Are Banks Really Special? New Evidence from the FDIC-induced Failure of Healthy Banks

Abstract

The FDIC used cross-guarantees in order to close 38 subsidiaries of First Republic Bank Corporation in 1988 and 18 subsidiaries of First City Bank Corporation in 1992 when lead banks from each of these Texas-based bank holding companies were declared insolvent. I use this plausibly exogenous failure of otherwise healthy subsidiary banks as a natural experiment in order to study the impact of bank failure on local area real economic activity. The resolution of these institutions was associated with a significant decline in failed bank lending that led to a permanent reduction in real county income of about 3 percent.