About the Authors

Richard Aspinwall is Senior Vice President and Chief Economist of theChase Manhattan Bank. He previously was Director of Bank and Finan-cial Market Research in Chase's economics department. Before joiningChase Manhattan Bank, he was a research economist at the Federal ReserveBank of New York. He has also served as an adjunct professor in theGraduate School of Business at Columbia University.Dr. Aspinwall has published widely in professional journals, and has

edited a number of books, including The Handbook for Banking Strategy(John Wiley & Sons, 1985). He serves as an associate editor of the Journalof Financial Services Research. Aspinwall is a member of the ShadowFinancial Regulatory Committee.

George J. Benston is the John H. Harland Professor of Finance, Account-ing and Economics at Emory University, where he was also previously theAssociate Dean for Research and Faculty Development in the School ofBusiness. He has taught at the University of Rochester and the Universityof Chicago and has been a visiting professor at Oxford University and theLondon School of Economics. He has served as a founding member of theboard of directors of the Federal Agriculture Mortgage Corporation, asan elected trustee of the College Retirement Equities Fund, as a consultantto the World Bank, and as a visiting scholar at the Federal Reserve Bankof Atlanta.Professor Benston has published widely in professional journals and has

authored/edited numerous books in finance, economics, and accounting,including Financial Services; The Changing Institutions and GovernmentPolicy (Prentice-Hall, 1983), Perspective on Safe and Sound Banking (MITPress, 1986) and The Separation of Commercial and Investment Banking

174 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

(Oxford, 1990). He is co-editor of the Journal ofFinancial Services Researchand an associate editor of the Journal of Money, Credit and Banking,Contemporary Accounting Research, Journal of Financial Research, andthe Journal of Accounting and Public Policy. Benston is a member of theShadow Financial Regulatory Committee.

Franklin R. Edwards is the Authur F. Burns Professor of Free and Com-petitive Enterprise and Director of the Center for the Study of FuturesMarkets at Columbia University. He previously served as an economist atthe Federal Reserve Board and at the Comptroller of the Currency. Healso served as vice-dean for Academic Affairs at the Graduate School ofBusiness at Columbia University in 1979-81.Professor Edwards has published widely in professional journals and

has authored/edited a number of books including Issues in FinancialRegulation (McGraw-Hill, 1979) and Futures and Options (McGraw-Hill,1992). He is co-editor of the Journal of Financial Services Research and anassociate editor of the Journal of Futures Markets, and Managerial andDecision Economics. He has testified in Congress on many occasions. Heserved as a public director of the Futures Industry Association and on thenominating committee of the American Stock Exchange. Edwards is amember of the Shadow Financial Regulatory Committee.

Robert A. Eisenbeis is the Wachovia Professor of Banking and AssociateDean for Research at the School for Business Administration of theUniversity of North Carolina. He previously served as an officer at theFederal Reserve Board and the Federal Deposit Insurance Corporationand as a visiting scholar at the Federal Reserve Bank of Atlanta.Professor Eisenbeis has published widely in professional journals and

has authored/edited a number of books including Perspectives on Safe andSound Banking (MIT Press, 1986), Handbook of Banking Strategy (JohnWiley, 1983), and Applications of Classification Techniques in Business,Banking, and Finance (JAI Press, 1981). He is a co-editor of the Journalof Financial Services Research, and an associate editor of the Journal ofBanking and Finance and the Journal of Economics and Business. He hastestified numerous times before Congress. Eisenbeis is a member of theShadow Financial Regulatory Committee.

Richard Herring is Professor of Finance and Director of the WhartonFinancial Institutions Center at the Wharton School in the University ofPennsylvania. He is also the Academic Director of the Wharton AdvancedManagement Program for Overseas Bankers, and previously was Director

ABOUT THE AUTHORS 175

of the Wharton Program in International Banking and Finance. He hasserved as a Visiting Professor at the Institute of Banking Lore at theJohann Wolfgang Goethe University in Frankfurt, Germany.Professor Herring has published widely in professional journals and

authored/edited a number of books. He was co-author of the BrookingsStudy A Blueprint for Restructuring American Financial Institutions (1991).His articles have appeared in the Journal of Financial Services Research,Contemporary Policy Issues, the Journal of Money, Credit, and Banking,the Journal of Finance, and the Journal of Political Economy. He serveson the editorial boards of the Journal of Financial Services Research, theJournal of International Financial Markets, Institutions and Money, andColumbia Journal of World Business. Herring is a member of the ShadowFinancial Regulatory Committee.

