%mutual.tex
% February 17,1987 %first names and double spacing, July 16,1987.
% again, double spacing, Feb. 9, 1988. minor: June 3, 2001. 
%The phone number of  Sara Dutton is (312) 702-9603.
			\documentstyle[12pt]{article}
\lineskip 6pt       
\normallineskip 6pt
%\def\baselinestretch{2}% THIS DOES THE DOUBLE SPACING.
         \begin{document}
         \titlepage
          
         \begin{center}
\begin{large}
         {\bf Mutual Banks and Stock Banks.$^*$ }\\
%This drraft is formatted for the Journal of Law and Economics.
\end{large}
%(Draft 5.A6).
          
         
        \bigskip
        Eric Rasmusen\\
         
\end{center}

 Published as: ``Stock Banks and Mutual Banks,'' 
  \underline{Journal of Law and Economics}   (October 1988), 31: 
395-422. 

\begin{small}
     

*I would like to thank Henry Hansmann, David Hirshleifer, John Wiley,
Ronald Masulis, Maureen O'Hara, Brett Trueman, and participants in
the UCLA Sloan Workshop for helpful comments, and Timothy Opler for
research assistance.  }\\
 \end{small}

        \newpage

       \section{Introduction.}

 Mutual associations are something of an oddity in a capitalist
economy, but they have long been significant in banking in the United
States.$^1$ Mutual savings banks, credit unions, and most savings and
loans are mutual associations, while national banks, state banks,
trust companies and some savings and loans are stock companies.$^2$ I
will refer to the two categories as mutual banks and stock banks.

   The difference between mutual and stock banks lies in who controls
the bank and receives the profits. A stock company is owned by
stockholders, who vote for the firm's managers, distribute its
profits, and are free to sell their privileges. Depositors are merely
customers.  A mutual association is ``owned'' by its depositors, but
not controlled by them. As I discuss below, the managers are
effectively self-controlling, limited only by government
intervention.  In {\it savings and loan associations} (hereafter
called {\it S\&L's}) and {\it credit unions}, each depositor has the
rarely-exercised right to vote for the managers of the bank. In {\it
mutual savings banks}, authorized in only seventeen states (including
the New England states and New York), the depositors lack even the
fiction of control, since they lack the right to vote.$^3$
 Depending on state law, the board of trustees that controls the firm
is either self-perpetuating or elected by a self-perpetuating ``board
of corporators.'' The trustees' control is not absolute, since
blatant harm to the depositors' interests could provoke legal action,
but depositors cannot otherwise influence the firm's policy except by
withdrawing their funds.

         Since the managers of a mutual cannot be punished by
stockholders, they are unlikely to minimize the cost of banking
services. Previous studies have noted this, and used favorable
government regulation to explain the continued existence of
mutuals.$^4$
 The more difficult question is why mutuals flourished before the New
Deal, and that is the question addressed in this paper.

         We shall see that the mutual bank can be explained as a
self-enforcing contract in which managers provide low-risk banking
services to rational but ill-informed savers who are risk-averse and
unprotected by deposit insurance. A stock bank could provide banking
services at lower cost, but could not guarantee the asset portfolio's
safety. If depositors are unable or unwilling to monitor the
portfolio, they prefer a mutual bank because the managers have
stronger incentives to choose a safe portfolio: the upside gains of
the mutual managers are limited by legal constraints on their
compensation, while if the banks fail, they loses a lifetime of high
income. The very lack of cost-minimization by mutual managers makes
them choose a safer portfolio.

       Section 2 explains why we would not expect mutuals to minimize
costs. Section 3 sets out a formal model in which depositors prefer
the mutual bank. Section 4 discusses alternative explanations for
mutual banks, and Section 5 discusses the historical evidence.
                
\section{The Disadvantages of Mutual Associations.}

   Mutual and stock companies differ in the incentives given to the
three groups--- owners, customers, and managers--- whose interlocking
contracts make up the firm. Economists studying these contracts have
concentrated on managers' incentives in stock companies, which are
highly efficient.$^5$
  The stockholders hire managers to sell financial services to the
depositors.  If a depositor does not like the bank's services or
prices, he switches to a competitor.  If a manager is less than
competent, the stockholders lower his salary or replace him. If
ownership is too diffused for individual stockholders to be willing
to expend effort to discipline the manager, one stockholder can buy
enough shares from the others to make the disciplining profitable to
himself. The stockholders expect zero profits, adjusting for risk,
but if the bank earns more or less, they claim the residual and
consume or save it as they please. Being residual claimants gives
them incentive to ensure that the firm minimizes its costs and
produces the efficient output.

