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Not all financial crises are alike!

Introduction

The United States has experienced numerous financial crises characterized by widespread abrupt and sharp increases in the failure of financial institutions, particularly commercial banks, and in equally sharp jumps in credit spreads for high credit quality debt. Specifically, there were recessions in 1907, 1920-21, 1929-33, 1980s, 2000-01, and 2007-10. Carmen Reinhart and Kenneth Rogoff in their seminal book This Time is Different (2009) focus on the similarities of the crises and the conditions leading up to them in both the U.S. and elsewhere. These include a rapid buildup of credit, both in the aggregate and in important individual sectors, leading to bubbles in real estate and commodity and stock prices, which when burst led to a sharp decline in credit, economic contraction and failures of many financial institutions. Notwithstanding the work of Reinhart and Rogoff, we find financial crises are not all alike nor do they have similar consequences.

There are three important dimensions in which these crises differ. First, the macroeconomic and related policy environments were different. The Great Depression (1929-33) was a postwar environment, the thrift crisis (1980s) was heavily driven by the inflation and regulatory environment, and the Great Recession was in our view largely an unintended consequence of government housing policies. Second, each crisis exhibited different systemic risk, liquidity, and bank and thrift institution failure impacts. Third, the longer term policy responses in terms of legislation enacted were directed toward different perceived problems and theories about the operation of financial markets and institutions. As such, appropriate public and private policy responses to future crises may be expected to differ.

In the sections that follow, we examine the differences outlined above in three different dimensions. We first explore the macroeconomic and policy environments leading up to the three financial crises and, the short term policy responses and evidence of their effectiveness. Next, we analyze differences in runs on depository institutions and in liquidity problems. Finally, we examine the longer term regulatory and legislative policy responses that were designed to ensure that the kinds of problems experienced would "never again" occur.

The Macro Policy and Economic Environment Leading Up to the Crises

The macroeconomic environments in terms of inflation, GDP growth and employment were significantly different leading up to the Great Depression as compared to the thrift crisis of the early 1980s and the Great Recession of 2007-2010. Figure 1 provides a long view of three series of interest, annual percent change in real GDP and average annual rates of unemployment and inflation, from 1920 to 2014. This time span includes many recession periods the U.S. economy has experienced. And in some instances the crises periods span more than one single recession. The next subsections look at each of these periods in greater detail.

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The Great Depression (1929-33)

The Great Depression was preceded by three shorter recessionary periods as defined by the National Bureau of Economic Research (NBER):1) Q1 January 1920 to Q3 July 1921, 2) Q2 May 1923 to Q3 July 1924, and 3) Q3 1926 to Q4 1927. Inflation in the first of these three recessions peaked at 15 % in 1920. This was a direct result of World War I (WWI): the debt financing associated with that war in the US and the inflow of gold in payment of European purchases of war supplies from the US. In fact, no discussion of inflation during this period is complete without recognizing the importance of the gold standard and central bankers' adherence to it.

Fixing a currency's value and outstanding volume to gold and settling trade imbalances by shipping gold can create deflation in one country and inflation in another, unless gold inflows are sterilized. One consequence of WWI, its financing, and the gold standard was that by 1923 the US had accumulated approximately 60 % of the world's nearly $6 billion supply of gold, up from about 40% in 1913 (Ahamed 2009, p. 162). As a consequence, the price level had increased by some 60 % in the US during the war. Federal Reserve Bank of New York Governor Benjamin Strong estimated that prices would double if the country followed strict adherence to the gold standard without attempting to sterilize those inflows.

To avoid a possible firrther expansion of credit and prices, Strong and the Fed embarked upon efforts to sterilize the inflow. The principal monetary policy tools available at that time were the discount rate, which was raised to help push up interest rates (Fig. 2), reserve requirements, and, to a more limited extent, open market operations. (1) The discount rates were raised to 7 % in 1920-1921, but this only reinforced to the recession once wartime production and demand fell off (Ahamed 2009). (2)

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The first three of the four recessions that followed the end of WWI were accompanied by a deflation (Figure 1). The rate of inflation dropped to minus 10%in 1921. It was well below 2 to 3 % through the next two recessions until plummeting back to minus 10 % in 1932. Unemployment jumped in the 1920-21 recession to nearly 17 % before declining to a low of 2.8 % in 1926 and remained thereafter in the 4.7-6.4 % range until 1930. The real difficult times were in the 1930s until the onset of World War II (WWn). Unemployment peaked at about 35 % in 1933, GDP declined some 13 % in 1932 and prices decline 9.9 % that year as well.

With the onset of the recession in 1929, the Reserve Banks cut the discount rate from 6 % in the fall of 1929 to 1.5 % in 1931. But, in light of the deflation that occurred, Fishback (2010) estimated that the ex post real discount rate actually rose slightly from 4.5 to 4.77 % in 1930 and increased further to 10.5 % in 1931. To support the rules of the gold standard and to counteract the inflow of gold, the nominal discount rate was increased to 3.5 % and then allowed to decline to 2.5 % in 1932. But because of the 10 % deflation that occurred, the estimated ex post real discount rate actually increased to 12.5 %. The illusion of monetary policy accommodation was undermined by the failure of the Fed to compensate sufficiently for the effects deflation had on real rates, which led to a de facto tightening of policy. Each of the three recessions leading up to the Great Depression was short lived, and occurred within a year or so of each other (Fig. 1).

Even today, economists cannot agree on what caused first the sharp run up in the stock market in 1929 and then the bursting of its bubble. There does seem to be a consensus, however, that policy mistakes were made by the Fed. Friedman and Schwartz (1963) went so far as to suggest lack of both leadership and competence were significant contributing factors. Others have blamed enforcement of the rules of the gold standard, poor tax policy, and increases in both the discount rate and reserve requirements that resulted in a collapse of the money supply. (3,4,5) What is not in question is that the money supply declined by 26 % between 1929 and 1933, (6) the price level fell by 25 %, unemployment increased to one quarter of the workforce in 1933, wages fell by some 42 %, and real GDP declined by about 25 % between 1929 and 1933. The U.S. experienced the longest depression in its history, and the downturn only ended with the onset of WWII. (7)

The Recession of 1981-1982

In contrast to the short inflation leading up to the 1921-22 recession, Fig. 1 shows that inflation was on a steady upward trend that began more than a decade before the onset of the 1980-1982 recession. After 1956, inflation peaked at over 11 % in the height of the 1972-1974 recession, and declined to about 6.2 % in 1973 before accelerating again to 13.5 % in 1980. Inflation remained high for the 10 years from 1973 to 1982, averaging 8.75 % with a low 6.2 % and high of 13.5 % in 1980. Except for the brief period of WWII, this was the longest period of high inflation the nation has experienced from 1922 to the present.

The inflation of that period could be explained by two divergent hypotheses. The first period starting about 1956 to 1971 was the heyday of belief in the Phillips curve and attempts by Fed board Chairman Arthur Bums to exploit what economists believe to be a short-term tradeoff between inflation and employment. The evidence was that the Federal Open Market Committee (FOMC) was skeptical about its ability to control inflation and was reluctant to act if in tightening there was the likelihood of adversely affecting employment. The period came to an end with the imposition of wage and price controls by the Nixon administration in 1971 and the final and total decoupling of the US from the gold standard, the onset of the 1973-1974 recession, and first major oil shock in 1973.

The second period, 1972 to 1982, saw a continuation of the run up in inflation until it was addressed by the Volcker Fed which raised interest rates to finally break the back of inflation. But this action culminated in the recession of 1981-1982.

The pressures were especially great because of the Regulation Q deposit rate ceilings on banks and thrifts. Deposit rate ceilings capped the rates that could be paid by depository institutions on their deposits. These ceilings were not binding for many years after their enactment in 1933, until inflation began to accelerate in the early 1960s. The acceleration in inflation triggered increases in nominal interest rates that bumped against Regulation Q ceilings. Depository institutions were caught funding asset/liability maturity mismatches that resulted in both negative spreads and disintermediation as depositors withdrew funds seeking alternatives in higher paying government securities and money market mutual funds. Savings and loans (S&Ls), who were the primary mortgage providers were especially stressed. To relieve their situation, S&Ls were given a quarter point interest rate differential on deposit rate ceilings compared to commercial banks to attract more funds as part of government policies to support housing.

