Market forces are not a substitute for government regulation of banks. That's the conclusion of University of Missouri professor John R. Hall and Federal Reserve Bank of St. Louis economists Andrew P. Meyer and Mark D. Vaughan.
Looking at stock data from 1988 to 1993, the researchers found that investors were keenly aware of credit risk, remembering the crises in lending to real estate developers and developing countries. The market, however, failed to distinguish between adequately capitalized and well capitalized institutions.
They next reviewed BOPEC ratings, which are the confidential scores examiners give bank holding companies. They found that BOPEC grades took into account credit risk and capital strength.
Why the discrepancy? The researchers say investors and regulators look at risk differently. Investors only care about being compensated for risk. If the expected return is high enough, they will accept almost any level of risk.
Regulators, however, fear that more risk-even if it results in greater profits-could cause an institution to fail. That would drain the deposit insurance fund. To guard against this, regulators demand adequate capital.
"As long as the market and regulators are not close substitutes for publicly traded holding companies, the market cannot completely supplant supervisors," they concluded.
For a copy of "Do Markets and Regulators View Bank Risk Similarly," call 314-444-8859.
The Federal Reserve Board has adopted a new model of the U.S. economy that places more emphasis on how expectations of growth affect spending decisions.
Describing the model in the April edition of the Federal Reserve Bulletin, five Fed economists write that the new model gives policymakers a better indication of future growth. This helps the Fed decide when to raise and lower short-term interest rates.
The model relies on 50 measures of behavior, half of which apply to consumption of nondurable goods and services. The model uses separate equations to calculate behavior in the household, business, and government sectors of the economy.
For a copy of "The Role of Expectations in the FRB/US Macroeconomic Model," call 202-452-3244.
Borrowers in states that protect homes and large amounts of personal property from seizure by creditors are more likely to file for bankruptcy.
That is the preliminary conclusion in a working paper by University of Pennsylvania professor Richard Hynes. Past studies that failed to find a link between personal exemptions and bankruptcy were flawed because they did not account for borrowers paying off secured loans on exempted items.
For a copy of "Property Exemptions and Loan Repayments," call 215-573- 5838.
Combining monetary policy and bank supervision in a single agency is most important in countries that have undeveloped financial sectors, according to Federal Reserve Bank of Cleveland economist Joseph Haubrich.
After examining the practices of 24 countries, Mr. Haubrich finds that authorities in undeveloped countries may need to use credit controls and interest rate limits to manage the economy. He finds fewer reasons to combine the functions in developed countries, but noted that many central banks in these countries also supervise banks.
For a copy of "Combining Bank Supervision and Monetary Policy," call 216-579-2847.
