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Bank Failures and Stock Returns

| | Posted in: Economic Indicators

How does the rate of bank interventions by the Federal Deposit Insurance Corporation (FDIC) relate to U.S. stock returns? To check, we compare the percentage of banks with FDIC closing and assistance transactions with the annual change in the Dow Jones Industrial Average (DJIA). We exclude savings and loan institutions from the sample for comparability of long-run data. Using FDIC bank population and intervention data and contemporaneous DJIA data over the period 1934-2007 (74 years), we find that:

The following chart compares the annual percentage of banks with FDIC closing and assistance transactions (“interventions”) with the same-year return for the DJIA over the entire sample period. The bank population shrinks from 13,000-14,500 during 1934-1988 to 7,283 in 2007. The average annual FDIC intervention rate is 0.22%, and the average annual DJIA return is 8.1%. The FDIC intervention rate is very high during the Great Depression in the 1930s and the savings and loan crisis in the late 1980s/early 1990s. Visual inspection indicates no systematic relationship between the bank intervention rate and stock returns.

For a more precise comparison, we switch to a scatter plot.

The following scatter plot relates the annual FDIC bank intervention rate and same-year DJIA return over the entire sample period. The Pearson correlation is 0.08 and the R-squared statistic is 0.01, suggesting that variation in the bank intervention rate explains 1% of the variation in stock returns. Excluding bank intervention anomalies (1935-1942 and 1982-1993) produces an R-squared of 0.00. These results do not support a belief that the annual FDIC bank intervention rate relates systematically to annual stock market behavior.

The correlations between the annual FDIC bank intervention rate and DJIA returns for the subsequent one, two, three and four years are all less than 0.10.

In summary, evidence from simple tests does not support a belief that there is a systematic relationship between the annual rate of FDIC bank closings and assistance transactions and annual U.S. stock market returns.

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