Abstract
This article examines the earnings performance of nontraditional assets allowed to thrifts since the early 1980s. It uses the statistical cost accounting methodology developed by Hester and Zoellner to estimate average returns on thrift portfolio investments for the years ending June 30, 1987 and June 30, 1988. Results show that average returns on land loans, service corporation investment, real estate investment, and commercial loans were significantly lower than returns on more traditional assets. The results are far more pronounced at capital deficient institutions, lending support to the hypothesis that they used nontraditional investments as a means of exploiting the deposit insurance system. Returns on nontraditional assets are significantly affected by geographic factors, even for well capitalized institutions. The article concludes with an evaluation of the reimposition of portfolio restrictions on thrifts by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Barth, J., and Bradley, M. 1989. “Thrift Deregulation and Federal Deposit Insurance.”Journal of Financial Services Research, (September).
Barth, J., Brumbaugh, R., Sauerhaft, D., and Wang, G. 1985. “Thrift-Institution Failures: Causes and Policy Issues.” InProceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago.
Benston, G. 1985.An Analysis of the Causes of Savings and Loan Association Failures, Monograph Series in Finance and Economics, New York University, Graduate School of Business Administration, Salomon Brothers Center for the Study of Financial Institutions.
Benston, G. 1989. “The Federal ‘Safety Net’ and the Repeal of the Glass-Steagall Act's Separation of Commercial and Investment Banking.”Journal of Financial Services Research, (December).
Benston, G., and Brumbaugh, R. D. 1988. “On the Controversy over Asset Restrictions for Thrift Institutions.”Housing Finance Review, (Fall/Winter).
Benston, G., and Koehn M. 1988. “Capital Dissipation, Deregulation, and the Insolvency of Thrifts.” Paper presented at the Annual Meetings of the American Finance Association, New York, (December).
Boyd, J., Hanweck, G. and Pithyachariyakul, P. 1980. “Bank Holding Company Diversification.” inProceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, (May).
Breusch, T., and Pagan, R. 1979. “A Simple Test for Heteroscedasticity and Random Coefficient Variation.”Econometrica, (September).
Brewer, E. 1988. “The Impact of Deregulation on the True Cost of Savings Deposits: Evidence from Illinois and Wisconsin Savings and Loan Association.”Journal of Economics and Business, (February).
Cole, R. 1990a. “Agency Conflicts and Thrift Resolution Costs.” FIS Working Paper No. 3-90, Federal Reserve Bank of Dallas, (July).
Cole, R. 1990b. “Insolvency versus Closure: Why the Regulatory Delay in Closing Troubled Thrifts?” FIS Working Paper No. 2-90, Federal Reserve Bank of Dallas, (July).
Cole, R., Guilkey, D., Miles M., and Webb, B. 1989. “More Scientific Diversification Strategies for Commercial Real Estate.”Real Estate Review, (Spring).
Cole, R., McKenzie, J., and White L. 1990. “The Causes and Costs of Thrift Institution Failures: A Structure-Behavior-Outcomes Approach.” New York University, Leonard N. Stern School of Business, Salomon Brothers Center for the Study of Financial Institutions, Working Paper S-90-26, (October).
Crockett, J. and King, A. T. 1982. “The Contribution of New Asset Powers to S&L Earnings: A Comparison of Federal- and State-Chartered Associations in Texas.” Working Paper No. 110, Federal Home Loan Bank Board, (July).
Demirguc-Kunt, A. 1990. “Modeling the Bank Regulator's Closure Option: A Two-Step Logit Approach.” mimeo. 1989.
Federal Home Loan Bank Board. 1989.Report on Direct Investment Activities of FSLIC-Insured Institutions, (February).
Felgran, S. 1988. “Bank Participation in Real Estate: Conduct, Risk, and Regulation.”New England Economic Review, (November/December).
Flannery, M. 1982. “Deposit insurance Creates a Need for Bank Regulation.”Business Review, Federal Reserve Bank of Philadelphia, (January/February).
