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        Faculty, Research

        Auburn professor's 1980s research cited in Nobel Prize selection

        November 16, 2022 By Laura Schmitt

        All News


        Jim Barth portrait

        Jim Barth's past research on the 1980s savings and loan crisis was cited in the scientific justification for the 2022 Nobel Prize in Economic Sciences.

        Last month, the Royal Swedish Academy of Sciences awarded the 2022 Nobel Prize in Economic Sciences to former Federal Reserve chairman Ben Bernanke and academics Douglas Diamond and Philip Dybvig for their 1980s-era research on banks and financial crises.

        Following the announcement, Stockholm University economist and prize committee member John Hassler said that their research was important in averting economic calamity from the 2008-09 global financial crisis and the early days of the SARS-CoV-19 pandemic in February and March 2020.

        "Had those not been stopped, things could have gone as bad as it did during the 1930s," he said, referring to the Great Depression, the worst economic crisis in modern history. "From the laureates … we can learn how important it is to make sure that this system doesn't collapse."

        One of the papers that the Academy cited in its scientific justification for the prize was written by Auburn University Professor James Barth, who played a lead role in unraveling and understanding the Savings and Loan (S&L) crisis of the 1980s.

        Barth's paper, "Determinants of thrift institution resolution costs," which he co-authored with Philip Bartholomew and Michael Bradley, developed a model to explain the failures that caused the S&L crisis while calculating the actual costs of bailing out insolvent thrift institutions between 1980 and 1988.

        As the authors stated in their paper, "This knowledge is imperative if a recurrence of the thrift crisis is to be avoided and if the federal deposit insurance system is to be appropriately reformed."

        Barth acknowledges that their paper attracted attention near the tail end of the S&L crisis, which accounts for why it was cited in the justification for the 2022 Nobel Economics Prize.

        "Whenever there's a crisis in an industry, it attracts the attention of academics because [we] want to write about what happened, why it happened, and how to prevent a similar event in the future," he said.

        Jitka Hilliard, professor of finance at Auburn, attests to the impact of Barth’s work and said it's a huge honor for him to have the Nobel Prize committee cite his S&L banking research.

        "Jim's paper was about the crisis before the 2008 banking crisis, and it helped build an understanding of how important the banks are for the economy," said Hilliard, who has collaborated with Barth on several research studies about banks and payday lenders. "For [academics], the ultimate measure of the importance of our research is how often it's cited. Jim has 18,000 citations [in Google Scholar], which is incredible. He's an excellent researcher and a great mentor for junior faculty and Ph.D. students."

        According to Barth, the 1990 paper also paved the way for him to pivot from economics research to research on banking institutions—conducting studies not only on the problems they create and ways to prevent them but also examining how banks promote economic growth and development.

        A look back

        When the banking crisis began, Barth was a highly regarded economics faculty member at George Washington University who had held positions with the U.S. Congressional Budget Office, the National Science Foundation, and had served as a visiting scholar with the Federal Reserve Bank of Atlanta.

        In September 1987, he was invited by the Reagan administration to serve as chief economist at the Federal Home Loan Bank Board (FHLBB), the agency that oversaw the S&L industry and the Federal Savings and Loan Insurance Corp. (FSLIC), which insured deposits at federally chartered S&Ls.

        According to Barth, the crisis unfolded due to the Federal Reserve's actions to reduce inflation by raising interest rates in the late 1970s and early 1980s, which created severe problems for S&L institutions.

        "At the time, S&Ls predominantly took in deposits and used them to fund home mortgages," explained Barth, who is now the Lowder Eminent Scholar in Finance at Auburn and Senior Finance Fellow at the Milken Institute. "When interest rates rose, the banks had to pay more interest on deposits, but they weren't receiving any additional interest on the fixed-rate mortgages they held."

        This mismatch resulted in most S&Ls becoming unprofitable and many even insolvent. Policymakers in Washington began to deregulate the S&L industry, hoping this action would enable them to become more like banks that did not suffer like S&Ls.

        "Unfortunately, before this could happen, many institutions gambled for resurrection by investing in excessively risky activities," said Barth.

        The gamble didn't work, and the crisis grew worse.

        In 1989, Barth and his colleagues at the FHLBB released a working paper based on their studies that concluded that the FSLIC insurance fund, which protects depositors and which their agency oversaw, was insolvent.

        "At the time, I was told the head of FHLBB wasn't happy with a paper from economists within the agency saying FSLIC was insolvent," said Barth.

        Media outlets like the Washington Post, LA Times, and United Press International picked up on Barth's report and began publishing stories about the plight of the savings and loan insurance fund.

        "As the stories in the press circulated," Barth said, "even some members of the Senate Banking Committee disagreed with the findings of the paper."

        As the scope of the S&L problem became more apparent, the FHLBB eventually conceded, as well as its auditor (GAO), that the insurance fund was indeed insolvent, which vindicated Barth's original assessment.

        In the end, Congress passed legislation that instituted reforms for the industry. For example, the FHLBB and the bankrupt FSLIC were abolished. S&Ls became insured by the Federal Deposit Insurance Corp. (FDIC). When the FHLBB was abolished and replaced with the Office of Thrift Supervision, Barth became its chief economist.

        The total cost of bailing out the troubled S&Ls by the end of the 1980s had reached $150 billion, including $120 billion in taxpayer funds and about $30 billion in new taxes on commercial banks and healthy S&Ls. The banking industry stabilized until the mid-2000s when the next crisis occurred with the collapse of home prices followed by the Great Recession.

        Analyzing past crises to prevent future ones

        In the meantime, Barth joined the Auburn faculty in the fall of 1989, and the groundbreaking research paper by he and his colleagues was published in the Journal of Finance in 1990.

        Since then, Barth has continued his banking research and has written several important books on the subject—two of which have won honorable mention accolades of the Professional & Scholarly Excellence (PROSE) Awards as being among the top three books in business, finance, and management for a given year.

        Released in 2009, "The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown" provides a definitive data-driven analysis of the 2008 mortgage meltdown and ensuing financial crisis. Barth and his economist colleagues at the Milken Institute explored what went wrong in critical areas such as securitization, loan origination practices, Fannie Mae and Freddie Mac, and the rating agencies, while describing ways policymakers can prevent similar crises from shaking the foundations of the financial system.

        According to Barth, the commercial banks got in trouble as the real estate boom went bust.

        "It turns out what happened to these banks is a follow on to what happened to the S&Ls during the 1980s," Barth said. "We went from an S&L crisis to a banking crisis, which was far worse. Our book was one of the first to come out about the housing crisis."

        In 2012 Barth co-authored, "Guardians of Finance: Making Regulators Work For Us" (MIT Press), which argued that the actions of regulators at the U.S. Treasury Department, FDIC, Federal Reserve, and Office of the Comptroller of the Currency precipitated the 2008 global financial crisis. Barth and his colleagues also provided guidance on how to reform the banking system to help prevent a future crisis.  

        "We looked at the 10 years before the crisis, and we presented evidence that a lot of [their] actions contributed to the crisis or made it worse than it would have been," Barth said. "It's hard to argue that Chairman Bernanke and the Fed should not have done what they did at the time—they had to inject capital into the banks to keep them functioning. But the actions that were taken raised the issue of whether some banks are too big to fail and others are too small to save."

        A Forbes Magazine review described Guardians this way: The book is a magisterial account of financial crises over the last hundred years in the US and around the world. There is much to love in the book—its detail, its clarity, its historical perspective, and its global scope. Anyone who would like to understand why the arcane world of financial regulation might suddenly wipe out their entire lifetime savings will find this book essential—and frightening—reading.”