         While the depositors of a mutual association may be legally
termed ``shareholders'', a mutual association effectively has no
stockholders, because only the managers exert significant influence
over the association's policies. The managers sell financial services
to the depositors. Depositors can switch to another bank, but they
cannot discipline the managers, and they are not residual claimants
in the usual sense, because the bank's earnings may be either greater
or smaller than the interest payments promised to them.

        The mutual manager's incentives are different from those of
his stock bank counterpart, for he collects not only his marginal
product, but also a greater or lesser amount of ``perks'', the total
compensation depending on the bank's resources and the threat of
legal action. The manager must pay the depositors the promised
interest, but he is otherwise free to operate the firm as he pleases.
Previous studies such as those of Nicols and O'Hara have noted this
and investigated the differences in the behavior of managers of
mutuals and stocks.$^6$  The problem  is similar to that of
managerial control in non-profit firms, which has been analyzed by
Easley \& O'Hara and Hansmann.$^7$ 

         The mutual manager does not control the firm simply because
ownership is diffuse, for this is also true of most stock
companies.$^8$ What is more important is that no individual can
concentrate ownership of a mutual by purchasing the diffused shares.
The manager is freed not by the absence of concentration, but by the
absence of the threat of concentration. Nor is the proxy fight, a
second means of concentrating the power of diffuse stockholders,
available to the mutual depositors. In a stock company the main
obstacle to a proxy fight is the lack of incentive for any one to
expend the resources to organize it, but in mutual banks the problem
is even more severe. The depositors of a mutual savings bank lack a
legal vote, while uncooperative depositors of an S\&L can be expelled
by the managers, a practice tested in 1958, when a shareholder who
requested a list of other shareholders shortly before the annual
meeting was refused the list and refunded his deposit. He went to
court, and lost.$^9$ Such drastic action by managers is rare, because
shareholders rarely try to use their votes. The president of one San
Diego S\&L admitted that no one had turned up at annual meetings in
thirty years,$^{10}$ and a 1937 study of mutual insurance found that the
percentage of policyholders voting in eleven major companies varied
from .02 to 2.5.$^{11}$

  If the manager of a mutual faced no constraints, the mutual bank
would behave like a private, manager-owned bank.  Inefficiency arises
not because the manager is free from outside control, but because he
is partly constrained by the law. If he were free to put his salary
to any level, hire ghost managers, and sell shares in his salary to
outsiders, then the mutual association would be no different from a
stock company. Since he does face legal constraints, the manager's
compensation takes inefficient forms and he is not simply the
residual claimant.  The constraint need not be anything so simple as
a compensation cap. Even if the constraint is a probability of
prosecution gradually increasing with the size of compensation, or
increasing costs of covering up illegal actions, the manager is still
not a residual claimant and does not receive the full value of an
extra dollar of bank profits.  Legal action against managers of
mutuals is uncommon, but does occur occasionally.$^{12}$ The legal
status of the managers of mutual savings banks has been unclear, but
whether they are regarded as trustees or as agents for the
depositors, their actions are legally constrained.$^{13}$

\noindent
{\it Perks}

      I use the term ``perks'' for the difference between a mutual
manager's compensation and his market wage. The most straightforward
and efficient form of perk is an excessive salary, but perks need not
be monetary.  Fringe benefits, pleasant working conditions, nepotism,
and a low managerial effort level also increase the costs of the
bank, while a manager's loans to friends or firms in which he has an
interest reduce the bank's expected return. Another perk is the
information that a bank manager acquires in the course of his duties.
The efficiency implications of this perk are not clear, but if
borrowers would be hurt by the leakage of information about their
loans, they will require the interest rate to be lower.  Most perks
are inefficient because they hurt the bank more than they benefit the
manager; both would benefit by replacing the perk with an increase in
cash wages.$^{14}$

         A perk with especially important implications for efficiency
is the job given to an incompetent manager.  He cannot trade his job
for cash or hire someone to perform its duties, although he would
profit from either of these alternatives.  He retains the job, and
when on retiring he gives it away, he is more likely to give it to a
friend or relative than to a competent executive.$^{15}$

         Mutuals have the further disadvantage that they cannot
compensate their managers based on the stock price. Even a stock bank
may have difficulty in inducing managers to undertake the efficient
effort and risk, but it can use stock-based contracts to change the
manager's incentives, whereas the depositors of a mutual bank,
limited to accounting data prepared by management, have difficulty
even knowing the manager's past performance. The stock bank has the
further advantage that because speculation is possible in its stock,
outside analysts will bear the costs of acquiring information about
managerial performance and leak the information to the market,
whether by unintentional rumours or by moving the stock price.

