Previous Government Caused Banking Fiascos

Subsequent to a recent discussion with a colleague at odds about the supposed fallacies of free markets which I argued were caused at root by government intervention, I found this article detailing the historical trail of government policies that caused the Savings and Loan crisis of the late '80s.

Many people mistakenly attribute the implosion of the S&L's to Reagan's deregulatory policies and perhaps that may have been the tipping factor, but the house was on the verge of collapse already because it had not been built not by market forces, but by incompetent governmental tinkerers.

From "The Real Reagan Record" in The National Review of Aug 31, 1992

http://www.nationalreview.com/reagan/niskanen200406101410.asp


Going all the way back to 1932 with the creation of The Federal Home Loan Bank System, instabilities were exacerbated by non-free market factors.
"the structure of the savings-and-loan industry was designed in Washington, rather than by evolutionary market processes. A 1932 act created the Federal Home Loan Bank System, with a structure much like that of the Federal Reserve System, to increase the funds available to reasonably solvent S&Ls to finance home mortgages."
Regulatory restrictions on their asset structure incentivizing home mortgages seems to be the the primary cause of the instability.

One of the interesting conclusions of this article is it's negative judgement of the FDIC in 1934. If there is validity to this, then the recent increase in deposit insurance limits from $100K to $250K would be rather alarming.

"Most important, deposit insurance creates a moral hazard for the owners of weak or insolvent banks and S&Ls, in effect setting up a one-sided bet. If they make unusually risky loans that do not later default, all the returns accrue to the owners; if these loans fail, the losses are borne by the insurance fund and, ultimately, the taxpayers. Heads I win, tails you lose. "