Cleaning up the Depository Institutions Mess

FUTURE FINANCIAL and economic historians will mark 1989 as a watershed year for the American financial system. This is the year policymakers forced themselves to come to terms with their failure to supervise adequately the nation's depository institutions and to adopt sound capital regulation to attempt to offset properly the "moral hazard " due to federal deposit insurance. In early 1989, the new administration proposed a comprehensive plan for ridding the financial system of at least 700 insolvent thrift institutions over the next decade and for reforming the regulatory system that was supposed to have prevented their collapse. Over the next few months Congress debated and changed the adminis-tration's proposal. Although it is likely that some parts of the final legislation will clearly move in the right direction, serious problems should remain. In our view the projections by the administration on which the plan is based under-state the cost and budgetary effect of addressing what has come to be called the "thrift crisis. " For its part, Congress may weaken the administration's proposed capital standards and thus frustrate efforts to restore proper incentives for thrifts to avoid excessive risk-taking. Meanwhile, the widespread attention given by policymakers and the media to the problems in the thrift industry has unfortunately obscured similar significant problems among commercial banks. 24