         Perks have implications for the manager's choice of
portfolio.  In a stock bank, the stockholders can design the
manager's compensation to encourage him to take any level of risk
they desire. In a mutual, the manager's lifetime flow of perks is
part of his wealth, but because it is undiversified he is averse to
firm-specific risk. In addition, because his perks are capped by an
implicit legal limit, he has only weak incentives to increase the
bank's profits.

         The possibility of adding to the bank's reserves  moderates
the manager's disinclination to increase bank revenues. Even if the
manager cannot take more than a limited amount of perks in a given
year, he can add to  reserves rather than increasing the interest
rate to depositors. Reserves help the manager in two ways: by reducing
the risk of bankruptcy, and by  smoothing the flow of perks (
important if  he may be liquidity-constrained). But if a manager is
keeping a reserve to protect against risk, he will be reluctant to
incur risk to increase the reserves.$^{16}$

    Yet another problem is starting a mutual in the first place.
Initial capital cannot be raised by a standard stock offering, so the
first manager must supply seed capital or incur the cost of a complex
solicitation of initial depositors.  He can reap a return via perks,
but the return is limited on the positive side.

 Once the system is in place, depositors are always free to switch to
a stock bank, so the price and product of the mutual must be just as
attractive if the two forms coexist. The mutual's costs are higher,
but its interest rate must be the same, so it canot survive
indefinitely without some countervailing advantage. 

\section{ A  Model of Bank Behavior.}
         A more formal model of the set of contracts between the
manager, depositors, and (for stock banks) stockholders is useful to
distinguish the crucial features of the problem.  Since the model is
heuristic rather than theorem-proving, I present it as a numerical
example.

         Consider two systems, commercial banking and mutual banking,
each consisting of a large number of competing banks of a single
organizational type. The manager chooses between the three investment
projects in Table 1: a safe project with a unit return of $1.2$; a
risky project whose return is with equal probability either .8 or
1.7; and a bad project whose return is with equal probability either
.1 or 1.8.  
 \begin{center}
              Insert Table 1
\end{center}

 Individuals are of two types: the risk-averse, whom we assume are
unwilling to accept any additional risk to increase their expected
income, and the risk-neutral. The stockholders are  risk-neutral, while
the manager and depositors are risk-averse. The depositors deposit
their entire wealth $X=20$   in the bank for one period.

At the beginning of the period the stockholders of the stock bank
choose a capital reserve, which is available at the end of the period
to pay the promised interest to depositors. The stock bank's manager
makes decisions which maximize the utility of the stockholders.  At
the end of the period the manager is paid his competitively
determined wage rate, which is .05 times the amount initially
invested. Depositors are paid an amount $(1+r)X$ which is determined
by competition between banks.  The stockholders retain whatever funds
are left after paying the manager and the depositors. 

         The manager of the mutual bank makes decisions which
maximize his own utility. If the revenue from the project is
sufficient, he is paid not only the wage $.05X$, but also an amount
of perks $P=.5$, where $P$ is determined outside the model by the
threat of legal penalties. Depositors are paid $(1+r)X$ if the
project's revenue is sufficient, where $r$ is determined by
competition between the mutual banks. Any funds remaining after
depositors and managers are paid is put in a reserve and never paid
out.

