Working Paper: NBER ID: w16825
Authors: Eugene N. White
Abstract: Although bank supervision under the National Banking System exercised a light hand and panics were frequent, depositor losses were minimal. Double liability induced shareholders to carefully monitor bank managers and voluntarily liquidate banks early if they appeared to be in trouble. Inducing more disclosure, marking assets to market, and ensuring prompt closure of insolvent national banks, the Comptroller of the Currency reinforced market discipline. The arrival of the Federal Reserve weakened this regime. Monetary policy decisions conflicted with the goal of financial stability and created moral hazard. The appearance of the Fed as an additional supervisor led to more "competition in laxity" among regulators and "regulatory arbitrage" by banks. When the Great Depression hit, policy-induced deflation and asset price volatility were misdiagnosed as failures of competition and market valuation. In response, the New Deal shifted to a regime of discretion-based supervision with forbearance.
Keywords: bank supervision; Federal Reserve; national banking system; financial stability; moral hazard
JEL Codes: E58; G21; G28; N11; N12; N2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Federal Reserve's establishment (E58) | weakened existing supervisory regime (G28) |
| weakened existing supervisory regime (G28) | increased moral hazard (G52) |
| Federal Reserve's conflicting monetary policy decisions (E52) | compromised financial stability (F65) |
| compromised financial stability (F65) | increased competition among regulators (L59) |
| compromised financial stability (F65) | regulatory arbitrage by banks (G18) |
| Federal Reserve's monetary policies (E52) | exacerbated the Great Depression (N12) |
| transition from market-discipline-based supervision (G18) | lenient, discretion-based approach (K40) |
| lenient, discretion-based approach (K40) | future financial crises (G01) |