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Independent Regulators and Financial Stability Evidence from Gubernatorial Election Campaigns in the Progressive Era

Journal: Journal of Financial Economics

Date: 20240201

Author: Del Angel, Marco; Richardson, Gary

Abstract:
Regulatory independence forms a foundation for modern financial systems. The institutions' value is illuminated by a Progressive Era policy experiment when independent state-bank regulators came under governors' supervision. Afterwards, bank resolution rates declined during gubernatorial election campaigns for banks supervised by state but not national authorities. This gubernatorial-campaign effect diminished by two orders of magnitude, but did not disappear, after the FDIC became the independent resolver for all insured banks in 1935. In addition, during the Progressive Era, declines in bank resolutions led to declines in business bankruptcy rates, an effect that is not observed in the FDIC era. Our findings indicate regulatory independence can dramatically reduce but may not eliminate politics' impact on banks and the economy.

Link: Google Scholar

Key Findings

Political Influence on Bank Resolutions

During Progressive Era (1903-1929), bank resolutions declined by about 140 times more during gubernatorial campaigns compared to modern era (1976-2012), showing impact of regulatory independence.

Crisis vs Non-Crisis Impact

The impact was particularly pronounced during financial crises, with resolution deferrals reaching 26.19 per year during crisis periods compared to 6.54 per year in non-crisis times.

Business Impact

Deferring bank resolutions during campaigns led to 9-33% decline in business bankruptcy rates, demonstrating broader economic effects of political interference.

Bank Resolution Rates Before and After FDIC

  • Bank resolution deferrals were highest in the Progressive Era at 13.54 per year
  • After FDIC creation, deferrals dropped dramatically to 1.06 per year (1934-75)
  • Modern era shows minimal deferrals at 0.08 per year (1976-2012)

Crisis vs Non-Crisis Resolution Patterns

  • Resolution deferrals were lowest during non-crisis years at 6.54 per year
  • Financial crises saw increased deferrals at 12.90 per year
  • Agricultural crisis period showed highest deferrals at 26.19 per year

Impact on Business Bankruptcies

  • Business bankruptcy rates declined during campaign quarters (-2 and -1)
  • Sharp increase in bankruptcies occurred after elections
  • Pattern shows clear relationship between political cycles and business failures

Contribution and Implications

  • Demonstrates substantial economic costs of political interference in bank regulation
  • Provides historical evidence supporting importance of regulatory independence
  • Highlights potential risks of weakening FDIC's political independence in modern era

Data Sources

  • Resolution rates comparison chart based on Table 3 "Gubernatorial elections and commercial bank resolutions over the 20th century"
  • Crisis vs non-crisis chart constructed using data from Table 1 "Bank resolutions and business bankruptcies rates, 1903 to 1929"
  • Business bankruptcy visualization based on event study results presented in Figure 5 of the paper