Paul M. Horvitz is the Judge James A. Elkins Professor of Banking andFinance at the University of Houston. He previously served as director ofresearch at the Federal Deposit Insurance Corporation and as an economistat the Comptroller of the Currency. He also was a visiting scholar at theFederal Reserve Bank of Atlanta, a public director of the Federal HomeLoan Bank of Dallas, and a director of four saving & loan associations andone commercial bank.Professor Horvitz has published widely in professional journals and has

authored/edited a number of books including; Perspectives on Safe andSound Banking (MIT Press, 1986), Commercial Banking and InterstateExpansion (University of Michigan Press, 1985), Sources of Financing forSmall Business (JAI Press, 1985), and Monetary Policy and the FinancialSystem (Prentice-Hall, 6th edition, 1987). He is co-editor of the Journal ofFinancial Services Research. He has testified numerous times beforeCongress, has been a consultant to a number of financial services organ-izations, and was a columnist for the American Banker. Horvitz is a mem-ber of the Shadow Financial Regulatory Committee.

Edward J. Kane is the James F. Clearly Professor in Finance at BostonCollege and a research associate in the National Bureau of EconomicResearch. He previously taught at Ohio State University Princeton Uni-versity, and Iowa State University. He has also served as visiting professorat Arizona State University, Simon Fraser University and Istanbul Univer-sity, as a visiting scholar at the Federal Reserve Bank of San Francisco andthe Federal Deposit Insurance Corporation, and both an elected andappointed trustee of the Teachers Insurance and Annuity Association.

176 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

Professor Kane has published widely in professional journals andauthored/edited many books including the Savings & Loan Insurance Crises:How Did It Happen? (Urban Institute Press, 1989), The Gathering CrisesIn Federal Deposit Insurance (MIT Press, 1985), and Perspectives On SafeAnd Sound Banking (MIT Press, 1986). He is a co-editor of the Journal ofFinancial Services Research, and an associate editor of the Journal ofBanking and Finance, Journal of Money, Credit and Banking, Journal ofFinancial Research, the Journal ofEmpirical Finance, and the Pacific-BasinFinance Journal. He has testified numerous times before Congress. He hasbeen honored by his peers by being elected President of the AmericanFinancial Association in 1977. Kane is a member of the Shadow FinancialRegulatory Committee.

George G. Kaufman is the John F. Smith Jr. Professor of Finance andEconomics at Loyola University of Chicago. He previously taught at theUniversity of Oregon and was an economist at the Federal Reserve Bankof Chicago. He has been a visiting professor at Stanford University andthe University of California at Berkeley, a visiting scholar at the FederalReserve Bank of San Francisco and the Comptroller of the Currency, andalso served as Deputy to the Assistant Secretary for Economic Policy atthe U.S. Treasury Department. He is a member of the board of directorsof the Rochester (NY) Community Savings Bank and was an elected trusteeof the College Retirement Equities Fund.Professor Kaufman has published widely in professional journals and

authored/edited many books including; The U.S. Financial System (Prentice-Hall, 5th edition, 1992), Perspectives on Safe and Sound Banking (MIT Press1986), Deregulating Financial Services (Ballinger, 1986) Restructuring theFinancial System (Kluwer, 1990), and Assessing Bank Reform (Brookings,1993). He is a co-editor of the Journal of Financial Services Research andan associate editor of the Journal of Money, Credit, and Banking, theJournal of Financial Research and Contemporary Policy Issues. He hastestified numerous times before Congress. He has been honored by hispeers by being elected President of both the Western Finance and theMidwest Finance Associations. Kaufman is co-chair of the Shadow FinancialRegulatory Committee.

Kenneth E. Scott is the Ralph M. Parsons Professor of Law and Businessat the Law School of Stanford University. He was formerly the generalcounsel of the Federal Home Loan Bank Board in 1963-67 and chief deputysavings and loan commissioner of the State of California in 1961-63. Heserves on a number of committees of the American Bar Association and

ABOUT THE AUTHORS 177

the State Bar of California and on the board of the National Center onFinancial Services at the University of California at Berkeley.Professor Scott has published widely in professional journals and has

authored/edited a number of books including; Economics of CorporationLaw and Securities Regulation (Little, Brown and Company, 1980), andRetail Banking in the Electronic Age: The Law and Economics of ElectronicFunds Transfer (Allanheld, 1977). He has testified many times beforeCongress and has served as a consultant to a number of bank regulatoryagencies and law firms. Scott is a member of the Shadow FinancialRegulatory Committee.