The attempts by government and policy makers to address the financial problems in the S&L industry included selective relaxation of Regulation Q ceilings, deregulation of a number of thrift and bank product lines, promulgation of policies designed to encourage thrifts to grow out of their problems, injection of overvalued net worth certificates by the Federal Savings and Loan Insurance Corporation (FSLIC) in insolvent institutions, which were counted as capital in satisfying regulatory capital requirements, and raising the minimum denomination of Treasury securities from $1000 to $10,000 to make them less attractive investment vehicles to households. But these actions only served to postpone the inevitable collapse of the S&L industry, and possibly increased the cost of the failures to the taxpayer in the long run. (8) This, combined with efforts by the Federal Reserve to break the back of inflation by raising rates had predictable consequences-the collapse of the thrift industry. The S&L collapse has been well documented (Kane 1989a).

The Great Recession (2007-2009)

In contrast to the 1981-1982 recession, the Great Recession of 2007-2009 was not accompanied by a significant run up in inflation. But short-term interest rates went from under 1 % for one month constant maturity Treasuries to a peak of 5.25 % in March of 2007 before the onset of the crisis. After the double-dip recession that began in 1980 and ended in the fourth quarter of 1982, the U.S. entered a 25 year period where recessions were moderate and infrequent. The economy prospered from the mid-1980s through the early 2000s and ushered in what many came to call the "Great Moderation" (Fig. 3).

During this period, the economy experienced only two mild recessions. The first began in the third quarter of 1990 and lasted through the first quarter of 1991. The second started in early 2001. Prices for internet stocks, which had run up sharply, collapsed and aggregate investment contracted, the economic effects of which were exacerbated by the September 11, 2001 terror shock. This resulted in a short and mild recession that ended in the fourth quarter of 2001. The 2001 recession was even more moderate than the 1991 recession.

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During the periods immediately following the 1982, 1991 and 2001 recessions, the Federal Funds rate, the unemployment rate and inflation generally drifted down. Real gross domestic product (GDP), however, was on a significant upward trend.

The result of this extremely benign economic performance coming out of the 2001 recession was a resurgence of optimism on the part of both businesses and consumers. Because the perceived risks of a significant decline in economic activity were reduced, they were willing to take on greater leverage and increased debt, both consumer and housing related. (9)

By June 2004, the economy seemed to be returned to its earlier, faster growth path. But signs indicated that inflation was picking up. In response, the FOMC decided that it could preemptively begin to remove the policy accommodation put in place following September 11 and the 2001 recession that had resulted in low short-term interest rates. (10) In respond, the Fed embarked upon a path of slow and "measured" increases in the targeted Federal Funds interest rate. But, longer term interest rates did not increase initially in mid and late 2004 as market participants expected (Fig. 4). (11)

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Overly accommodative monetary policy on the part of the Fed is only part of the story of the preconditions and macro environment that led up to the Great Recession. The causes of the financial crisis were numerous, including economic policy actions that created preconditions without which the crisis would not likely have occurred or been as severe, policies to support housing, and regulatory policy mistakes.

The policies at issue caused both borrowers and lenders to invest (and, in hindsight, to over-invest) in housing and to increase leverage and risk-taking. These policies also indirectly created incentives to employ newly developed complex financial instruments like financial derivatives, credit default swaps, asset-backed securities and innovative mortgage instruments to expand mortgage lending. Especially important was the role played by government-sponsored entities, and most importantly, Fannie Mae and Freddie Mac. (12,13) Both of these firms' activities were confined to the secondary mortgage market, where they issued mortgage-backed securities against pools of mortgages assembled by mortgage originators in exchange for the underlying assets. (14) They also purchased mortgage-backed securities for their own portfolios as well as whole mortgages and some other liquid securities. They benefited and dominated the secondary market because of the implicit government guarantees that lowered their overall cost of funding relative to other purely private financial institutions. By 2003, those two institutions held over $4 trillion in mortgage obligations and accounted for approximately 45 % of the residential mortgage market.

Congress pressured Fannie Mae and Freddie Mac to further exploit their implicit subsidies. They were pressured to expand borrower eligibility by lowering lending standards and to accept progressively lower quality assets in their investment portfolio and mortgage-backed security activities. (15) The systematic subsidization of loans to less credit-worthy bonowers is one of the distinguishing factors in the U.S. mortgage market. (16) This support was a major factor in creating the housing bubble and the large costs of the ensuing crisis. (17)

Other significant factors acting to keep interest rates low leading up to the Great Recession were the U.S. trade and fiscal situations, not unlike the period leading up to both the Great Depression and the 1982-83 recession. Over most of the period of the Great Moderation the U.S. was running persistent fiscal deficits. Entitlement spending was expanded without adequate funding being provided. (18) Historically, most increases in U.S. fiscal deficits were the result of wars which increased defense spending sharply. But, once the conflicts stopped, government spending would return in line with revenues within a relatively short period of time. This did not happen during the 1990s or 2000s. The continued growth in government spending outstripped additional revenue collections (taxes). To fund these expenditures, the Treasury had to continually expand the size of the outstanding Treasury debt issued, putting persistent upward pressure on government borrowing costs and interest rates rose.

In the 1990s and the 2000s, the U.S. began to run large trade deficits on current accounts on the order of 5 % of its GDP. (19) The result of the persistent trade deficit was an accumulation of dollar claims abroad. Those dollar claims were accumulated by governments and in sovereign wealth funds that invested heavily in U.S. Treasury and agency securities, which were safe and attractive to those risk-averse investors. (20) There were three key causes associated with the accumulation of dollars abroad. That helped fuel demand for U.S. Treasury debt and kept worldwide interest rates lower than they otherwise would have been. (21)

First, was the oil crisis of the mid-1970s, characterized by the rise of oil prices from Organization of Petroleum Exporting Countries (OPEC) countries and the continued and growing dependence of the U.S. on oil imports. Oil exporting countries accumulated significant dollar claims, which came back into the U.S. mostly in the form of private investment and purchases of large amounts of U.S. Treasury debt. Second, beginning in the 1990s, China emerged as a major exporter of consumer goods and, in the process, began accumulating additional large reserves of dollar claims. Next to the Federal Reserve, China is the largest external holder of U.S. Treasury debt.

Third, the expansive domestic monetary policies followed by Japan were another contributing factor to the ability of the U.S. to fund its twin deficits on favorable terms. Japan, which was mired in a protracted slowdown and experiencing price deflation, introduced accommodative domestic monetary policies. Auerback (2006) argued that during this time Japan underwent a deleveraging, which, when combined with the Bank of Japan's extremely expansionary monetary policy, flooded the market with cheap funds which could be borrowed at near zero interest rates. (22) Arbitragers quickly perceived an opportunity to borrow yen and purchase higher yielding dollar assets, namely U.S. Treasuries, in the yen "carry trade," earning a nearly risk-free return. While the size of the yen carry was difficult to measure, various estimates had put its size at between $400 billion to $1 trillion. (23)

Those factors allowed the U.S. Treasury to finance debt internationally at low rates. If the same volume of debt were to have been financed domestically, the required interest rates would have increased. To keep its target rate at the desired level, the Fed would have had to buy Treasuries in the market, thereby increasing the monetary base at the risk of increasing inflation. The combination of external demands for U.S. debt from three disparate sources contributed to keeping inflation and interest rates lower than they might otherwise have been. Indeed, this downward pressure on rates provided incentives that fueled the housing bubble despite the efforts of the FOMC to raise rates in 2004. (24)

Not only were the macroeconomic conditions leading up to the Great Recession different from those preceding both the Great Depression and the recession of 1982-83, but also the short-term policy responses to the liquidity problems experienced in the highly leveraged asset-backed commercial paper market and subprime mortgage market were substantially different. (25)

Cracks began to appear in the subprime mortgage market in early 2007, after several months of declines in housing prices, when HSBC announced unexpected losses in its subprime mortgage portfolio. In June, S&P downgraded over 100 bonds backed by subprime mortgages. Bear Steams then suspended redemptions of two of its special purpose vehicles and BNP Paribas announced that it was suspending valuing three of its sponsored money market funds. The T-bills and ED (TED) (the difference between three month. LIBOR and three month. US Treasuries) spread widened from about 25 basis points to about 237 basis points in August 2007 (Fig. 5.). The Fed responded with a cut in the discount rate and the European Central Bank (ECB) provided emergency liquidity to its banks.

The initial Fed response to the 2008 crisis was that financial markets were experiencing a temporary liquidity problem that could be handled by the Fed's discount rate and window, which were the classical responses by a lender of last resort. However, as subsequent events would reveal, temporary liquidity problems do not persist for long.

