Does Going Easy on Distressed Banks Help the Macroeconomy?

During banking crises, governments often refrain from closing or taking over troubled banks. I estimate the effects of such “regulatory forbearance” during the U.S. Savings and Loan Crisis by comparing outcomes of states with differing levels of forbearance. I use the limited diffusion of a particular bank charter during the 1800s to instrument for the extent of regulatory forbearance in the 1980s. High forbearance states initially experience greater lending and real estate activity, but subsequently suffer larger declines in real estate, credit, and aggregate output growth after forbearance ends in 1989. Estimated magnitudes indicate that stricter regulatory policy could have avoided the 1990-1991 recession.