\subsection{The Informed Depositor Model.}
         We will look at two versions of the model, which differ in
their information structure. In the Informed Depositor
Model,  the manager must pick a project and truthfully
announce it before proposing an interest rate to depositors. The
sequence of actions is
 \begin{enumerate} \item The manager chooses a
capital reserve and a project.  \item The manager offers an interest
rate to depositors.  \item The project's outcome is observed.  \item
The manager takes his perks ( in a mutual bank).  \item The
depositors are paid their interest, and the manager his salary. If
the bank assets are insufficient, they are divided in proportion to
the size of the debts.  \item The stockholders receive the residual
profits (in a stock bank).  \end{enumerate}

% 9 = .8K - .05K

      The stockholders' profit-maximizing policy is to direct their
manager to choose the risky project and  a capital reserve of  12. The bank
competes for depositors by offering them $(1+r)X = [.5(.8) + .5(1.7)]
20 - .05(20) = 24,$ which can be paid regardless of the success of the
project. If the project fails, the bank's assets equal $.8(12) + .8(20)
=25.6$, of which  1.6 is paid to the manager, and 24 to the depositors. If
the project succeeds, the assets equal $1.7(12) + 1.7(20) = 54.4$, of
which 1.6 is paid to the manager,      24 to the depositors, and 28.8
to the stockholders. The stockholders' expected unit return is 1.2,
so the economic profits are zero.

  The safe project would not permit the bank to maintain zero profits
while offering depositors the same interest rate.  A lower level of
capital would drive away the depositors by introducing a positive
probability of bankruptcy.

      Shareholder's capital is similar to  deposit insurance because it
allows depositors to be repaid even if the bank's investments are
unsuccessful.$^{17}$
Many states have  required that bank stock specify double liability,
under which persons holding stock during some legal time limit before
the failure of the bank must contribute up to the par value of the
stock, over and beyond the price they originally paid. Double
liability  reduces the risk to depositors even further, and like
deposit insurance it does not require the stockholders to tie up extra
capital in the bank except in emergencies.$^{18}$

         In the mutual banking system, the manager chooses the safe
project and offers depositors $(1+r)X=1.2X -.05X-P = 21.5 $. Choosing
the risky project would expose him to the risk of lower compensation,
because if the project failed the bank's assets of 16 - .5 (the perks
having already been taken) would have to be split between the
depositors, owed at least 20, and the manager, owed 1. Even if the
manager were willing to accept the risk, the depositors would not be
willing. Thus the interest rate in the mutual system is lower than in
the stock system for two reasons: the perks are deducted and the safe
project is adopted instead of the risky project. The stock bank pays
a higher rate of interest without being any riskier for depositors or
managers, so mutuals would not survive in a system with both kinds of
banks.

      The mutual's choice of the safe project is not an artifact of
using a one-period model without initial reserves. A mutual's
reserves are part of the wealth of its manager. If he chooses
projects like B that can deplete the reserves, he runs the risk of
eventually not being able to extract $P$. If the mutual initially
held reserves, its manager could respond to competition from the
stock banks in one of two ways. He could adopt the risky project,
with the attendant risk that a series of reverses could deplete the
reserves quickly and the knowledge that reducing the reserves by an
expected $P$ each period will eventually deplete them anyway. Or he
could adopt the safe project, paying depositors the market interest
rate by drawing from the reserves as well as the investment income,
so that the date by which the reserves are exhausted is closer but
has lower variance than under the policy of choosing the risky
project. In either case the mutual bank fails in the long run.

         If the mutuals began with reserves sufficient to protect the
depositors, and their managers chose risky projects and refrained
from taking perks, the mutuals could survive competition from the
stock banks, but the mutual manager has no incentive not to take
perks. If he takes perks, his bank will eventually fail and he loses
his privileged position, but if he does not take perks, that
privileged position is useless to him, no better than a stock
manager's job. The only reason not to take perks now is to increase
consumption of perks in the future, which is not something the
manager of a mutual in a mixed system can look forward to.

         The example elucidates another point which causes some
confusion: whether dividends ought to be considered an expense of the
stock bank, equivalent to the perks of the mutual bank. The stock
bank does pay dividends-- equal in expectation to .24(12) = 2.88 in
the example-- but the revenue to pay the dividends is generated by
the capital and does not diminish the earnings of the depositors.
Although a stock bank pays out more to non-depositors than does a
mutual, the stock bank also has more assets.

\subsection{The  Uninformed Depositor Model.}
   A change in the information structure reverses the mutual bank's
disadvantage. In the preceding model the manager chose the project
before the depositors agreed to the contract. In the Uninformed
Depositor Model the depositors must agree to the contract without any
guarantees about the project or the capital reserve.

