BPEA | 1989 No. 1

Cleaning up the Depository Institutions Mess

Discussants: Benjamin M. Friedman
Benjamin M. Friedman Harvard University

1989, No. 1

FUTURE FINANCIAL and economic historians will mark 1989 as a watershed
year for the American financial system. This is the year policymakers
forced themselves to come to terms with their failure to supervise
adequately the nation’s depository institutions and to adopt sound capital
regulationt o attemptt o offset properlyt he “moralh azard”d ue to federal
deposit insurance. In early 1989, the new administration proposed a
comprehensive plan for ridding the financial system of at least 700
insolvent thrift institutions over the next decade and for reforming the
regulatory system that was supposed to have prevented their collapse.
Over the next few months Congress debated and changed the administration’s
Although it is likely that some parts of the final legislation will clearly
move in the right direction, serious problems should remain. In our view
the projectionsb y the administrationo n which the plan is based understate
the cost and budgetary effect of addressing what has come to be
called the “thrift crisis.” For its part, Congress may weaken the
administration’sp roposedc apitals tandardsa nd thus frustratee fforts to
restore proper incentives for thrifts to avoid excessive risk-taking.
Meanwhile, the widespread attention given by policymakers and the
media to the problems in the thrift industry has unfortunately obscured
similar significant problems among commercial banks.