The unending deposit insurance mess

Area of Science:

• Economics
• Public Policy
• Financial Regulation

Background:

• The thrift institution deposit insurance system faces a significant crisis.
• Existing incentives create rational responses for both government and industry that exacerbate the problem.

Purpose of the Study:

• To identify the root causes of the thrift institution deposit insurance crisis.
• To critique the proposed solutions and offer a path toward resolution.

Main Methods:

• Analysis of political and bureaucratic accountability within the regulatory framework.
• Examination of incentive structures for government and thrift institution managers.
• Critique of existing and proposed policy responses.

Main Results:

• The crisis stems from defects in political and bureaucratic accountability, not solely poor management or deregulation.
• Covering up poor performance and relaxing capital requirements are rational governmental responses.
• Aggressive industry risk-taking is a rational response to regulatory forbearances.

Conclusions:

• The Bush administration's plan incorrectly identifies the causes of the crisis.
• Resolving the crisis requires addressing incentive defects and surrendering political discretion.
• Accurate budgeting for governmental financial commitments is essential for systemic reform.