Flannery, M. 1989. “Pricing Deposit Insurance When Insurer Measures Risk with Error.” InProceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, (May).
Freund, J. 1986. “Real Estate Investments by Thrift Service Corporations.” Staff Paper, Division of Research and Statistics, Board of Governors of the Federal Reserve System.
Hanweck, G. and Crockett, J. 1989. “A Theoretical and Empirical Analysis of the Incentives for ‘Go-for-Broke’ Behavior by Thrift Management and Regulatory Implications for Risk-Based Capital Requirements and Federal Deposit Insurance Premia as Incentives for Risk-Taking Control.” Mimeo, George Mason University.
Hartzell, D., Hekman, J. and Miles, M. 1986. “Diversification Categories in Investment Real Estate.AREUEA Journal, (Winter).
Hester, D. and Zoellner, J. 1986. “The Relation Between Bank Portfolios and Earnings: An Econometric Analysis.”Review of Economics and Statistics, (November).
Kane, E. 1983. “The Role of Government in the Thrift Industry's Net Worth Crisis.” InFinancial Services: The Changing Institutions and Government Policy, George Benston, Englewood Cliffs, N.J.: Prentice-Hall.
Kane, E. 1989.The S&L Insurance Mess: How Did It Happen?, The Urban Institute Press: Washington, D.C.
Lintner, J. 1965. “Security Prices, Risk, and Maximal Gains from Diversification.”The Journal of Finance, (December).
Markowitz, H. 1959.Portfolio Selection: Efficient Diversification of Investment, New York: John Wiley.
Merton, R., 1977. “An Analytic Derivation of the Cost of Deposit Insurance and Loan Guarantees: An Application of Modern Option Pricing Theory.”Journal of Banking and Finance, (June).
Merton, R. 1978. “On the Cost of Deposit Insurance When There Are Surveillance Costs.”Journal of Business, (July).
Miles, M., Cole, R. and Guilkey D. 1990. “A Different Look at Commercial Real Estate Returns.”AREUEA Journal, (Winter).
Miles, M. and McCue, T. 1984. “Commercial Real Estate Returns.”AREUEA Journal, (Fall).
Mossin, J. 1966. “Equilibrium in a Capital Asset Market.”Econometrica, (October).
Pantalone, C. and Platt, M. 1987. “Predicting Failures of Savings and Loan Associations.”AREUEA Journal, (Summer).
Rose, J. and Wolken, J. 1986. “Statistical Cost Accounting Models in Banking: A Reexamination and Application.” Staff Studies No. 150, Board of Governors of the Federal Reserve System, (May).
Rosen, R. Lloyd-Davies, P., Kwast, M. and Humphrey, D. 1989. “New Banking Powers: A Portfolio Analysis of Bank Investment in Real Estate.”Journal of Banking and Finance. (July).
Rudolph, P. and Hamden, B. 1988. “An Analysis of Post-Deregulation Savings-and-Loan Failures.”AREUEA Journal, (Spring).
Sharpe, W. 1978. “Bank Capital Adequacy, Deposit Insurance and Security Values.”Journal of Financial and Quantitative Analysis, (November).
Author information
Authors and Affiliations
Additional information
The views expressed in this paper are those of the authors and do not necessarily represent the views or opinions of the Federal Housing Finance Board, the Board of Governors of the Federal Reserve System, or the Federal Deposit Insurance Corporation. George Benston, Tom Fomby, Allen Berger, John Wolken, and anonymous referees made numerous constructive suggestions.
Rights and permissions
About this article
Cite this article
Mckenzie, J.A., Cole, R.A. & Brown, R.A. Moral Hazard, portfolio allocation, and asset returns for thrift institutions. J Finan Serv Res 5, 315–339 (1992). https://doi.org/10.1007/BF00114070
Issue Date:
DOI: https://doi.org/10.1007/BF00114070