not too different from what the within–state bank market shares were during the bailouts described in our study,” say Nurisso and Prescott. “Therefore, if one of the nation’s top four banks got into trouble today, regulators would face the same problem they faced earlier, namely, that an acquisition by another large bank could create a possibly unacceptable level of concentration.”
Nurisso and Prescott say regulators during the 1970s and 1980s struggled with the tradeoffs involved in doing a bailout: Do the short–term costs of a failure, particularly if a panic ensues, outweigh the long–term costs of increased moral hazard and a decline in market discipline? “This tradeoff underlies the well–known time–consistency problem identified by Kydland and Prescott (1977), which implies that if well–meaning policymakers cannot stick with a strategy in the face of short–term costs, then policies that are harmful in the long run may be implemented,” say the researchers.
They note that one implication of the commitment problem is that the too–big–to–fail size threshold is smaller than it would be otherwise. “Converting assets to 2016 figures would make Commonwealth and First Penn (two of the banks bailed out in the time period examined by the researchers) the fifty–third and thirty second largest commercial banks in the United States today, respectively,” say Nurisso and Prescott. “We find it hard to believe that financial markets could not have handled a failure by First Penn, let alone one by Commonwealth, so we take these bailouts as evidence that the lack of commitment does indeed lower the too–big–to–fail threshold.”Read The 1970s Origins of Too Big to Fail
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Federal Reserve Bank of Cleveland
The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.
The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.
Doug Campbell, email@example.com, 513.455.4479