Over the ensuing months, the Fed designed a series of programs to provide additional liquidity, while not subjecting financial institutions to the stigma typically associated with discount window borrowing. In the fall of 2008, the TED spread had spiked again, this time to well over 500 basis points, and it was clear that a full blown financial crisis was in process. Table 1 describes these programs. (Calomiris et al. 2011).

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Programs were targeted mainly at the largest financial institutions, many of which were primary dealers. (26) The defining characteristic of the beneficiaries of the programs was: that they were the largest financial institutions operating in the US, both foreign and domestic, heavily involved in securitization and highly leveraged. (27) For such institutions, even small increases in credit spreads put them under heavy pressure to cover collateral requirements, and threatened their solvency.

The pressure on the largest institutions contrasts sharply with pattern of failures and runs on small banks during the Great Depression and the demise of the thrift industry during the crisis of the 1980s. This experience is detailed in the next section.

Financial Intermediaries, Runs, Failures and Systemic Risk

Bank runs play important roles in the financial crises of 1929-33 and 2007-10, but were less important in the crises of the 1980s. Moreover, the runs differed significantly in type in these two crises periods. In the 1930s, bank depositors ran primarily from deposits to currency outside banks (Friedman-Schwartz type of runs) resulting in a decline in aggregate bank credit and the money supply.

In the 2007-2010 crisis, two other types of runs were experienced. One was a run to quality and the other was a run to take down lines of credit in case there was a credit crunch. Currency did not increase significantly. Indeed, both the monetary base and money supply did and the currency ratio declined. Collateral requirements in non-Treasury securities were upgraded to Treasury securities, haircuts were increased, and interest rate spreads increased. In addition, while aggregate bank credit increased, its composition changed significantly. Ivashina and Scharfstein (2010) observed that entering the recession, many firms that relied primarily upon the money and capital markets for short-term funding had established backup lines of credit with commercial banks. Following the failure of Lehman Brothers, those firms rushed to take out loans from those commitments before a credit crunch could develop. As a result, while syndicated bank lending fell by nearly 47 % and merger and acquisition (M&A) activity also declined, bank commercial and industrial (C&I) lending increased by about $100 billion in less than a month as a result of those takedowns. Ivashina and Sharfstein state that "These credit line drawdowns were part of a 'run' on banks that occurred at the height of the crisis. Unlike old-style bank runs by depositors when there was no deposit insurance--this bank run was instigated by short-term creditors, counterparties and borrowers, who were concerned about the liquidity and solvency of the banking sector." It differed from other runs since borrowing was increased rather than funds withdrawn by depositors.

Runs and Failures in the Financial Crises

Banking developed and expanded rapidly in the U.S. in the post-Civil War period. People increasingly preferred bank deposits to currency to finance their purchases and store their wealth. As a result there was a long downward trend in the ratio of currency to bank deposits. In 1867, the first year in Friedman and Schwartz's data on currency and total bank deposit, the ratio of currency to bank deposits was 0.83. By 1940, the ratio had declined to 0.14.

After remaining relatively constant in the decade before the Great Depression, the public's holdings of currency jumped sharply in 1931 and 1932. Depositors did not perceive any bank in their market area to be safe and converted bank deposits into currency.

At the same time, total deposits at commercial banks declined sharply after increasing in the 1920s. As a result, the ratio of currency to total bank deposits declined slowly in the 1920s from 0.14 in 1921 to0.09in 1930 beforejumping sharply, doubling in size, to 0.19 in 1933. For a number of reasons, the Federal Reserve did not fully replenish the loss in bank reserves from the withdrawal of currency, so despite the sharp increase in currency, the increase was smaller than the decline in either bank deposits or the money supply. A large number of banks failed. (Figure 6 shows that a total of 15,162 banks failed between 1921 and 1940. Failures peaked at near four thousand in 1933 and then dropped off to nearly zero after the bank holiday and creation of the FDIC.)

In contrast to the Great Depression, currency runs were of little importance in the crises of the 1980s and 2007-10 for four primary reasons. First, the introduction of FDIC deposit insurance in 1933 backed by the federal government effectively made small covered deposits 100% safe at all insured banks and largely removed the need for small depositors to run in response to the threat of financial problems at their banks. (28)

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Second, the Federal Reserve had learned the high cost of not folly replenishing bank reserves drained by any increase in currency, particularly in crisis periods. This was clearly evident in the near overnight development by the Fed of broader and deeper liquidity facilities in 2008 to supplement the traditional discount window.

Third, as the volume of business increased and the average size of transactions increased, the cost of using currency as a medium of exchange for transactions also increased. Less currency was held per unit of income than in earlier years, reducing its importance as a medium of exchange. At the retail level, payment by debit and credit cards replaced currency through increased convenience and wider acceptability. This also reduced the need for runs to currency held outside of the banking system, compared to the early 1930s and earlier periods of financial stress.

Notwithstanding the lack of runs, there was a radical shift in the composition of bank and thrift institution liabilities. The rapid rise in inflation and market interest rates combined with restrictions on the ability of banks and thrifts to pay market rates on deposits due to depression era deposit rate ceilings kept at below market rates resulted in banks and thrifts losing deposits and suffering loses that drove many into insolvency and failure. Figure 7 shows the pattern of bank and S&L failures over the period.

Three observations may be made. First, the failure problem was prolonged and lasted more than a decade, in part due to regulatory and related efforts to avoid recognizing the extent of the problem, especially for thrift institutions. Second, the number of failures (2912, between 1980 and 1994) was much less than that experienced during the Great Depression. Third, the run-up and peak in bank failures preceded that for S&Ls.

As noted earlier, the runs experienced during the Great Recession were different than those experienced during the Great Depression, and not surprisingly, the failure experience was also different. Runs to quality were large in 2008-2010, and the integrity of the balance sheet of nearly all large financial institutions was threatened.

But, there were no reductions in aggregate bank credit or money supply, in part because potential increase in interest rates on risky private securities was also offset by the Fed liberally accepting such securities at its expanded discount facilities. Additionally, runs on both bilateral and triparty repos were to other more liquid securities that did not exert strong downward pressure on aggregate money or aggregate credit, but primarily widened interest rate risk spread above the riskless rate. Table 2 shows the total assets invested in taxable money market funds by investments in default-free (federal government) securities or in high credit quality private (prime) securities annually from 1988 to 1992 and from 2006 to 2010.

Both types of money market funds expanded steadily throughout the first period, although government funds somewhat more rapidly but were not indicative of a significant run to quality. But the picture was sharply different in 2006 to 2010.

Assets in prime funds increased slightly in this period, while assets in government funds more than tripled in size and increased from 28% of prime funds in 2006 to 80% in 2008 before declining sharply. This clearly indicated a run to quality.

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The bank failure experience was also significantly different from that experienced either in the Great Depression or during the thrift crisis of the 1980s. Figure 8 shows that 525 banks failed between 2007 and 2015.

But the striking difference from the previous two experiences was what happened to the nation's largest institutions. They are listed in Table 3. Also listed are large foreign banks that failed. Many of the foreign institutions were also major beneficiaries of the Federal Reserve's emergency liquidity and lending programs.

Potential for Systemic Risk

The failure of financial institutions is perceived to be more damaging to economic welfare than the failure of other firms of similar size for a number of reasons. The failure of one bank may spill over to other banks more easily, endangering their solvency. This occurs because banks tend to be interconnected through interbank deposits and loans. The risk of problems at one or a small group of banks spilling over to other banks and the system as a whole is referred to be as systemic risk.

Moreover, the more similar are the balance sheet of banks, the more likely is an adverse exogenous shock to affect a larger geographic area more strongly. Both of these effects are affected by the number of banks. The larger the number of banks, the more different their balance sheets are expected to be. Thus, systemic risk is less likely with low concentration ratios and vice-versa, the greater the concentration of banks in a market area, the greater the potential for systemic risk. The percent of FDIC insured commercial bank assets held by the largest three banks was near 10% in the 1930s and declined slowly until the early 1950. Thereafter, the share increased steadily, reaching 15% in early 1980 before declining back to 10% in the early 1990s before the relaxation of restrictions on interstate banking. Thereafter, it accelerated rapidly to about 25% just before the financial crisis. But the most rapid rise was during the financial crisis. Emergency mergers of large troubled institutions resulted in a banking system in which the three largest institutions held about 33% of total banking assets. Thus, while the potential for national systemic risk was low in the first two crises, it has become a major concern following the Great Recession. Unless concentration is reduced, in the future, this suggests that the potential for national systemic risk in banking remains high.