Barry Weingast is Professor of Political Science at Stanford University anda Senior Fellow at the Hoover Institution, where he serves as AssociateDirector of the Program for Public Policy. He previously taught at Wash-ington University (St. Louis) and was a research associate at their Centerfor the Study of American Business.Professor Weingast has published widely in professional journals and

books. His articles have appeared in the Journal of Political Economy andThe American Political Science Review, among other journals.

Index

Abu Dhabi, 128, 131, 132, 133Accounting coverups, 37-39Accounting objectives, standards, and

requirements, 12Accounting reforms, advantages, 78"Action-forcing rules", 78Adequately capitalized, 101, 115Agricultural income, effect on state

economies, 25American Banking Association Academic

Task Force, closure rulerecommendation (1986), 5

American Enterprise Institute, SEIRproposal, 14n

American Enterprise Institute Task Forceon financial regulation reform(1986-1987), 5, 7

Arms deals, 131Assessment insurance premium

classifications, 95Assurance coverage, 92Attorneys, institutional, 83"Audit trail", 43Average resolution cost, 63

Bahamas, banking supervision, 127-128Bailouts, government, 85Banco Ambrosiano, 121, 125, 137, 138n,

139nBanco Ambrosiano Andino in Peru,

126

Banco Ambrosiano Holdings SA (BAH),126, 127, 128

Banco Ambrosiano Overseas Ltd., 126Banco Ambrosiano SpAcollapse of, 126-127, 128compulsory liquidation after failure,125, 126

"Bank bashing", 111Bank charters, 58, 128, 129, 130, 133Bank failures, 46Bankhaus Herstatt of Cologne, 122-123,

126Banking Act (Glass-Steagall) of 1933, 99Banking reform, 19-35current reform legislation, 31-32economic propellants, 20-27government accounting of liabilities, 35inadequate regulation and supervisionof banks, 27

legal impediments to diversificationneeding removal, 33

market segmentation, 27, 34moral-hazard hypothesis, 20-22, 24-27,31, 32, 35n

policy implications, 25-27political impediments, 27-31prescription for reform, 33Bank insurance fund (BIF), 4, 37, 42,

43-44,73FDIC repeating mistakes that ruinedFSLIC, 74, 77

incentive conflicts, 77

180 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

net "accounting income" from futurepremium receipts, 46-47

pushed into same ruts FSLIC took in1983, 39, 41-42, 43

unbooked loss exposure, 44, 45, 46Bank of America, 60, 128-129, 130Bank of Credit and Commerce

International (BCCI), collapse andimplications, 19, 121-139

Concordat of 1975, 121-125diversity of depositors, 131dual banking structure, 129fraud documented on a global scale, 132Holdings SA, 129office locations, 128options for improving the supervisionof international banks, 133-137

Overseas (Cayman Islands), 129-130, 133recapitalization, 132"regulatory college" formed to shareinformation about BCCI, 132

"restrictive measures" to be imposedby supervisory host country, 135

revised Concordat, 125-128, 131,134-135, 137, 138n

rise and fall of BCCI, 128-133SA (Luxembourg), 129, 133structure circa June 1991, 129Bank of England, 14On, 141n, 167BCCI and, 131, 132, 135-136Bank of Italy, 125, 127, 128Bank of New England, 26, 118Bank regulators, 8Bankruptcy costs, 52, 56Bankruptcy law, 83Basle Accord on Capital Adequacy, 138nBasle Committee for Banking

Supervision, 123-125, 127-128,131, 134, 136, 137n

Basle risk-based capital requirements,110,116

Benston-Kaufman proposal, 5-8, 100-102legislative adoption, 9-13vs. FDICIA (1991), 10Benston-Kaufman/Shadow Financial

Regulatory Committee/BrookingsSEIR proposal, 11, 108, 112

Black-Scholes options pricingmethodology, 53

Board of directors, 80, 83, 84Bonding safeguards, 86Bonding services, and profits, 84-85, 87Book-value capital, 112Book values, 24, 43, 55-59British-Israel Bank of London, 122Brokered deposits, 12Brookings Institution, 8, 14nBrookings Institution Task Force, 9, 100Bureaucratic accountability, 73

