Chapter 1 Summary and Implications
History of the EightiesLessons for the Future 47
wholesale forbearance as practiced by the FSLIC was a high-risk regulatory policy whose
main chances of success were that the economic environment for thrifts would improve be-
fore their condition deteriorated beyond repair or that the new, riskier investment powers
they had been granted would pay off. The latter type of forbearance, which the FSLIC
adopted against the background of a depleted insurance fund, is widely judged to have in-
creased the cost of thrift failures.
73
Because of the state of the FSLIC fund, forbearance be-
came a necessity for the thrift regulators rather than a matter of choice
74
and continued to
be widely granted after interest-rate reductions in the early and middle 1980s had alleviated
maturity mismatches in thrift portfolios, and poor-quality assets had become the chief prob-
lem of S&Ls. Generally, the bank regulators did not practice such wholesale, protracted,
and risky forbearance.
The bank regulators did, however, allow several large banks that subsequently failed
to operate for long periods with minimal capital (see Impact of Prompt Corrective Action
below). As noted above, bank regulators also eased the problems of money-center banks
with large holdings of LDC loans by not requiring prompt establishment of reserves against
such loans. This was a form of temporary forbearance; eventually money-center banks sub-
stantially increased their reserves.
75
Finally, bank regulators administered three forbearance
programs that were applied to classes of banks rather than to individual institutions (see
table 1.8). These programs were initiated or inspired by Congress rather than by the bank
regulators.
The first such program was the Net Worth Certificate Program for thrifts that was
adopted, despite FDIC reservations, as part of the GarnSt Germain Act.
76
This program
was applied mainly to FDIC-insured mutual savings banks in New York and other north-
eastern states that were suffering extreme earnings pressures in a period of high and rising
73
See, for example, Edward J. Kane, The S&L Insurance Mess: How Did It Happen? (1989); Eisenbeis and Horvitz, For-
bearance and Its Costs, 4968; Edward J. Kane and Min-Teh Yu, Opportunity Cost of Capital Forbearance during the Fi-
nal Years of the FSLIC Mess, Quarterly Review of Economics and Finance 36, no. 3 (fall 1996): 27190; and Ramon P.
DeGennaro and James B. Thompson, Capital Forbearance and Thrifts: An Ex Post Examination of Regulatory Gam-
bling, in Proceedings of the 29th Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, May
1993, 40620. However, one analysis concluded that [F]orbearance was not a major culprit in the taxpayer bill for the
thrift crisis. See George J. Benston and Mike Carhill, FSLIC Forbearance and the Thrift Debacle in Credit Markets in
Transition, Proceedings of the 28th Annual Conference on Bank Structure and Competition, Federal Reserve Bank of
Chicago, 1992: 131.
74
One analysis concluded that the FSLICs ability to dispose of insolvent thrifts was constrained by S&L industry pressures,
by the extent of past cover-ups of thrift insolvencies, and by the actions of elected officials (Kane, The S&L Mess, 97, 98).
75
According to some authors, the case for forbearance rests on the existence of market imperfections (such as legal impedi-
ments to diversification), deadweight bankruptcy costs, inefficient markets for bank assets, information asymmetries
whereby assets have greater value when managed by the banks that originated them than when managed by FDIC liquida-
tors, and macroeconomic considerations (Eisenbeis and Horvitz, Forbearance and Its Costs, 52, 64, 65).
76
FDIC, The First Fifty Years, 102.