Longer Term Legislative Responses to the Crisis

In all three episodes considered above, Congress responded to the threat to financial institution safety and soundness by passing legislation designed to remedy the problems exposed by the crisis and to strengthen and enhance the supervision and regulation of financial institutions and markets so as to ensure that the problems exposed would not be repeated. Whether or not these attempts have succeeded is considered in this section.

In the case of all three crises, there were significant legislative responses designed to ensure that subsequent crises would either never occur or not have the same kinds of systemic spillover effects that had occurred. In each case, there was a rush to pass remedies based upon the perceived causes of the problems rather than first conducting a thorough forensic evaluation of the sources and nature of the flaws in the structure and regulation of both financial institutions and markets and how they might best be addressed. With respect to the Great Depression and 1980s crises, the changes adopted were largely unrelated to the underlying causes of the crises and often sowed the seeds for the subsequent crises. While the evidence is still out with respect to the responses to the Great Recession, it can be argued that, like the other two attempts to ensure that crises would "never again" occur, the Dodd-Frank Act failed to address the key underlying issues and perhaps the most significant single contributor to the crises, government housing policy, was totally ignored. We briefly detail responding legislative initiatives and indicate how they may have contributed to later crises.

The Great Depression

In large part due to the depth and breadth of the Great Depression and its devastating effects on employment and the general level of economic activity, the federal government responded with a wide range of both fiscal and financial reform proposals that far eclipse the later responses to the 1980s recession and even the Great Recession. The Roosevelt New Deal put in place public works programs designed to put people to work and increase aggregate demand. Social welfare and safety nets like Social Security and Federal Deposit Insurance were instituted. In terms of financial system reform, legislation enacted in 1933, 1934 and 1935 reformed how stocks and securities were distributed, established norms for both brokers, dealers, and investment advisors, redefined the landscape between banks and investment banks, and restructured the Federal Reserve. As previously mentioned, federal deposit insurance was established. The Banking Act of 1933 (Glass-Steagall Act), among other things, separated investment banking from commercial banking, established ceiling rates that banks could pay for deposits (and later protected savings institutions and their role in housing finance by giving thrift institutions a somewhat higher permissible rate for savings compared to commercial banks through Regulation Q), prohibited the payment of interest on demand deposits and restructured the Federal Reserve by shifting the power of the Board of Governors from the Presidents of the Reserve Banks and created the FOMC. Other legislation created a parallel government insurance fund and regulatory body for thrift institutions. Table 4 provides a brief summary of the key features of this legislation.

Much public attention focused on evidence that surfaced during a series of 1932 congressional hearings on the role of Wall Street in the crisis. Ferdinand Pecora, an assistant district attorney from New York, exposed perceived abuses in a series of congressional hearings that served as part of the rationale for passage of the Banking Act of 1933 and the Securities Act of 1933. Many of the provisions had been included in previously proposed legislation, but were not enacted. Much subsequent research has shown that two of the main provisions of the Glass-Steagall separation of banking and commerce and the imposition of deposit rate ceilings were based upon faulty premises. (29) Indeed, Calomiris (2010) argues that what he regards as the three major pieces of banking legislation: Glass-Steagall prohibitions on bank underwriting of securities, deposit rate ceilings and the creation of the FDIC, were rooted mainly in (1) the populist desire to protect small banks, despite evidence of their frailty and propensity toward failure, by preserving the unit banking system and (2) the false reliance upon the "real bills" doctrine that dominated the then view on the proper role of a central bank in the economy. The "real bills" doctrine held that banks, and hence also the central bank, should only lend against good collateral defined to mean short-term self-liquidating loans that arose naturally in the normal course of trade. According to Calomiris (2010), this meant that accommodation through the discounting of eligible credit would not accommodate expansion of lending associated with securities activities, real estate, or industrial or consumer credit. As such, rather than targeting the growth of aggregate credit or the money supply, Calomiris suggests that the "real bills" doctrine led the Fed to pursue contractionary monetary policy in 1929 and hence contributed to the conditions that led to the stock market collapse in October of that year.

Adherence to the "real bills" doctrine, coupled with the desire to adhere to the rules of the gold standard, further led the Fed to pursue restrictive policies, both by sterilizing the inflow of gold and by reinforcing its mistaken believe that the low interest rates that existed in the Depression signaled that credit was easy.

Proponents of the restriction on the payment of interest on bank deposits also held the mistaken belief that left unregulated, banks would engage in ruinous rate competition and, again reflecting the unit banking theme noted by Calomiris, would also enable large money center banks to attract funds from rural areas and direct those funds into securities markets, thereby disadvantaging small rural banks. This competitive disadvantage also inhibited their ability to accommodate the productive deployment of credit, especially over the agricultural cycle, consistent with the "real bills" doctrine.

Benston (1964) specifically investigated empirically the role that payment of interest on deposits had on bank failures and incentives to engage in ruinous rate competition. He examined data on 1) earnings, expense, interest expense and bank loss data, 2) national bank interest rate expense, returns on assets, and loss experience for selected years prior to the Great Depression, and 3) national bank failures and the rates paid on deposits from 1929 to 1935. His conclusion was that there was no empirical support for the ruinous rate competition or safety and soundness hypotheses used to justify the imposition of deposit rate ceilings. In fact, Benston found a negative relationship between interest payments on deposits and the probability of bank failure. Another empirical study by Cox (1966) also failed to find that payment of interest on deposits had a significant effect on bank failure probabilities.

Unlike Calomiris (2010), who argues that the prohibition on securities underwriting was in part the desire to preserve the dual banking system and protect small banks, proponents, in particular the powerful Senator Glass, chairman of the Senate Banking Committee, argued that banks had not adhered to the real bills doctrine and instead engaged in speculative lending that was not productive. Moreover, Wall Street banks were thought to have engaged in fraudulent activities, the business of securities underwriting was fraught with conflicts of interest, and securities activities had contributed to the failures during the crisis. These concerns were given life in a series of congressional hearings conducted by Ferdinand Pecora, that lead to the separation of much of banking from investment banking. The legislation permitted only limited securities activities by providing exemptions for federal government securities and certain municipal bond activities.

The Great Depression legislation reflects a hasty, and understandable desire on the part of policy makers to "do something" to address what was truly a crisis situation. Unfortunately, the remedies chosen were often ill-conceived and based upon faulty theories, incomplete evidence, and populist bias against large money center banks and other Wall Street institutions (not all of which was unfounded). Unfortunately, some of that legislation, namely Regulation Q, the prohibition of the payment of interest on transactions accounts, and poorly designed deposit insurance (in particular, the FSLIC and the Home Loan Bank System), arguably directly contributed to the subsequent financial crises and the near demise of thrift institutions in the late 1970s and 1980s.

The Recession of 1981-1982

The banking and thrift crisis of the 1980s and early 1990s was radically different from the Great Depression in terms of its precursor events, the long duration of the demise of the thrift industry and the legislative responses. The seeds for the thrift crisis were sowed in the run up in inflation and interest rates that occurred during the 1970s and described earlier in this paper, combined with the perverse effects that Regulation Q ceilings had on the financial condition of commercial banks. From 1932 to 1957, the ceiling rate on bank small time and savings deposits were initially set at 3% but were quickly reduced in 1935 to 2.5% where they remained until 1957. During that period, market interest rates were generally below the ceiling. Because the ceilings were not binding, they had little or no effect on institutions and in effect were essentially irrelevant. In 1957 the ceilings were raised to 3%, but the real impact of duly binding ceilings began to materialize only in the early 1960s. Cook (1978) indicates that, as hanks began to compete more aggressively with S&Ls for small savings deposits, interest rates began to rise. The Federal Reserve raised the ceilings twice in 1964 and again in 1965 to 5.5%. Market interest rates rose relatively quickly, and those increases, combined with increased bank competition both for funds and in mortgage lending, pressed thrift institutions, which were not at that time subject to the ceilings. Thrifts, caught funding relatively long duration fixed rate mortgages with shorter term deposits, saw their net interest margins decline quickly and turn against S&Ls and savings banks. The margin pressure problem was compounded by the disintermediation of funds as depositors withdrew funds seeking higher rate alternatives to time and savings deposits subsect to Q ceilings. Congress responded to pressure from thrift institution constituents by passing the Interest Rate Adjustment Act of 1966.