California, agricultural income effect onstate economy, 25

Callable put model, 53-54CAMEL rating, 63Capital adequacy requirements, 56Capital certificates, 60Capital ratio for required resolution, 11Capital ratios, 2, 14n, 60, 100, 101Capital standards, improvement of, 12Capital stock, 146Capital-to-asset ratios, 62, 101-102Capital tranches, 6, 9-10Capital zones, 11Cayman Islands, BCCI Overseas location,

129-130, 133CenTrust Savings Bank (Miami), and

BCCI,133Citicorp, 7, 60Clearing House Interbank Payments

System (CHIPS), 130Closure rule, 2, 4-5, 7-8, 13, 50bank specific, 54based on book rather than marketvalues, 55-56

cost of closing market-value insolventthrifts, 61

forbearance, 52, 53structured early regulatory interventionsystem, 5-7

Closure rule of zero book value capital, 3Closure threshold, 57Coinsurance, private sureties, 93Coinsurance contracts, 81, 84Coinsurance cost, increased for

institutions not taking risks, 92Coinsurance profits, 84-85Collusive pricing, 85

INDEX

Commercial banks, 2-4, 6, 9-11differences between Benston-KaufmanlShadow Financial RegulatoryCommittee Proposal and FDICIA,11-13

failures, 4, 19interest-rate risk, 23net worth, 24, 63Committee on Banking Regulations and

Supervisory Practices, 127, 128Competitive Equity in Banking Act

(CEBA) of 1987, 3, 50, 62Computer software, for interest-rate risk

analysis, 41Concordat of 1975, 121-125, 130Conference on Bank Structure and

Competition,14nConflicts of interest, between banks and

sureties, 94Congressional Budget Office, 8-9, 19-20,

77Conservatorship, 12, 101, 113Consolidation, principle of, 126Construction-performance bonds, 93Consultants, outside, 80, 83Consumer protection, 10Continental-Illinois, 52Contra asset accounts, 60Core-deposit intangible, 110Cost of capital, definition, 155Coupon payments, 102Creditor discipline, 21-22Creditors, 80, 81-83, 84Credit-risk accounting, 116Credit unions, net worth approaching

zero, 63Cross-guarantees, 81CrossLand Savings, 26, 76, 118

"December surprise", 43-46, 119Defense Department, 117Deferred loss recognition program, 62De jure coverage pattern, 86Deposit insurance, 2-4, 5, 24, 29, 31accounting coverups, 37effective supervision, 60European Community directive onbank supervision, 133-134

181

legal limit, 21mispriced, 54, 57privatization of, 85, 94-97six component subsystems, 71-72value affected by different closurerules, 52

Deposit insurance premiums, 11, 14nDepositors, 29, 80, 81-83Depository Institutions Reform Task Force

of the Brookings Institution, 8Dereliction of duty, 78Deutschebank, 164-165Dingell bill, 31, 32Disciplinary actions, 88Discretionary supervisory forbearance, 60Diversifiable risk, 23Dividend payments, suspension of, 101Drexel Burnham, 19Duration, 116Dynamic programming model, 54

Early resolution, 12Employee benefit plans, 11Emulation, effective, of market discipline,

93Energy and Commerce Committee, 32Equity capital requirements, 31Equity duration, 116Equity premium, 161-162Equity shares, 105Ernst and Young (auditing firm), 130Ethical duties of federal officials, 78Europe, ratio of CEO's pay to average

worker's pay, 145European Community (EC), 133-134, 136Executive branch, ethical duties, 78Exit-policy mandate, 40

Fairly priced insurance premiums, 56Faith-breaking behavior, 74Federal budget, deposit-insurance losses, 78Federal coverage limits, 88Federal deposit insurance, 6, 70-71Federal Deposit Insurance Corporation

(FDIC), 3, 8, 9, 32; see alsoFederal Deposit InsuranceCorporation Improvement Act

