Financial Cycles

Throughout the 1980s and into the early 1990s, the effects of several financial cycles severely battered the banking system of the United States. As used here, the term "cycle" does not imply a recurring phenomenon, but rather a cycle through various phases--as in a boom and bust cycle. Most of these cycles began with a prolonged period of extraordinary growth centered in a particularly risky type of asset. Typically, banks developed abnormal asset risk concentrations and, in the later portion of the growth phase, acquired many assets at a time of market euphoria and reduced credit standards. The economic underpinnings of the assets eventually deteriorated, the market psychology turned pessimistic, and substantial losses to important segments of the banking system proved unavoidable. This paper catalogs the more destructive of these financial cycles, noting the timing and nature of successive phases, the influence of underlying economic factors, and the extent of the damage inflicted on the banking system. The underlying cause of failure is determined for large institutions, and the assets of failed banks are allocated to one or another of the financial cycles where appropriate. For convenience in exposition, institutions formerly insured by the Federal Savings and Loan Insurance Corporation (FSLIC) are referred to as thrifts and collectively as the thrift industry, while those insured by the Bank Insurance Fund (BIF) are referred to as banks and collectively as the banking industry. The term "banking system" is used more broadly to encompass all depository institutions.