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[quote=Anonymous][quote=Anonymous][quote=Anonymous]Like this comparison to the S&L crisis from the 80s, Paul Krugman:

[b]In banking, insuring deposits means that depositors have no reason to concern themselves with how the banks are using their money. This in turn creates an incentive for banks to engage in bad behavior, such as making highly risky but high-yielding loans. If the loans pay off, the bank makes a lot of money; if they don’t, the owners just walk away. Heads, they win; tails, the taxpayers lose.[/b]

This isn’t a hypothetical case; it’s pretty much what happened during the S.&L. crisis of the 1980s, when savings and loan associations, especially but not only in Texas, effectively gambled on a huge scale with other people’s money. When the bets went bad, taxpayers had to compensate depositors, with the total cost amounting to as much as $124 billion — which, as an equivalent share of gross domestic product, would be something like $500 billion today.

The thing is, it’s not news that guaranteeing depositors creates moral hazard. That moral hazard is one of the reasons banks are regulated….[/quote]

The alternative is everyone flocking to a bank that they know is too big for the government to ever let fail. It's really hard for the average account holder to dive into a bank's financials, it's much easier to go to a too big to fail institution. If I'm worried about the FDIC maybe declining to step in, I avoid local and regional banks because they can be allowed to fail. Wells Fargo or Bank of America cannot be allowed to fail, so no matter how stupid or reckless management is, my deposit is probably safe [/quote]

With all due respect to Krugman, his remarks are not particularly insightful.  Ever since deposit insurance was instituted in the thirties, it has been well understood that this government safety net created moral hazard and required far more scrutiny of banks' activities to safeguard the funds of taxpayers that are at risk once you have such a safety net.

This is why banks are so heavily regulated and subject to federal supervision (and not just state supervision).

The dynamic at S and Ls was a bit different.  Their supervisory agency was subject to extreme government capture.  Also, in many cases shareholders who put up most of the money did not have voting power commensurate with their investment.  A few investors--often the same people as management--had small investments but controlled the votes.  Since they had relatively little at stake, they could take big bets on strategy.  If they succeeded they would get a lot, if they failed they did not have much to lose.  So management had very skewed incentives.[/quote]

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