182 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

authorization to borrow, 33, 77capital forbearance plan, 62-63closure rule enforcement, 6coverage of losses not stipulated ininsurance contracts as "least cost"procedures, 92

feasibility study of a privatereinsurance system, 95

forbearance for banks, 50, 51-52insurance agency closure ruleconditions, 54

insured depository institutions withdefinite threat of loss restored tosoundness, 60

no effort made to diversify risks, 91open-bank assistance, 49projections of BIF net "accountingincome", 46-47

recapitalization, 10reinsurance proposal deficienciesenumerated, 96, 97

Federal Deposit Insurance CorporationImprovement Act (FDlCIA), 1-15,31, 38; see also Federal DepositInsurance CorporationImprovement Act, improvement of

accountability reforms, 75-76banking authorities to limitinadequately capitalized banksfrom raising brokered deposits,54-55

Benston-Kaufman/Shadow FinancialRegulatory Committee Proposaldifferences, 11

central purpose, 40changes in the structure of theregulatory bureaucracy, 72-73

FDIC to compromise a reinsurer'sinterests, 96

five major parts, 1forbearance from misdesign ofinsurance system, 55

forbearance policy, 50-51Foreign Bank SupervisionEnhancement Act, 136

future of, 117-119implementation timetable for depositinsurance reform provisions, 12

insolvency, 19-20, 27-29

market valuations used by privateinsurers to analyze capitalsufficiency, 96

misregulation blame put on regulators,75

privatization plans, 95prompt implementation and correctiveaction required, 65

regulator efforts to discredit, 39-43requirements for regulatory agencies,92-93

ridiculed openly by Federal Reserveand Treasury officials, 42

risk sensitivity as a factor in bankinsurance coverage, 91-92

supervision of domestic offices offoreign banks, 1

Federal Deposit Insurance CorporationImprovement Act, improvementof, 99-119; see also FederalDeposit Insurance CorporationImprovement Act

avoidance of closure costs, 103-104Benston-Kaufman proposal, 100-102capital ratios being too low, 114-115deposit-insurance provisions, 111-117division into five major areas, 111early intervention resulting in biggerbank risks, 107-108

higher bank capital costs andcompetitive equality, 107

implementation timetable for reformprovisions, 12

interest-rate risk in capital standards,115-116

government takeovers, 107greater bank efficiency, 104greater regulatory efficiency, 104-105low cost to the deposit-insurance fund,103

market force substitution, 102-103market-value accounting for SEIR,108-110

moral-hazard costs of forbearance,103-104

neglect of accounting reforms, 116-117operational and political feasibility,105-106

SEIR, 99-111

INDEX

shortcomings of the act and itsimplementation, 114

Federal Financing Bank, 33Federal Home Loan Bank Board

(FHLBB), 3, 8, 23-24, 59-61, 74Management Consignment Program(MCP), 63-64

Federal Home Loan Bank Board TaskForce, 4

Federal Home Loan Bank of Boston, 8Federal Home Loan Bank of San

Francisco, 7, 8, 74Federal regulators, 69-70, 94, 112Federal Reserve Bank, 37Federal Reserve Bank of Boston, 8Federal Reserve Bank of Chicago, 7,

14nFederal Reserve Board, 15n, 42, 140nassurance coverage extended, 92civil money penalty action, consent byBCCI,133

enforcement action, BCCI acquiring ofIndependence Bank, 133

least cost resolution, 12role in establishment and terminationof foreign banks in U.S., 136

Federal Reserve discount window loans,10-12, 111-112

Federal Savings and Loan InsuranceCorporation (FSLIC), 60, 63-64

accounting coverups, 37, 59bank insurance funds repeating itsmistakes, 74, 77

bankruptcy and bailout, 4, 19causes of insolvency made inoperativeby Congress, 38

Fidelity bonds, 93Financial Executives Institute, 143Financial holding company, 126Financial Institutions Reform Recovery

and Enforcement Act (FIRREA)(1989), 38, 73

Financial markets and managerialmyopia, 141-169

big ownership and relationshipinvestors in Japan and Germany,163-167

capital spending, 145-146cost of capital, 144, 167

183

cost of capital differences and U.S.short-termism, 155-163

cost of equity capital, 161-163, 167"hurdle rates", 154institutional investors, 152-155institutional ownership of stock, 142,152-155

investments of GNP in new plants andequipment, 145

leverage and frequency of bankruptcy,160-161

long-run dividends and earnings,149-151

net domestic investment, 146on-the-job training, 146-148policy implications for the U.S., 167-168ratio of CEO pay to average worker'spay, 145

real wages of workers, 145research and development spending,145, 146, 149-150, 156-157, 162

short-term investment horizons of U.S.,141-142, 143

stock turnover in U.S. vs. that inJapan, 142, 153-154

taxation bill on capital gains tradedafter a short term, 143-144

U.S. multinational firms, 148-149U.S.'s competitive decline and its linkto managerial myopia, 144-149

venture capital market, 150-151Wall Street's preoccupation withquarterly earnings, 149