 The sequence of actions is
\begin{enumerate}
\item
The manager and  depositors agree to an interest rate.
\item
The  manager chooses a project and capital reserve.
\item
The project's outcome is observed.
\item
The manager takes his perks (in a mutual bank).
\item
The depositors are paid their interest, and the manager his salary. If
the bank assets are insufficient, they are divided in proportion to the
size of the debts.
\item
The stockholders receive the residual profits (in a  stock bank).
\end{enumerate}

 %The manager needs to be paid 1 for sure, to be willing to work.
 The stock bank's best credible contract is to offer the depositors
$1.8(20) - .05(20) = 35$ at the end of the period if the project is
successful, and $.1(20) - .05(20) = 1$ otherwise, with a reserve of
zero. The contract yields an expected profit of zero, so the
depositors are receiving the full benefits of the risk, but it is
both risky and inefficient.  The problem is that now the stockholders
have incentive to pick the bad project, whatever the contract,
because they can declare bankruptcy if the project is unsuccessful,
but collect the residual profits if it succeeds. If, for example,
they offered depositors the contract (33 if successful, 15 if
unsuccessful), which could be paid by picking the risky project, the
stockholders would still want to pick the bad project. If the project
were successful, they would make a profit of 2, and if it were
unsuccessful, they would declare bankruptcy.

         The mutual bank, on the other hand, can credibly offer
depositors the fixed return given by $(1+r)X = 1.15(20) - .05(20) -
.5 = 21.5$, the same contract as in the Informed Depositor Model. The
manager is unwilling to take on risk, so he chooses the safe project,
and given that he is known to choose the safe project, the depositors
do not require a reserve. 

         The advantage of the mutual is that the manager is
self-controlled but limited in his perks. Being limited in the amount
he can take out of the firm, he is not attracted by risky investments
with high payoffs. Since his compensation exceeds his market wage and
he can lose his perks only by letting the bank fail, he has strong
incentives to avoid downside risk. Moreover, the manager cannot be
replaced involuntarily or sell his job to someone else, so the
depositors can depend on continuity in managerial tastes and
policies.  The advantages of stability and safety outweigh the
disadvantages of poor management and high expenses.$^{19}$

   It is interesting to contrast this with the explanation Grossman
and Hart advance for high levels of debt in stock
corporations.$^{20}$ In their signalling model, a manager whose
compensation is based on the market value of the firm chooses a high
level of debt to show his willingness to exert enough effort to avoid
the risk of bankruptcy. Stockholders do not mind the extra risk
because they are diversified, but they do value the extra effort. In
the Uninformed Investor Model of mutuals the opposite occurs:
unidiversified depositors are willing to accept less effort in
exchange for less risk.

    The principle at work in the Uninformed Depositor Model is similar
to the justification for high wages found in Klein \& Leffler and 
Adam Smith.$^{21}$
 The manager does not want to lose the stream of rents he receives
from his job at the mutual bank, and although he is safe from being
fired, he can lose the rents by following an investment policy which
bankrupts his firm.  Depositors can therefore trust him to make
cautious investments.

\section{Alternative Explanations for Mutual Banks.}

\subsection{ The Stockholder-Debtholder Conflict.}
         The stockholder-debtholder conflict gives rise to an
explanation similar to and not inconsistent with the Uninformed
Depositor Model. Mayers and Smith suggest the following explanation
for mutual associations in the insurance industry.$^{22}$ Every firm
with both debt and equity faces an incentive problem between
debtholders and stockholders. Shareholders have  incentive to
increase the riskiness of investments after  debtholders have
invested in the firm, and writing debt covenants to cover every
possible contingency is very costly. The policyholders of a stock
insurance company  are like debtholders, but a mutual
insurance company has only one class of capital-providers, so the
only incentive problem is between managers and policyholders.$^{23}$
 The argument applies to banks because bank depositors are similar to
insurance policyholders.

 The stockholder-debtholder conflict explains why an all-equity bank is
desirable, but not why it should be management-controlled. Management
control leads to managerial perks and to investment policies not under
the control of the owners. To minimize costs, the all-equity bank could
be organized to permit proxy fights and takeovers which would prevent
the managers from taking perks, or the voting shares could be limited
in number and restricted to non-managerial owners. 

%Fama and Jensen talk about this in teir 1983 ppers too.

