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Econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics White, Eugene N. Article Historical perspectives on bank supervision, asset bubbles, and market microstructure NBER Reporter Provided in Cooperation with: National Bureau of Economic Research (NBER), Cambridge, Mass. Suggested Citation: White, Eugene N. (2012) : Historical perspectives on bank supervision, asset bubbles, and market microstructure, NBER Reporter, National Bureau of Economic Research (NBER), Cambridge, MA, Iss. 4, pp. 16-18 This Version is available at: http://hdl.handle.net/10419/103231 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu Historical Perspectives on Bank Supervision, Asset Bubbles, and Market Microstructure Eugene N. White* Evaluating the appropriate policy to limit risk-taking. Earlier regimes had because of the surge in failures occa- responses to financial crises and banking simpler regulatory structures and lower sioned by the sharp post-World War I scandals represents one of the major chal- expectations for supervision, yet seem recession. The New Deal regime took lenges of macroeconomics and financial to have been more successful in limiting shape after Great Depression policy- economics. My research on earlier finan- risk-taking. In a paper that examines how induced deflation and asset price vol- cial crises and regulatory regimes pro- the establishment of the Federal Reserve atility were misdiagnosed as failures vides useful comparative insights. In in 1913 altered the norms of bank super- of competition and market valuation. research with several co-authors, I have vision,2 I find that bank failures in the Double liability was abandoned, and investigated issues concerning the role late nineteenth century resulted in sur- deposit insurance with discretion-based and effectiveness of bank supervision, prisingly small losses for depositors. In supervision was introduced, increasing the origins and responses to asset bub- the National Banking Era, regulations incentives to take risk. bles, how to minimize moral hazard defined banks narrowly but were rela- when intervening in financial crises, and tively simple. Federal and state super- Asset Bubbles the design of market microstructure to visors used surprise examinations and manage counterparty risk. Another area marked assets to market, suspending Another major component of my of my research examines coerced inter- banks promptly if they appeared to be research is the study of asset booms and national transfers in wartime. insolvent. Crucially, double liability for busts. I was drawn to the subject after national bank shares — where sharehold- the 1987 crash that shocked many who Bank Supervision ers were liable to be assessed up to the par had assumed that a 1929 crash could value of their stock in the event of fail- never happen again after the New Deal In an overview paper,1 I outline ure — induced many weak banks to close reforms. I returned to the subject again an asymmetric information-based tax- before they failed. These voluntary liqui- after the dot.com crash and wrote a onomy of regulation and supervision, dations outnumbered insolvencies four paper that compared the three major identifying five distinct regimes in to one. For this fifty-year period, total twentieth century stock market booms the United States from the Civil War losses to depositors of national banks and busts.3 Claims typically were made to 2008. My current research project were $44 million, and for all banks were that these booms were driven by the focuses on the first two periods, the less than $100 million — less than one accelerated growth of a “new economy.” National Banking Era (1863–1913) and percent of GDP — even though there Yet, the sharp rise in equity prices can- the early years of the Federal Reserve were periodic financial crises. not be readily explained by fundamen- (1914–1932), after which I will fol- The establishment of the Federal tals, as represented by expected divi- low the evolution of supervision from Reserve as the primary regulator of dend growth or changes in the equity the New Deal Era (1933–1970) to the state member banks created tension premium. The difficulty in identify- post-New Deal period (1970–1990) with the Office of the Comptroller of ing fundamentals implies that central and the Contemporary Era (1991– the Currency, the primary regulator of banks could not easily deploy pre-emp- 2008). national banks. The resulting “compe- tive policies, although they would still After the Crisis of 2008, the search tition in laxity” led to a weaker super- play a critical role in preventing crashes for financial stability has led to adop- visory regime. In addition, with access from disrupting the payments system or tion of increasingly complex regulations to the discount window, fewer troubled sparking an intermediation crisis. and higher expectations for supervision banks liquidated. Although this was The emergence of anomalies is one intended as only a temporary source of possible means of identifying a boom * White is a Research Associate in the liquidity, it led to a significant number that has exceeded its fundamentals. NBER’s Program on the Development of of banks becoming habitual borrowers. Using data from the New York Stock the American Economy and a Professor While losses to depositors increased Exchange and regional exchanges, I find of Economics at Rutgers University. His in the 1920s, the overall impact of the that in the months prior to the 1929 Profile appears later in this issue. Fed on bank losses is difficult to assess crash, the price of a seat on the 16 NBER Reporter • 2012 Number 4 NYSE — which reflected brokers’ valu- Market Microstructure— occurred in 1882 when 14 of the ation of their access to trading in Booms and Busts exchange’s 60 brokers defaulted. While floor — was abnormally low.4 Rising the guarantee fund could handle random stock prices and volume should have Following my work on asset market broker failures, it was overwhelmed by a driven up seat prices during the boom bubbles, I have examined the response systemic event — a stock market crash of 1929; instead there were negative of securities markets’ microstructure to of 1882. In a separate study, I examine cumulative abnormal returns to the booms and busts. Lance Davis, Larry how the Bank of France, acting as the ownership of a seat of approximately 20 Neal, and I6 study how the NYSE “insurer of last resort” intervened to percent in the months just before the responded to the erosion of its position provide a lifeboat rescue.8 As the guar- crash. At the same time, trading nearly as the dominant American exchange dur- antee fund was exhausted, credit from ceased in the thin markets for seats on ing the stock market boom of the late the Bank of France enabled the Bourse the regional exchanges. Brokers appear 1920s. Constrained by the number of to complete vital end-of-month settle- to have anticipated the October 1929 seats — fixed at 1,100 in 1879 — surg- ments. High assessments levied by the crash, although investors did not recog- ing order flows raised costs to consum- Bourse on the remaining brokers even- nize this information. ers, measured by spiking bid-ask spreads. tually repaid the loan and induced them While the recent housing market The geography of trading on the floor to tighten the exchange’s oversight. crash appears to be unprecedented, ear- of the exchange mattered; and if trades The Bank of France’s intervention lier real estate collapses provide instruc- were not concentrated at a few posts, as in 1882 and in other nineteenth cen- tive comparisons. Long obscured by the measured by a Herfindahl index, spikes tury financial crises differs from Walter Great Depression, the nationwide resi- were amplified. Higher costs caused the Bagehot’s rules for a lender of last resort dential housing boom that appeared in NYSE to lose market share to the Curb that were the standard for the Bank of the early 1920s and burst in 1926 was and regional exchanges. Following a pro- England. While some economists would similar in many respects to the recent longed debate, the membership of the uphold Bagehot’s prescription of lend- boom and bust. In a paper on this largely NYSE approved of a 25 percent increase ing freely on good collateral in crises, forgotten episode,5 I consider the funda- in the number of seats in 1929 by issuing others see them as outdated in a world mentals that helped to ignite the boom, a quarter-seat dividend to all members. of complex financial markets with deriv- including a post-World War I construc- An event study revealed that the aggre- atives. Examining late nineteenth cen- tion catch-up, low interest rates, and a gate value of the NYSE rose when the tury interventions by the Bank of France “Greenspan put.” Applying a Taylor rule vote was announced. These expectations during stock market crashes in 1851, model, I find that higher interest rates were justified, as bid-ask spreads became 1882, and 1896,9 I find that the Bank would have dampened but not elimi- less sensitive to peak volume days.
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