The impact of federal deposit insurance on savings and loan failures: a comment.

In a recent issue of this Journal, Professor Cebula [2] empirically investigates the impact of federal deposit insurance on Savings and Loan (S&L) failures. His paper represents a useful scholarly investigation of the causes of the S&L crisis. However, his study contains an econometric flaw that casts doubt as to one of his conclusions, the conclusion that the failure rate of S&Ls is a positive function of the real federal deposit insurance ceiling level. In addition to discussing the econometric flaw, this comment presents some new estimates of the basic model in Cebula which show that the ceiling on federal deposit insurance does not significantly affect the failure rate of S&L's.

Cebula estimates several models in his paper. These models are based extensively on Barth [1]. The most basic model is given by:

[PSL.sub.t] = [a.sub.0] + [a.sub.1][INS.sub.t-2] + [a.sub.2][COST.sub.t-2] + [a.sub.3][RP.sub.t-2] + [a.sub.4][REC.sub.t-1] + [a.sub.5][CAP.sub.t-2] + u (1)

where:

[PSL.sub.t] = the percent of federally insured S&L's that failed in year t.

[a.sub.0] = constant term.

[INS.sub.t-2] = the federal deposit insurance ceiling per account in year t - 2, in thousands of 1982 dollars.

[COST.sub.t-2] = average cost of acquiring funds for the S&L industry in year t - 2, expressed as a percent per annum.

[RP.sub.t-2] = the average price per barrel of imported crude oil in year t - 2, expressed in 1982 dollars.

[REC.sub.t-1] = a binary dummy variable with a value of 1 for the two years following the 1981-82 recession.

[CAP.sub.t-2] = the required capital/asset ratio for an S&L in year t - 2, expressed as a percent.

u = the stochastic error term.

Using this model and several modifications of it, Cebula shows by estimating this model using OLS that the coefficient on [INS.sub.t-2] is positive and statistically significant, indicating that federal deposit insurance contributed to the S&L failure rate.

The problem with the OLS estimates of the model presented in Cebula [2] is that the cost of funds variable ([COST.sub.t-2]) is, in fact, endogenous. This is indicated by the results of the Hausman specification test [6]. Also, several recent papers on the determinants of nominal interest rates verify the endogeneity of [COST.sub.t-2] [3; 4; 5; 7]. Thus, the conclusion reached in Cebula [2] may be the result of simultaneous equation bias.

To correct for the possible simultaneity bias, equation (1) is re-estimated using an instrument variable (IV) technique. It is found that the cost of acquiring funds (COST) is largely a function of the treasury bill rate. Thus, the instrument for [COST.sub.t-2] is [TBILL.sub.t-3], the three-year lagged average nominal interest rate of the 13-week treasury bill. This instrumental variable systematically explains [COST.sub.t-2] but is not correlated with the error terms in the basic system.

The IV estimate of equation (1) using [TBILL.sub.t-3] as the instrument for [COST.sub.t-2] is:

[Mathematical Expression Omitted].

Terms in parenthesis below the coefficients are the t-ratios. The Cochrane-Orcutt procedure was used to correct for first-order serial correlation.

The results presented in (2) reveal that when the endogeneity of [COST.sub.t-2] is accounted for, the coefficient on [INS.sub.t-2] is no longer statistically significant at even the ten percent level. This result suggests that federal deposit insurance did not contribute to the S&L crisis. The other variables remain statistically significant as in the OLS estimate of equation (1), a result consistent with Cebula [2].

Two other tests are performed to verify the above result. First, the variable [CAP.sub.t-2] is dropped from the model. This is done to eliminate some possible collinearity with [INS.sub.t-2] and because this variable was significant at only the ten percent level while all other variables were significant at the five percent level or beyond. The IV estimate of (1) with [CAP.sub.t-2] deleted and, again, using the Cochrane-Orcutt procedure to correct for first-order serial correlation reveals:

[Mathematical Expression Omitted].

The results in (3) indicate no change in the non-significance of [INS.sub.t-2]. Thus, after having correcting for the endogeneity of [COST.sub.t-2], there is still no evidence that federal deposit insurance was a determinant of the failure rate of S&L's. The statistical significance of the other variables in the model remain virtually as they were in Cebula [2] and in equation (2).

The second change in equation (1) is to decrease the lag on the insurance variable to one year. Thus, equation (1) is re-estimated using [INS.sub.t-1] instead of [INS.sub.t-2] and with [CAP.sub.t-2] deleted as in equation (3). Estimation is, again, done using instrument variables and the Cochrane-Orcutt procedure. The result is:

[Mathematical Expression Omitted].

The results still indicate that the coefficient on [INS.sub.t-1] is not statistically significant at even the ten percent level. Thus, after accounting for the endogeneity of [COST.sub.t-2], all three estimates of the basic model reveal that federal deposit insurance did not significantly affect the failure rate of S&L's.

This comment shows that the conclusion in Cebula [2] that federal deposit insurance contributed to the failure rate of S&L's may have been a result of simultaneous equation bias. This comment has also presented evidence that the other variables in the analysis presented in Cebula [2] were not significantly affected by this simultaneous equation bias. However, the main point of this comment is that, after accounting for the endogeneity of [COST.sub.t-2], the conclusion that federal deposit insurance affects the failure rate of S&L's is unsupported.

Ira S. Saltz Valdosta State University Valdosta, Georgia 

References

1. Barth, James. The Great Savings and Loan Debacle. Washington: AEI Press, 1991.

2. Cebula, Richard J., "The Impact of Federal Deposit Insurance on Savings and Loan Failures." Southern Economic Journal, April 1993, 620-28.

3. -----, "Federal Government Budget Deficits and Interest Rates: An Empirical Analysis for the United States, 1955-84." Public Finance, No. 3, 1988, 337-48.

4. -----, "Federal Government Budget Deficits and Interest Rates: A Brief Note." Southern Economic Journal, July 1988, 206-10.

5. Feldstein, Marin and Otto Eckstein, "The Fundamental Determinants of the Interest Rate." Review of Economics and Statistics, May 1970, 363-75.

6. Hausman, Jerry A., "Specification Tests in Econometrics." Econometrica, October 1978, 1125-51.

7. Hoelscher, Gregory, "New Evidence on Deficits and Interest Rates." Journal of Money, Credit, and Banking, February 1986, 1-17.