The Act extended Regulation Q ceilings for the first time to thrifts but gave them a differential higher ceiling rate relative to commercial banks on comparable deposits. Cook argues that the intent was to limit the ability of banks to attract funds from thrifts, but the action was undermined by financial innovations, such as money market funds and other market instruments. Over the remainder of the 1960s and into the 1970s, the Federal Reserve repeatedly raised the ceilings, while preserving a 25 basis point ceiling differential in favor of thrifts. At the same time, the Treasury increased the minimum denomination Treasury obligations from $1000 to $10,000, which effectively denied small depositors a safe market rate alternative relative to that available to more wealthy depositors. (30) For a partial list of such innovations see Table 5.

The event that triggered the recession of 1981-82 was the decision by the Federal Reserve to end the 1970s inflation by raising rates in 1979. Between 1979 and the onset of the recession, interest rates peaked at 15% on long-term Treasuries and mortgage rates were over 18% for 30 year mortgages. The sharp increase in rates combined with Regulation Q constraints and financial innovations caused the market value of thrift portfolios to decline both in value and size. Kane (1985) estimated that by the end of 1982, more than 66% of all thrift institutions were economically insolvent and a much higher percentage were unprofitable. Over the period from 1980-1994 more than 1600 banks and 1200 thrift institutions failed or received FDIC assistance. (31)

In contrast to the Great Depression legislative approach, the response to the thrift crisis of the 1980s was more drawn out. Over the period 1980-94, five separate pieces of important legislation were enacted that ushered in a decade of financial deregulation. These Acts are detailed in Table 6.

The first, the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA),was mainly an attempt to correct the perceived competitive disadvantage thrift institutions had with commercial banks by deregulating both rates that could be paid and products that could be offered. It permitted thrifts to offer a form of interest-bearing checking accounts in the form of negotiable orders of withdrawal (NOW) accounts that resembled demand deposits but on which interest could be paid and provided for the phase out of Regulation Q ceilings. The Act also broadened the permissible types of loans and credit card services as well as trust services thrifts could offer. The intent was to permit thrifts to diversify the types and maturities of their assets, thereby lowering their exposure to credit and interest rate risks. Nevertheless, the decline of the thrift industry continued and efforts to enable it to "grow and diversify" its way out of economic insolvency clearly had the opposite effect as many increased their risk exposure and more institutions sank into economic insolvency.

The FDIC (1997) attributes the Gam-St Germain Act (1982) to the recognition that, despite the DIDMCA of 1980, the thrift industry continued to deteriorate and by 1982 was in crisis. One of the Act's most troubling provisions to reduce failures was the authorization for the creation and purchase of net worth certificates by the Federal Savings and Loan Insurance Corporation (FSLIC). These certificates could be counted as capital by troubled institutions for purposes of capital adequacy giving then the appearance of solvency. Those certificates were widely used. They enabled the FSLIC to avoid closing insolvent institutions on a timely basis and encouraged moral hazard excessive risk taking behavior by insolvent institutions. This compounded the ultimate losses that taxpayers absorbed.

The next piece of major legislation triggered by the ongoing insolvency of the nation's thrift industry was the Competitive Equity in Banking Act (CEBA) of 1987. Its purpose, as stated by the FDIC (1997) was "... to aid the deteriorating FSLIC. CEBA provided $10,875 billion towards recapitalization of the fund and created a forbearance program for certain 'well-managed' thrifts." It also revised selected accounting standards and appraisal standards for real estate loans, and slightly increased capital standards for thrifts.

But the industry's deterioration continued. By 1989, it was clear that something real had to be done to deal with the insolvency of thrifts. Both the industry and its insurance fund were essentially insolvent. Among other provisions the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) provided government funds to resolve long insolvent institutions, and to reconstitute the structure of the deposit insurance system and regulation of thrift institutions. The Act did not reform the Federal Home Loan Bank System. Faced with the loss of its S&L constituency and associated reserves, the System morphed into a subsidized loan system for commercial banks, both large and small.

But the S&L industry's problems did not disappear. Problems in real estate, agriculture and energy hit small institutions in the southwest particularly hard and continuing problems in real estate markets were especially hard in 1990-91 for larger institutions in the northeast. Insolvencies continued to increase pressure and exerted sufficient pressure on the Bank Insurance Fund (BIF) that the need for meaningful changes could not be delayed further. This resulted in the important Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991.

FDICIA primarily addressed issues concerning the need for resolving existing insolvent institutions and preventing future insolvencies and the need for additional funding for the BIF. In particular it sought to reform deposit insurance, increase backstop funding for the insurance fund, create a loss sharing arrangement whereby solvent insured institutions would be taxed to replenish the insurance fund before drawing on the Treasury and taxpayers, enhance bank supervision, increased bank capital requirements, introduce progressively harsher regulatory sanctions on poorly performing institutions to encourage management to turn the institution around more promptly (prompt corrective actions), and mandate least cost resolution when failures occurred. Importantly, it also incorporated a unique idea originated by the academic community designed to resolve troubled institutions before their net worth went to zero, and either sell or liquidate them without loss to either the taxpayer or deposit insurance fund. (32) Unfortunately, as enacted implementation was based upon book value measures of bank solvency rather than market values, the sanctions were often applied too late. In addition, there was insufficient pressure on regulators to act in a timely fashion as specified in the law. As a result, implementation was flawed and the act did not work as intended.

The 1980s through the early 1990s was a period both of financial crisis and of an attempt to deregulate the banking and thrift industry. The popular view is that rather than solving institutions' problems and reducing risk, these actions only worsened the situation. A better interpretation is that, while deregulation was important to the future competitive landscape for financial intermediaries, it could not substitute for increased capital. Capital adequacy standards needed to be based upon simple market value leverage ratios rather than a hodgepodge attempt by regulators to allocate bank capital to different bank asset classes using arbitrary and mis-measured risk weights. Moreover, there was little pressure on the regulators to comply with the intent of the regulations rather than travel the easier but more but more costly road in the long-run of forbearance. The result, as the experience of the Great Recession subsequently showed, was a false sense of security concerning the health of banks, and especially the largest institutions in the U.S.

The Great Recession

Unlike the two earlier crises, the main financial difficulties in 2002-2010 were concentrated in the nation's largest commercial and investment banks. Also important was the role played by foreign institutions, who, like major U.S. financial institutions were major participants in the issuance of mortgage-backed securities. By facilitating the separation of originating mortgages and the wholesale investment in large pools of the mortgage-backed securities (MBS), financial engineering encouraged the large-scale financing of long term assets with very short-term and even overnight money. This increased the interest rate risk exposure of the financial institutions. Moreover both the transactions themselves and the institutions that were issuing them were highly leveraged, complex and opaque. When the rapid ran up in housing prices reversed in mid-2006 and interest rates rose as the Federal Reserve started to tighten policy, the credit quality of the underlying assets in these transactions came into question. The first adverse liquidity event occurred in the fall of 2007 when some European hedge funds failed. This was followed in 2008 by a series of major liquidity events, including the failures of Bear Steams and AIG, the takeover of Freddie Mac and Fannie Mae by the federal government and the failure of Lehman Brothers. These resolutions involved the injection of large amounts of funds by the Treasury and Federal Reserve. After the short-term responses to the crisis by the Fed and Treasury in late 2008 stabilized the offending institutions and markets, Congress turned to legislative efforts to ensure such crises would never again occur.

Congressional and public wrath was largely directed at Wall Street institutions as well as to the Federal Reserve, who some felt provided too much support to troubled large institutions and were concerned that TBTF was alive and well, especially given the consolidation of the major financial institutions that occurred during the crisis. Congress responded in 2010 with passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA). The Act consisted of some 1000 pages that introduced many more regulations to limit bank risk taking, the creation of new regulatory and oversight groups and required studies. The key provisions are listed in Table 7.

Treasury Secretary Paulson lamented shortly after taking office about the byzantine regulatory structure of multiple regulators with overlapping jurisdictions and recommended that it should be simplified and consolidated. Instead Dodd-Frank increased complexity.

The industry ended up with even more regulations and regulators than prior to the crisis. As of the end of January 2015, Rosenblum (2015) indicates that only 165 of the 280 rulemaking requirements of the act or 59% have yet been finalized. The banking regulators had finalized only 70 of their 135 required rule making requirements, and only 1/3 or 7 of the 21 rules to implement the orderly liquidation provisions of Dodd-Frank had been put in place.

Arguably, and the jury is still out on this question, the reduced number of large financial institutions and expansion of implicit and explicit guarantees that have been extended, may actually increase rather than reduce moral hazard behavior and TBTF.