 The Uninformed Depositor Model is consistent with the mutual's
usefulness in avoiding stockholder-debtholder conflict, but also
explains why the manager should be independent of outside control---
to permit the additional advantage of stable, risk-averse management.
If the bank is both owned and controlled by depositors, there are no
stockholders to extract the profit when risky investments are
successful, but even though all depositors are treated alike, they
cannot feel secure if their tastes differ. A group of depositors who
gain control can change the portfolio to suit their own taste for
risk, and not that of the other depositors. For a company owned by
diversified and perfectly-informed stockholders this is not a
problem, but the mutual bank exists to serve small savers who lack
the sophistication to discover portfolio changes and undo them or
shift to another bank. Equal treatment of all providers of capital is
not sufficient protection; only the manager's independence guarantees
a cautious investment policy.

\subsection{ The Manager-Stockholder Conflict.}
 Another explanation for the mutual bank is that  agency problems
between manager and stockholders are so severe that the stock bank is
no more efficient than a mutual. The managers of a stock bank cannot
be induced to maximize its profits, but the managers of a mutual have
interests tied closely to their bank, so the mutual form acts as a
way to share profits with the manager. 

         A problem with this is that tying the manager's compensation
to the stock price is a simpler and more effective way to induce him
to increase the bank's profitability than tying his perks to bank
revenues. Because of managerial slack, a stock bank is efficient only
in a second-best sense, but the fact that stockholder control over
managers is imperfect does not mean that total lack of control is
better.  In addition, an empirical difficulty is that agency problems
are likely to be less important in savings banks, with their
relatively simple services and portfolios, than in commercial banks
or many other firms which use the stock form.

\subsection{ Altruism.}
 The first mutual savings bank in New York was founded by members of
the Society for the Prevention of Pauperism who hoped that the poor
could be encouraged to save. If the mutual manager is altruistic, he
abstains from taking perks and might even serve for less than his
market wage. Realizing this, depositors would prefer a mutual to a
stock bank, and stock banks could not compete with mutuals.

    Determining whether managers are altruistic is not easy, although
the earlier-cited work of Nicols suggests that in recent managers are
not.  The earliest mutual savings banks were very likely founded for
charitable reasons, but even then other motives seem to have existed.
Many antebellum mutual savings banks had close connections with
commercial banks. The second mutual savings bank in New York, the
Bowery Savings Bank, was founded with the cooperation of the
directors of two nearby commercial banks, the Butchers' Bank and the
Drovers' Bank, and cash reserves of the Bowery were kept in those two
banks at unfavorable interest rates.$^{24}$
 The Greenwich Savings Bank was founded in 1833 by the Greenwich
Bank, to which it remained closely tied by interlocking directorates,
and 1861 twenty-seven of eighty-nine savings banks in Massachusetts
were located in the same offices as commercial
banks.$^{25}$
 In his book on the early mutual savings banks, Olmstead concludes
that by and large the managers of ante-bellum mutual banks acted in
their depositors' interests.$^{26}$
 Keyes, however, writing in 1868, was disturbed by the number of
mutual banks operating in close cooperation with commercial banks,
and argued that ``if either is to suffer from the connection, we may
rest assured that it will not be the institution whose {\it business
is to make money.}''$^{27}$

 While some managers have been altruistic, others have not, and under
the altruism explanation it is crucial that depositors be able to
tell the difference. But what is important in a savings bank is not
so much altruism as stability and conservatism. An altruistic manager
devoted to buying the best high-yield, high-risk securities is worse
than a risk-averse scoundrel. In the Uninformd Depositor Model, the
depositor does not have to try to distinguish motives: the advantage
of the mutual is that the interests of depositors and managers
roughly coincide, and whether managers are conservative to protect
their perks or their depositors is a minor point.

\subsection{ Government Regulation.}
%         I need to deal with state deposit insurance before 1860. Blyn
%and Krnootnz p. 80. Insurance covered banknotes,not deposits. And it
%was not too effective.Before 1843, securities on file were ones with
%market value below par.

\noindent
{\bf  New Deal Banking Regulation.}

We must consider the possibility that organization is important only
because of government regulation. From 1932 to 1980, restrictions on
entry and interest rates, together with past history, do provide the
best explanation for industry structure.  The Banking Act of 1933
(the Glass-Steagall Act) separated commercial and investment banking,
prohibited interest on demand deposits, and created the Federal
Deposit Insurance Corporation (FDIC) to insure depositors against
losses and inspect the riskiness of bank loan portfolios. The Banking
Act of 1935 allowed the Federal Reserve to fix time deposit interest
rates and authorized the Comptroller of the Currency to bar entry of
new banks.  The Federal Home Loan Bank Board (FHLBB) and the Federal
Savings and Loan Insurance Corporation (FSLIC) were created to be the
regulatory equivalents of the Federal Reserve and the FDIC for S \&
L's.$^{28}$

