The Banking Crisis in the U.S.: How Effective Were U.S. Regulators?

Abstract

This study explored the causes of the tremendous spike in U.S. bank failures that occurred during the recent financial crisis of 2009-2010. Specifically, the study tested whether U.S. bank regulators identified early warning signals of the forthcoming crisis and once the industry began to falter significantly in 2008, if they took the appropriate actions. The study examined the hypotheses that regulators may have failed to identify signs of overheating in the residential real estate market well in advance of the crisis, and that they did not take sufficient action against financially weak banks during the crisis. Several recent studies of bank failures have focused on the impact of state-level economic factors in driving the extremely high failure rates during the credit crisis particularly among smaller community and savings banks. I analyzed the recent bank failure phenomenon primarily from a state-level perspective by first isolating only failed banks that did not have a national banking charter and whose banking activities therefore were concentrated mainly at the state level. The results of the Tobit regression model partially supported the hypotheses, as two of the three predictor variables chosen as proxies for regulatory effectiveness, subprime adjustable-rate mortgage (ARM) foreclosure rates and the volume of regulatory sanctions issued, both exhibited explanatory power that was statistically significant in relation to state bank failure rates in 2009-2010. These results, while suggesting several areas for further research, may prove useful to regulators as they likely search for new or enhanced methods of ensuring the safety and soundness of the banking sector and avoiding future banking crisis.