The Richmond Fed recently introduced a Bailout Barometer, which estimated that as of 2013 implicit and explicit government guarantees cover some 60% of the financial sector amounting to $25.9 trillion (Marshall et al. 2015). The subsidy to financial institutions that are the beneficiaries of such guarantees can be huge. Passmore (2005) for example estimated that the value of those subsidies just to Freddie Mac and Fannie Mae alone in the early 2000s was between $122 and $182 billion.

Summary and Conclusion

In summary, although excessive credit expansion and bursting of price bubbles were major causes of each of the three major financial crises, each crisis differed substantially in its characteristics. In the early 1930s, there were very large numbers of bank failures, but mostly of smaller banks, large depositor runs into both currency and liquidity, and a reinforcement rather than a triggering of an economic downturn. In the 1980s, the number of bank and thrift institution failures was not as great as in the 1930s. There were fewer bank runs and not into currency. Bank failures had relatively little impact on the macroeconomy. In 2007-2010, a relatively small number of bank and bank-like shadow financial institutions failed, but they were among the largest and most important such institutions in the world. There was no run into currency, but large depositors and creditors ran from troubled institutions and securities into safe Treasury securities or institutions holding Treasury securities. This caused the institutions to have to sell non-Treasury assets quickly at fire-sale prices, driving them further into insolvency, and freezing credit markets. This helped to ignite and power the deepest economic recession since the 1930s.

It may be concluded that financial crises will likely be with us periodically in the future and their primary cause remains excessive credit expansions leading to price bubbles in one or more important asset classes. But many of their symptoms and consequences will likely differ and require different private and public corrective responses. Preparing to fight the last crisis promises to be no more successful in avoiding or mitigating damage in future crises than it has been in the past.

DOI 10.1007/s11293-016-9483-9

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(1) See James (2012)

(2) Discount rates were coordinated but set individually by the Reserve Banks, and there was no requirement that they be the same.

(3) See Friedman and Schwartz (1963), Meltzer (2005). See Feinman (1993) for a history of reserve requirements.

(4) See Eichengreen (1989), and Bemanke (1983) for example.

(5) For a contrary view on the role of the discount rate see Calomiris and Wheelock (2011).

(6) See http://useconomy.about.eom/od/grossdomesticproduct/p/1929_Depression.htm and http://2012books.lardbuckct.org/books/theory-and-applications-of-macroeconomics/s11-01-what-happened-during-the- great.html

(7) Calomiris and Wheelock (2011) argue that some aspects of Fed policy were triggered by concern about inflation and the buildup of excess reserves in 1936 and 1937. Furthermore, they suggest that the Fed had lost control over the monetary base though discount rate and open market operations due to the Treasury having gained control through legislation in 1933 and 1934 of the power to set the price of gold, and hence control the size of the monetary base.

(8) For a complete discussion of this crisis and its costs, see Kane (1989b).

(9) See FSF/CGFS Working Group (2009)

(10) See the FOMC Statement, http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/ defaulthtm. The reasons are discussed more fully in the meeting's minutes: http://www.federalreserve.gov/ fomc/minutes/20040630.htm

(11) This frustrated the Fed's efforts to dampen the economy and Alan Greenspan called this lack of responsiveness of interest rates to Fed policy a "conundrum" in his congressional testimony. Sec "Greenspan (2005).

(12) Frame and White (2005) indicated that part of the reason for the shift was to get Fannie Mae's debt off the federal budget. See also Financial Crisis Inquiry Commission and United States (2011).

(13) Its stock was originally held only by the Federal Home Loan Banks and thrifts.

(14) In other words, they were prohibited from participating in the primary market as mortgage originators.

(15) "Lower quality assets," means loans that have credit characteristics that make them potentially worth less as assets than loans with better credit characteristics. This arises directly from lowered lending standards. Again, whether standards have been lowered has nothing to do with whether they were followed.

(16) To be fair, it is also well documented that the government-sponsored enterprises (GSEs) were willing partners in doing so. Pinto (2011) has provided an exhaustive list of GSEs aggressive behavior and much has been documented as well in Morgenson and Rosner (2011).

(17) See Eisenbeis et al. (2007).

(18) For discussions on the fiscal deficit see Auerbach (1997) and Reinhart and Rogoff (2009).

(19) See Chinn (2005), Scott (1999), Mann (1999) and Goldberg and Dillon (2007).

(20) See Bemanke, Bertaut, DeMarco, and Kamin (2007).

(21) For a discussion of China's exchange rate policies and global imbalances, see U.S. Treasury (2007), Bernanke (2005) and (2007).

(22) See Auerback (2006)

(23) See Cecchetti, Fender, and McGuire (2010) and Fackler (2008).

(24) This argument is emphasized in Obstfeld and RogofF (2009).

(25) This section draws heavily on Eisenbeis and Flerring (2015).

(26) Five of the programs were established under the emergency provisions of Section 13(3) of the Federal Reserve Act which granted the Fed the authority to lend to various nonbank entities but only in unusual and exigent circumstances. Once those conditions were no longer met, the programs were terminated.

(27) Reportedly some were leveraged as high as 52 to one.

(28) To the extent the FDiC did not pay covered depositors immediately for any losses, small depositors were not folly protected in present value terms (Kaufman and Seelig 2002)

(29) See White (1985) and Weiher (2001).

(30) Cook (1978) details the timing of rate changes and provides historical detail on the administration of the ceilings and bank and thrift deposit payment flow patterns throughout the 1970s.

(31) There have been many detailed discussions of the causes and nature of the thrift and banking crises, so this discussion is admittedly brief and omits much in terms of the depth of analysis and understanding that now exists for that period. See for example Kane (1989), Benston ct al. (1990) and FDIC (1997)

(32) Benston and Kaufman (1997)

[email] Robert A. Eisenbeis 770rae@gmail.com

Robert A. Eisenbeis [1] * George G. Kaufman [2]

Published online: 23 February 2016

[1] Cumberland Advisors, Sarasota, FL, USA

[2] Loyola University Chicago, Chicago, IL, USA
Table 1 Federal reserve liquidity during the crisis

          Facility                Date announced       Eligible
                                                       borrowers

DW        Discount window         Ongoing              Dipository
                                                         institutions
TAF       Term auction facility   December 12, 2007    Depository
                                                         institutions
ST OMO    Single-tranche open     March 7, 2008        Primary dealers
            market operations
TSLF      Term securities         March 11,2008        Primary dealers
            lending facility
PDCF      Primary dealer credit   March 16,2008        Primary dealers
            facility
AMLF      Asset-backed            September 18, 2008   Depository
            commercial
          Paper money market                             institutions
            mutual
          Fund liquidity
            facility
CPFF      Commercial paper        October 7, 2008      Commercial paper
            handing facility                             issuers

Programs for Central Banks and non-Bank,
non-primary dealer borrowers

CBLS      Central bank            December 12, 2007    Banks
            liquidity swaps
          Money market investor   October 21, 2008     Money market
            funding facility                             investors
          Term asset-backed       November 25, 2008    Asset-backed
            securities                                   securities
            loan facility                                investors

          Facility                Maximum amount
                                  outstanding

DW        Discount window         111

TAF       Term auction facility   493

ST OMO    Single-tranche open     80
            market operations
TSLF      Term securities         236
            lending facility
PDCF      Primary dealer credit   147
            facility
AMLF      Asset-backed            152
            commercial
          Paper money market
            mutual
          Fund liquidity
            facility
CPFF      Commercial paper        351
            handing facility

Programs for Central Banks and non-Bank,
non-primary dealer borrowers

CBLS      Central bank            583
            liquidity swaps
          Money market investor   0
            funding facility
          Term asset-backed       48
            securities
            loan facility

Notes: Maximum amounts outstanding in billions of dollars
based on weekly data as of Wednesday. Primary Dealer Credit
Facility includes other broker-dealer credit. Central bank
liquidity swaps are conducted with foreign central banks
which then lend to banks in their jurisdiction.

