Reint E. Gropp
In this paper, we test the cleansing effects of the recent banking crisis. We show that in the U.S. regions with higher levels of regulatory forbearance on distressed banks during the recent crisis, there was less restructuring in the real sector: fewer establishments, firms, and jobs were lost if more distressed banks remained in business. Consistent with the cleansing hypothesis, regions with less regulatory forbearance during the crisis experienced a better productivity growth path after the crisis with more establishment entries, job creation, and employment, wages, patents, and output growth. We provide evidence that banks under regulatory forbearance reduced lending to their out-of-state branch borrowers plausibly to redistribute it to their home-state borrowers in return for the regulatory forbearance favour they received at home. Furthermore, we show that regulatory forbearance was larger for state-chartered banks, and in regions with weaker banking competition and more independent banks. Finally, we find that recapitalization of distressed banks through TARP did not facilitate cleansing.