Financial regulation, long-run benefits,69-89

alternative of privatization, 78-83decomposing deposit insurance intocomponent subsystems, 71-72

delaying the accounting realization ofdeveloping losses, 74

ethical incentive reform asaccountability reform, 75-78

forbearance, 83intraindustry and other privatereinsurers, 84-88

source of the deposit-insurance mess, 72First American Bank of New York, 138nFirst American Bankshares, and BCCI,

130, 132, 133, 136

184 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

Fiserv,41Hat-rate deposit-insurance premium

structure, 50, 57Horida, agricultural income effect on

state economy, 25FOFs (Foes of FDICIA), 39, 40, 43Forbearance, and depository institutions,

49-66, 88-89arguments concerning, 51-52consequences of, 59-64evidence on forbearance and risk-taking behavior, 58

financial regulation, long-run benefits, 83implications of the theoretical work,57-58

incentive effects of an early closurerule, 56-57

maximum time S&Ls permitted to stayopen, 66n

more costly than closing insolventinstitutions, 53

optimal closure policies, 53-56review of theoretical literature onforbearance, 52-64

Foreign banks, U.S. offices of, 111, 112,121-139

Foreign Bank Supervision EnhancementAct of 1991, 136

Foreign branches, supervision of bankshaving, 134

Foreign deposits, 12Foreign-exchange contracts, 122Foreign-exchange trading, 122Foreign parent banks, 121-124FranceBCCI and, 138nreal wages of workers, 145

Franklin National Bank of New York, 122Fraud, 132, 134

Garn-St Germain Depository InstitutionsAct of 1982, 4, 35n

General Accounting Office, 77, 115Generally accepted accounting principles

(GAAP), 59-62, 108-109market value appropriateness, 49-50Germanybank funding of firms, 161, 164-167

big ownership and relationshipinvestors, 163, 167

corporate leverage and frequency ofbankruptcy, 160-161

cost of capital, 144, 156-159, 161cost of equity capital, 161-163hostile takeovers not possible, 143manufactured exports, 144-145real wages of workers, 145stock turnover rate, 142Government micromanagement, 13,

118Group of Ten, 123, 137nGuarantee system, 29

Hart-Scott-Rodino premerger notificationrules, 168

Healthy thrifts, 29Holding companies, supervision of, 128Hostile takeovers, 142, 143House Banking Committee, 9, 42, 119House Banking Committee bill, 31, 32"Human capital", 22

ICIC Holdings, 129Incentive-conflict theory, 88-89, 98Income capital certificates, 60Independence Bank (Encino, CA), and

BCCI,133Industrial Policy Bureau of MITI, 165Industry trade associations, 40Insolvency, 4, 24, 49, 50Institutional investors, 152-155Insurance corporation, 24Intangible assets and liabilities, 109-110Interbank exposure, 118Interbank liabilities, 12Interest payments on subordinated debt,

suspension of, 101Interest-rate risk, 41-42, 115-116, 118Interest rates, consequences of

forbearance, 59Interstate banking, 65Italy, banking supervision, 126, 128

Japanbank funding of firms, 161, 165-167

INDEX

big ownership and relationshipinvestors, 163-167

corporate leverage and frequency ofbankruptcy, 160-161

cost of capital, 144, 156, 157-159, 161cost of equity capital, 161-163hostile takeovers not possible, 143on-the-job training of workers, 146-148ratio of CEO pay to average worker'spay, 145

real wages of workers, 145manufactured export share, 144-145stock turnover rate, 142

Keiretsu (Japan), 165

"Least-Cost Resolution" (LCR), 12, 111,112

Less developed countries (LDCs), andcongressionally mandatedforbearance, 64, 65

Leveraged buyouts, 143Limited liability put option, 102, 107Lincoln Savings and Loan, 19, 74Liquidation costs, 55, 56Loan-loss reserves, 116Loans in process, 60Lobbying, 74, 75London Interbank Offer Rate, 122Loss-control techniques, for small

depositors, 81-82Loss recognition, deferred, 62Louisiana, fall in energy prices effect on

economy, 25LuxembourgBAH not classified as a bank, 127banking supervision, 126, 127-128BCCI charter, 128, 129, 130, 133in Basle Committee, 123supervision of BCCI, 135Luxembourg Banking Commission, 126Luxembourg Monetary Commission, 131