Source: Michael Fleming (2012)

Table 2 Assets at taxable money market funds 1988-1992 and
2006-2010 (Billions of dollars)

Year    Total   Prime   Government   Gov't/Total

1988    272     211     61           22.4 %
1989    359     284     75           20.9 %
1990    414     305     109          26.3 %
1991    452     314     138          30.5 %
1992    451     300     151          33.5 %
2006    1969    1542    427          21.7%
2007    2617    1857    760          29.0 %
2008    3338    1848    1490         44.6 %
2009    2916    1809    1107         38.0 %
2010    2473    1618    855          34.6 %

Source: Investment Company Institute, Fact Book 2014, p. 196

Table 3 Major US and foreign financial
institution failures

Domestic US institutions    Foreign institutions

* Bear Steams               * ABN AMRO
* Countrywide               * Northern Rock
* Fannie and Freddie        * HBOS
* Merrill-Lynch             * Fortis
* Washington Mutual         * Dexia
* Wachovia                  * Royal Bank of Scottland
* Lehman Bros               * Lloyds
* IndyMac                   * UBS

Table 4 Great Depression financial legislation

Federal Home Loan       1. Created the Federal Home Loan Board to
  Bank Act of 1932        charter and supervise federal savings and
                          loan associations
                        2. Created the Federal Home Loan Banks to
                          lend to S&Ls, cooperative banks, savings
                          banks, community development financial
                          institutions to lower the cost of home loans
Banking Act of 1933     1. Glass-Steagall--separated banking from
                          investment banking (with some exceptions)
                        2. Created Federal Deposit Insurance
                        3. Created FOMC whose members were the 12
                          Federal Reserve Bank governors
                        4. Prohibited payment of interest on demand
                          deposits and gave Fed authority to set
                          ceilings on other deposits subject to a
                          ceiling
                        5. Reaffirmed most restrictions on interstate
                          banking in McFadden Act
Securities Act of       1. Provided for federal regulation and
  1933 (the Truth         oversight of the offer and sale of securities
  in Securities Act)    2. Required registration of all but exempt
                          securities with the SEC
Securities Exchange     1. Established the SEC
  Act of 1933
  governed the
secondary trading       2. Provided for the regulation of exchanges
  of securities.        3. Regulated broker-dealers
                        4. Contained antifraud provisions
National Housing        Created the FSLIC to insure deposits in
  Act of 1934           savings and loan associations
Banking Act of 1935     1. Restructured the Federal Reserve renaming
                          the members of the Federal Reserve governors
                          and changed the titles of the reserve bank
                          governors to reserve bank presidents
                        2. Required reserve banks to establish the
                          discount rate every 14 days
                        3. Reformed the FOMC to consist of the seven
                          members of the Board of Governors and five
                          Federal Reserve Bank presidents
                        4. Gave the FOMC sole authority over open
                          market operations
                        5. Removed the Secretary of the Treasury as
                          Chairman of the Federal Reserve Board and the
                          Comptroller of the Currency from the Board
                        6. Created a permanent FDIC fund
                        7. Eliminated double liability for bank
                          shareholders plus other technical amendments

Table 5 Regulation Q related financial innovations and
regulatory response

Innovation             Time and regulatory response

1. Development of      a. Late 1950's--Early 1960's--None
  liability
  management and       b. Jan. 1, 1957 ceilings on nearly all
  purchased              accounts were raised 50 basis points
  deposits

2. Citicorp (FNCB)     1961-1970s. Rate ceilings on selected
  offered                categories of time and savings deposits were
  negotiable CDs         adjusted

3. FNB of Boston       Sept. 1964-Note sales of issues with
  announced sale         maturities less than two years, by banks
  of short-term          (including commercial paper) were subject to
  promissory notes       Regulations D&Q in 1966

4. Federal funds       a. July 1969, Applied Regulations Q&D to
  market                 Federal Funds transactions except for exempt
                         categories which included corporations.

                       b. Aug. 28, 1969 RPs subject to Regulations
                         Q&D.

                       c. February 12, 1970 narrowed exempt
                         categories excluding corporations.

5. Development of      a. Mid-1966- "London" checks were subjected
  Eurodollar             to reserve requirements July 31,1969.
  Market as Source
  of Funds             b. Oct. 16, 1969 a 10 % marginal reserve
                         requirement was applied.

                       c. Nov., 1969 marginal reserve requirement
                         increased to 20 %.

                       d. June 21, 1973, marginal reserve
                         requirements reduced to 8%.

                       e. May 22, 1975, marginal reserve requirement
                         dropped to 4%.

                       f. August 24, 1978 reserve requirement
                         dropped to zero.

6. Repurchase          a. August 28, 1969 applied regulations Q&D to
  agreements and         repurchase agreements to all nonbanks and on
  loan sales             all assets but U.S. Gov't and U.S. Agency
                         securities.

                       b. April 13, 1979, Public Comment requested
                         on proposal to apply 5 % reserve requirement
                         on RPs made

7. Regulation Q        a. July 20, 1966 Regulation Q ceilings were
  extensions             extended on selected categories of
                         intermediate- short term commercial bank time
                         deposits

                       b. September 26, 1966 ceiling extended to
                         S&Ls

                       c. October 1, 1966 ceilings extended to
                         mutual savings banks

                       d. April 19, 1968 ceilings were raised on
                         selected accounts of $100 K and more

                       e. Jan 21 1970 ceilings were raised on
                         accounts less than $100 K by 50 basis points

                       f. July, 1973 multiple-maturity rates on
                         negotiable CDs greater than $100were
                         suspended

                       g. July 1, 1973 rates on $1000 new
                         denomination four year CD's were suspended.
                         Subsequently, a limit of 5 % of total time
                         and savings was imposed

                       h. Nov. 1, 1973 a 7.5 % ceiling on four year
                         $1000 minimum denomination CDs was imposed.

                       i. 1974-present,minor modification in the
                         rates were instituted at least once yearly.

8. Small capital       June, 1970 extended Regulations Q&D to
  note sales             debentures with less than seven years,
                         maturity issued in amounts less than $500.

9. Bank Holding        a. September 18, 1970 bank holding co. and
  company and            subsidiary sales of commercial paper
  related                subjected to 10 % marginal reserve
  commercial paper       requirement under Regulation D and Regulation
                         Q ceiling applied when proceeds used to fund
                         bank.

                       b. One Bank Holding Co. Act of 1970, December
                         13, 1970 extended effective coverage

10. Documented         None
  Discount Notes
  and ineligible
  acceptances

11. Variable Rate      Ceiling re-imposed Oct 1973
  Wildcard CD

12. Citicorp           Passage of S. 3838, signed Oct 29, 1974,
  Floating               giving Board authority to define any BHC debt
  Rate Notes             issue as a deposit except commercial paper
                         sold to institution investors and to impose
                         Regulations Q&D

13. Citicorp Rising    July 1977--Federal Reserve decided to monitor
  Rate Notes             developments

14. 6 months, money    a. June 1, 1978--Money market CD with ceiling
  market CD              pegged to T-bill rate authorized for both
  authorized             banks and S&Ls. Differential permitted for
                         S&Ls

                       b. March 15, 1979, compounding was prohibited
                         and 1/4% differential permitted thrifts was
                         eliminated whenever ceiling reached a
                         percent.

15. 8 year             16. June 1, 1978 Authorized for banks and
  certificates           S&Ls

16. 4 year Floating    17. Effective July 1, 1979, ceiling on new
  Rate Certificates      four-year pegged to rate-on four-year Treas.
                         obligations, raised savings deposit rate to
                         5-1/4 % and eliminated minimum denomination
                         on all by 26-week money market certificate.

17. Reserve            Oct. 1979--An 8 % marginal reserve
  Requirement            requirement was imposed on increases in
  changes                managed liabilities in excess of $100 million
                         or the average amount of $1 billion managed
                         liabilities held by a member bank, Edge
                         Corporation or by a family of U.S. branches
                         or agencies of a foreign bank. Liabilities
                         include time deposits over $100 thousand with
                         maturities less than one year, Eurodollar
                         borrowings, RPs against U.S. Governments and
                         agency securities, and federal funds
                         borrowings from a nonmember institutions
                         (Federal funds borrowings from member banks,
                         Edge Corporations and U.S. Agencies or
                         branches of foreign banks with worldwide
                         assets in excess of $1 billion were exempt)

18. 2 1/2 yr.          a. January 1, 1980-2-1/2 year CD with ceiling
  certificates           pegged 50 basis points below similar rate on
                         Treasury obligation for thrifts and 75 basis
                         points below that rate for banks rate
                         determined 3 business days before first of
                         month. CUs permitted to offer same rate as
                         S&Ls and MSBs in share drafts over 90 days.

                       b. Eliminated 4 yr. floating rate CD
                         authorized May 30, 1979

                       c. Ceiling raised to 5 3/4% on certificated
                         maturing between 90 days and 1 year.

                       d. Eliminated differential on IRA/Keogh funds
                         and governmental unit funds when placed in
                         26-weeks. MMCs or new 2 1/2 years
                         certificates

19. 2 1/2 yr           March 1, 1980--Imposed temporary ceiling of
  certificates           12 % for thrifts and 11 3/4% for banks on 2
                         1/2 yr. floating rate certificates.

