FSLIC Forbearances to Stockholders and the Value of Savhings and Loan Shares

Introduction Policies of forbearance to stockholders of insolvent firms by federal deposit guarantors represent a wealth transfer from federal deposit-insurance agencies, and ultimately from federal taxpayers, to the stockholders of the insured institutions. Kane (1985, 1986), Pyle (19861, and Thomson (1987) discuss theoretical determinants of the value of forbearances to stockholders of financial institutions by the Federal Deposit Insurance Corporation (FDIC) and the Federal Savings and Loan Insurance Corporation (FSLIC). Brickley and James (1986) show empirically that the stockmarket returns of thrifts increase with the extension of FSLIC capital forbearances. This paper investigates the relationship between the market and book values of the firm's equity. It demonstrates that the market value of a thrift is positively related to its book value and to the value of its unbooked assets. We argue that one of the major unbooked assets of a thrift is its FSLlC insurance guarantee. Measures of FSLIC forbearance policy are shown to be related to the market value of the thrifts whose market values exceed their book values. Section I of this paper discusses the relationship between the market value and book value of a firm. It outlines the reasons that these values may diverge and argues that FSUC guarantees are one of the unbooked assets valued by the market. Section 11 gives a brief overview of the empirical evidence and theoretical arguments regarding the value of federal deposit guarantees and forbearances. Section 111 describes the data, the sample selection criteria, the regression experiment used to test the forbearance hypothesis, and the empirical results. The conclusions and policy implications of the paper are presented in section N.