Management Consignment Program(MCP), 63-64

Managerial breakdown, 80

185

Manufacturers Hanover, 60Market imperfections, 64Market protection, 94Market rates of interest, changes

accounted for, 109Market risk, 55Market values, 24, 55-58, 77-78appropriateness under GAAP, 49-50negative, 27surety's stock, 71Market-value (current-value) accounting,

103, 104, 106, 108-112used in Wallison's program, 96, 97Maryland, private surety's loss exposure,

79Modernizing the Financial System, 9Money-center banks, 60Money laundering, by BCCI, 131, 132Monograph Series in Finance and

Economics (Salomon BrothersCenter),7

Moral-hazard hypothesis, 20-22, 24-27,31, 32, 35n

arguments concerning forbearance, 51,53

forbearance costs and SEIR, 103-104,108

forbearance role, 55, 57, 63, 66nhazard reduced by structured earlyintervention and resolution, 100

S&Ls not engaging after they becomeinsolvent, 58

Multiperiod model, 58Mutual sureties, 87

Narrow banking, 13, 105, 118National Bank of Georgia, 133New York State banking license, refused

to BCCI, 131New York Stock Exchange, 166Nonsystematic risk, 23Nuovo Banco Ambrosiano, 125

Off-balance-sheet accounts, 101Office of Management and Budget

(OMB), 19-20, 77Office of Thrift Supervision (OTS), 116

186 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

Ohio, private surety's loss exposure, 79Oklahoma, fall in energy prices effect on

economy, 25Open-bank assistance, 49Operating capital, high levels required, 26Options-type models, 55Outliers, 116Outsourcing, 87, 97Overtrading, 122

Pakistan, BCCI managerial decisionmaking, 128, 130

Performance bonding, 93Peru, banking supervision, 126, 127, 128Pilot reinsurance program, 95, 96Policyholder committees, 87Political accountability, 73Porsche, 164Portfolio diversification, 56Price Waterhouse, 130, 132, 138nPricing guarantee services, 86Private insurance, application to banking

oversight, 91-98private insurance proposals, 94-97private insurance role, 92-94Privatization, 70-71, 79Privatization plans, deposit insurance,

94-97FDIC proposal, 95-96, 97Wallison's program, 96-97Product and geographic powers for

banks, 10Project risk, 55Prompt closure, 31"Prompt Corrective Action" (PCA), 12,

111, 118Purchase and assumption, 21"Puttable" subordinated debt, bank-

issued,82Put option, 107-108

Real estate, consequences of forbearance,59

Recapitalization, 40, 46of BCCI, 132as discretionary provision of FDICIA,113

emergency plan submitted to thetranche one level, 101

mandatory, and reorganization,101-102

privatization plans, 95to avoid an FDIC takeover, 107without a declaration of insolvency, 49Receivership, 12, 113Regional banks, 60Regulatory accounting procedures (RAP)

accounting, 60Reinsurance contracts, 81, 84, 96Reinsurance systems, 95-%, 97Required capital ratio, 57Research and development spending,

145-146, 149, 150, 156-157, 162Resolution Trust Corporation, 38, 77Rhode Island, private surety's loss

exposure, 79Risk-adjusted insurance premiums, 3, 10,

12,13Risk aversion, coefficient of, 57Risk-based capital, 8, 10Risk-based deposit insurance premiums, 2Risk-bearing, shifting a tier of insolvency

risk to the private sector, 84Risk-scaled premiums. See Risk-adjusted

premiumsRisk-sharing provisions, five proximate

targets, 80-81Risk-taking, 57, 75forbearance and, 58, 63, 64, 92

Salomon Brothers Center for the Studyof Financial Institutions at NewYork University, 7, 19

Sanctions, 6Savings and loan associations, 23-25failures, 4, 8, 19, 23-24new housing programs and bankingregulation, 31

Secondary federal insurer requirements,86-87

Second Banking Directive, 135Secrecy laws of banks, 126, 128, 129, 130Securities and Exchange Commission,

13n-14nSecurities Exchange Act, 168

INDEX

Securities industry, influence shown inDingell bill, 32

Senate Banking Committee, 9, 14n, 119Senate Banking Committee bill, 31, 32Shadow Financial Regulatory Committee,