20. Special Credit     a. March 14, 1980--Increased marginal reserve
  Restraint Program      requirement on managed liabilities to 10 %
                         for large banks and reduced base rate upon
                         which requirement was calculated

                       b. Established special deposit of 10 % on
                         increases in managed liabilities of nonmember
                         banks

                       c. Established special deposit requirement of
                         15 % on increases in assets after March 14,
                         1980

                       d. On March 28 certain technical adjustments
                         were made

                       e. Applied Regulation Q to debt issues of
                         BHCs in amounts less than $100 K maturing in
                         less than 4 years

21. Monetary           March 31, 1980--Provides comprehensive
  Control                regulatory reform including six years phase
  Act of 1980            out of Reg Q, reserve requirements at all
                         banks and thrifts on transaction accounts,
                         access to Federal Reserve Services, and
                         pricing of Fed services

22. Changes in         a May 29, 1980--Established minimum ceiling
  rates by D1DC          of 7.75 % on MMCs and estimated differential
                         when rates on 6 months. bills exceed 8.75 %

                       b. Revised ceilings on small saver
                         certificates

                       c. Increased early withdrawal penalties.

Table 6 1980s Banking legislation

Legislation            Major features

Depository             1. Equalized reserve requirements for all
  Institutions           depository institutions
  Deregulation and
  Monetary Control
  Act of 1980
  (DIDMICA)

                       2. Permitted all banks access to the discount
                         window

                       3. Authorized Negotiable Order of Withdrawal
                         accounts for all insured depository
                         institutions (essentially interest bearing
                         transaction accounts)

                       4. Phased out interest rate ceilings on time
                         and savings accounts

                       5. Permitted thrifts to offer consumer and
                         commercial loans, credit cards and trust
                         services

                       6. Increased deposit insurance coverage to
                         $100 K per account

                       7. Preempted state usury laws on certain
                         loans

                       8. Made modifications to Truth-in-Lending Act

The Gam-St Germain     1. Mandated creation of money market accounts
  Depository             at banks and thrifts
  Institutions Act
  of 1982

                       2. Allowed state and local gov'ts to hold NOW
                         accounts

                       3. Allowed federally chartered S&Ls to offer
                         demand deposits

                       4. Accelerated the phase out of Reg Q
                         ceilings

                       5. Permitted federally chartered S&Ls and
                         savings banks to expand investment in
                         commercial loans, consumer loans and invest
                         in state and local gov't revenue bonds

                       6. Liberalized restrictions on loans by
                         national banks to a single borrower

                       7. Removed statutory restrictions on real
                         estate lending by national banks

                       8. Expanded ability of FDIC and FSLIC to
                         provide aid to troubled institutions
                         including the purchase of net worth
                         certificates that would count as capital

                       9. Enabled the FDIC to authorize interstate
                         acquisition of a closed bank or savings banks
                         with assets over $500 million

Competitive            1. Provided additional funding for FSLIC
  Equality in
  Banking Act of       2. Created a forbearance program for thrifts
  1987 (CEBA)
                       3. Enhanced accounting, appraisal and capital
                         standards for thrifts

                       4. Redefined a bank for purposes of the Bank
                         Holding Company Acts eliminating the
                         "non-bank bank" loophole

                       5. Expanded and made permanent Gam-St
                         Germain's provision for interstate
                         acquisitions of trouble institutions.

                       6. Permitted the FDIC to assist the
                         acquisition of troubled institutions

                       7. Over road certain state laws governing
                         branching by interstate banks

                       8. Permitted the FDIC to create bridge banks
                         to facilitate resolution

                       9. Modified certain accounting amortization
                         of loan losses for agricultural banks that
                         had capital restoration programs

                       10. Provided for expedited funds availability
                         for consumers

                       11. Stated that insured deposits were backed
                         by the full faith and credit of the U.S.
                         government

Financial              1. Abolished the FSLIC
  Institutions
  Reform, Recovery     2. Established the Savings Association
  and Enforcement        Insurance Fund (SAIF) under separate FDIC
 Act of 1989            management
  (FIRREA)
                       3. Created the FSLILC Resolution Fund and
                         Resolution Trust Corporation

                       4. Abolished the Federal Home Loan Bank Board
                         and replace it with Office of Thrift
                         Supervision within Treasury

                       5. Enhanced accounting and capital standards
                         for thrifts equivalent to those for national
                         banks

                       6. Required thrifts to adhere to same limits
                         on loans to a single borrower as national
                         banks

                       7. Imposed limits on activities of state-
                         chartered thrifts

                       8. Restricted use of brokered deposits

                       9. Junk bond investment was prohibited

                       10. Dissolved Deposit Insurance Fund and
                         transferred its resources to the Bank
                         Insurance Fund

                       11. Established 1.25 reserve ratio to total
                         insured deposits for the BIF

                       12. Established assessment rates for
                         insurance

                       13. Mandated cross guarantee where insured
                         institutions were responsible for losses of
                         FDIC and healthy subs of a BHC might be
                         liable for losses in sister subs

                       14. Expanded regulatory agency enforcement
                         powers.

                       15. Numerous other provisions were enacted
                         related to enforcement poses.

The Federal            1. Increased FDIC's borrowing authority from
  Deposit Insurance      the Treasury from $5 billion to $30 billion.
  Improvement Act
  of 1991 (FDICIA)     2. Instituted prompt corrective action as
                         regulatory tool

                       3. Regulators were required to conduct annual
                         on sight bank examinations

                       4. Institutions with more than $150 million
                         in assets were required to submit annual
                         audited financial statements

                       5. Agencies were required to consider
                         interest rate risk in their risk-based
                         capital standards

                       6. Put limits on the ability of state
                         chartered banks to engage in activities not
                         permitted to national banks

                       7. FDIC was required to levy risk based
                         insurance premiums

                       8. FDIC was required to use least cost
                         resolution of failing institutions to limit
                         Too/big/to/fail unless it was determined by
                         2/3rds majority of the FDIC directors and
                         Board of Governors that failure would
                         constitute systemic risk and that judgment as
                         affirmed by the Secretary of the Treasury

                       9. Limited the Fed's ability to provide
                         discount window lending to undercapitalized
                         institutions

Table 7 Key features of the Dodd-Frank Act

1. Creates the Financial Stability Oversight Council chaired by the
Secretary of the Treasury with heads of the Fed, OCC, SEC, CFTC,
FDIC, FHFA, NCUA and Consumer Financial Protection Bureau and a
independent representative of the insurance industry

2. Creates Office of Financial Research in Treasury

3. Creates Bureau of Consumer Financial Protection Bureau within
and funded by, but independent from, the Federal Reserve

4. Creates Office of National Insurance within Treasury

5. Creates Office of Credit Rating Agencies within SEC

6. Fed takes over regulation of thrift holding companies

7. SEC to require registration of municipal financial advisors

8. Volcker rule to prohibit banks, bank holding companies and
certain other institutions from engaging in proprietary trading and
sponsorship of hedge funds and private equity funds

9. Requires large, complex financial institutions to submit
periodic living wills

10. GAO will conduct one-time audit of Fed lending facilities

11. Institutes orderly liquidation authority, creates an Orderly
Liquidation Fund, and process and criteria concerning
implementation.

12. Institutes regulation and oversight of over the counter swaps
market by SEC and CFTC

13. Gives Fed enhanced supervisory role to ensure against systemic
risk in payments and settlement systems

14. Institutes provisions to mitigate against regulatory capture of
the SEC

15. Creates new position within the Fed called the Vice Chairman
for Supervision

16. Establishes incentives for low and moderate income people to
participate in financial system

17. Limits Troubled Asset Relief Program by reducing its authorized
funding and limits use of unused funds

18. Numerous other provisions and requires over 250 studies to be
conducted

Fig. 8 Bank failures peaked during the Great Recession at 525

       Bank Failures-(left)

2007         3
2008        30
2009       140
2010       157
2011        93
2012        54
2013        24
2014        20
2015         4

Note: Table made from bar graph.
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Author:Eisenbeis, Robert A.; Kaufman, George G.
Publication:Atlantic Economic Journal
Date:Mar 1, 2016
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