Banking Reform: Economic Propellants, Political Impediments(34 Essays in Public Policy)

Our analysis unveils a critical paradox of banking reform. On the one hand, a series of critical economic factors--the propellants of reform--push for reform of the deposit insurance system and the financial system to avoid further debacles. On the other hand, the political factors the political impediments to reform seem to prevent meaningful reform of the financial intermediary system. The savings and loan (S&L) debacle occurred through the conjunction of three separate events, all economic consequences of political choices: first, regulatory-induced market segmentation that exposed the S&L industry to risk from an abrupt rise in interest rates: second, the sudden rise in interest rates in the early 1980s that wiped out the net worth of the industry; and third, the failure of elected officials to respond adequately to the problem in the mid-1980s. Few members of the public, however, perceive the S&L problem to be the result of politics. As a consequence, circumstances similar to the S&L debatcle could occur for other financial services, such as commercial banks, pension funds, and government-sponsored enterprises. This unfortunate possibility is due to general public ignorance of the political and economic forces bearing on a given industry. That ignorance, in turn, allows elected officials to devise programs that benefit certain constituents while hiding some of the costs in the form of future liabilities. To the extent that the latter are difficult for the public to perceive, officials are better off, as are the favored constituents. Of course, the general taxpayer may well have to pay for the liabilities if they are realized. By that time, however, few taxpayers will associate these liabilities with the structure of the regulatory regime itself, and hence they will not blame the politicians who created the potential for the problem in the first place. Thus one of the worst financial disasters to befall a major nation could well repeat itself."

About the Author :
Kenneth E. Scott is a senior research fellow at the Hoover Institution and the Ralph M. Parsons Professor of Law and Business Emeritus, Stanford University Law School. He has taught public regulation of banking institutions, corporation law, securities law, and administrative law. His current research focuses on legislative and policy developments related to the financial crisis, bank regulation, and deposit insurance. He has also studied the application of new economic perspectives to securities regulation, corporate law, and comparative corporate governance issues.Barry R. Weingast is a senior fellow at the Hoover Institution and the Ward C. Krebs Family Professor in the Department of Political Science at Stanford University. He received a BS from the University of California, Santa Cruz (mathematics, 1974), and completed his PhD in economics at Caltech (1977). Weingast served as chair of Stanford s Department of Political Science from 1996 through 2001."