8-10, 50, 100, 116, 134BCCI supervision, 130low-risk institutions expanding risktaking, 47

members, 14nProgram for Deposit Insurance andRegulatory Reform, 61

Short-term liability accounts, 60Single-period model, 58Smoke-and-mirrors accounting, 74Social risk, 54Spot exchange contracts, 122Spread-loss pools, 86, 89nStaff Memoranda Series of the Federal

Reserve Bank of Chicago, 7"Standards of Safety and Soundness", 12,

118Standing Committee on Banking

Regulations and SupervisoryPractices, 123

Status quo, 31, 32Stockholders (or mutual stakeholders),

80,83,84Stock mutual funds, 142Stock sureties, 87Structured early intervention and resolution

(SEIR), 1-2, 8-9, 10, 13, 103advantages, 6-7, 102basic concept, 99-100Congressional support for FDICIA, 14ngreater regulatory efficiency, 104-105market-value accounting required,108-110

modified version in deposit-insurancereform provisions, 111

not accounting for risk differences,110-111

one-year grace period to raise capitaland capital ratios, 119

operational and political feasibility,105-106

possible shortcomings, 106reduces losses that need taxpayerfunding, 106

187

regulations long and complex, 118supplements prompt resolution beforecapital is depleted, 108

Subordinated debentures, 101-103, 105,110,111

Subordinated debt, 65nSuretiesinstitutional, 79private, 81, 84-86, 87-88, 93-95Surety guarantees, 71Switzerland, in Basle Committee, 123Syndicates, to guarantee covered

liabilities, 96-97Systemic risk, 15n, 26, 54, 65n, 178declaration of, 12government not fully enforcing loss-participation provisions foruninsured creditors, 83

regulatory-induced, 33-34

Takeover bids, 80Taxationcosts of forbearance passed on totaxpayers, 64, 65

resources to cover past losses of BIF, 47Taxpayer backup, 79Taxpayer loss exposure in the bank

insurance fund, 37-47accounting coverups, 37-39false test of a "December Surprise",43-46

fraudulent benefits claimed forprojected BIF accounting profits,46-47

regulator efforts to discredit FDICIA,39-43

Taxpayers, 29-30bailout of FDIC, 20bailout of FSLIC, 19forbearance as a bad bet, 50Technical insolvency, 49Texasagricultural income effect on stateeconomy, 25

fall in energy prices effect on economy,25

Third World, 60, 128, 131, 134Thrift liabilities, 60

188 REFORMING FINANCIAL INSTITUTIONS IN THE UNITED STATES

Tiered guarantees, private andgovernment, 85

Tiered regulation, 88Tokyo Stock Exchange, 165-166"Too-big-to-fail" (TBTF) doctrine, 21,

25-26, 31, 33, 86assurance coverage extended, 92exemption to least cost resolution, 11forbearance arguments, 52Two-party insurance, 93

Underreporting loss exposures, 75Underwater agricultural loans, 62Undiversified asset portfolios, 64United Kingdombanking supervision, 137, 138nBCCI retail branch locations, 129, 133CEOs' belief in U.S. having shorterplanning horizons, 143

United Statesbanking supervision, 136-137real wages of workers, 145U.S. Congress, 3, 4, 8, 118-119addition of unrelated issues to banklegislation, 30-31

banking reform, 27, 28Benston-Kaufman proposal, 9deposit-insurance/moral-hazardportions of legislation, 32

ethical duties of federal officials, 78excuses for insolvency resolutionsmade inoperative by FIRREA andFDICIA,38

FDICIA,14nFed given more active foreign banksupervision role, 136

interpretation through theirconstituency, 33-34

legislation appropriating funds toFSLIC,28

multiple veto groups, 30provisions to raise required book-valuecapital ratios, 115

U.S. General Accounting Office, 8-9,14n, 19-20, 76

U.S. Senate, 8, 30-31, 78U.S. Treasury, 8-10, 12, 31, 33,42

accounting coverups for banks andsavings and loans, 37

Unmarketable assets, 111Utility function, 57

Veribanc, Inc., 44, 45Veto points, 34

Weak thrifts, 29Well capitalized, 10, 115Writer extendible call option model, 55

Zero-book-value net worth, 50Zero-market-value net worth, 50Zero-net-worth closure rule, 5Zombie firms or institutions, 38, 39,

44