 New Deal regulation went far towards equalizing the riskiness of
deposits in different kinds of banks, and if all deposits are equally
safe, the advantage of the mutual bank vanishes. If deposit insurance
and interest rate ceilings were the only forms of regulation, mutuals
would not survive in the long run.  Given the same interest rate for
the same risk in every institution, depositors would be indifferent
between mutuals and stocks.  Initially all the institutions would
make profits by lending at higher rates than they borrowed, although
the profits of the mutuals would be lower because of their
perk-inflated expenses. In the long run the profits would attract
entry, the profits of stock banks would fall to zero, and mutual
banks would make losses.

 Other aspects of regulation, however, benefited the mutuals. From
1913 until 1952 mutual savings banks and mutual S\&L's were not
subject to Federal corporate income tax, and until 1962 a bad debt
provision kept their taxes near zero.$^{29}$ For many years S\&L's
were not subject to Regulation Q, the upper limit on bank deposit
interest, and even after the Interest Rate Adjustment Act of 1966 was
passed, S\&L's were allowed a rate .25 percent higher than commercial
banks.

 The S\&L's expanded their market share during this period, although
the restrictions on entry prevented radical change. Stock S\&L's
grew faster, their market share increasing from 11 percent of total
S\&L assets in 1955 to 40 percent in 1983.$^{30}$ Nicols argues that
the FHLBB set an informal interest rate ceiling for S\&L's even
before 1966, enforced by the unwillingness of the FHLBB to make
advances to S\&L's that offered high interest rates, a policy which
further restricted the scope of the more efficient stock
companies.$^{31}$ \\

 \noindent
 {\bf Earlier Banking Regulation: Portfolio Restrictions and Usury
Laws.}\nopagebreak

         From the earliest days of mutual banks, some state
governments have restricted bank portfolios to a limited variety of
relatively safe assets. New York, for example, initially required
mutual savings banks to invest in New York and U.S. government debt
or commercial bank deposits, although the law was soon relaxed to
allow other kinds of government debt. Not until fifteen years after
the first charter were mortgage loans allowed.$^{32}$
 If mutual banks are structured so that managers voluntarily choose
conservative investments, why did the government intervene? Why could
stock banks not lobby for similar laws to constrain themselves to
choose safe portfolios?

         At first, state governments may not have realized that
mutual banks would be safe. Mortgages were soon allowed in the
portfolio, but since mortgages can be risky and require managerial
discretion, a bank constrained to own only mortgages might own a very
risky portfolio. Neither state legislation nor writing such a
restriction into the corporate charter could guarantee that the bank
was a safe investor.

Another explanation arises because governments often view banks as
institutions which exist to buy government debt.  Restricting mutuals
to own state bonds lowers the interest rate the state must pay, and
while allowing mortgages does not help the government directly, it
benefits local borrowers, and hence might be attractive to
legislators.  Portfolio restrictions were useful to New York. For
more than a decade The Bank for Savings was by far the largest holder
of the state's Erie Canal debt, at one time holding thirty percent of
the entire issue. From 1819 to 1831 over half of the bank's assets
were in New York canal bonds.$^{33}$
 Lack of diversification was one reason the Bank for Savings lobbied
for changes in its charter to allow itself to hold mortgages.$^{34}$

\bigskip

         State usury laws are also potentially important.  We have
already discussed the New Deal deposit interest rate ceilings, but
many states had already imposed ceilings on the loan interest rates.
If the ceilings were binding, riskier loans would be rationed out of
the market and the loans of stock banks would not be much riskier
than those of mutuals. Moreover, often mutual S\&L's were exempt from
usury laws, which in 1921 existed in all but five states, with
interest limits varying from six to twelve percent and a wide range
of penalties, of which forfeiture of all interest was the most
common.$^{35}$ Evidence is not easily available to test the
importance of usury laws, but I have not seen them mentioned as a
source of competitive advantage for mutuals in any of the sources I
consulted, and the legal status of the mutuals' usury exemption was
dubious.$^{36}$

  Usury laws were enforced irregularly, and were not difficult to
evade.  In 1916, for example, the maximum rates of interest allowed
in North Carolina and South Carolina were 6 and 8 percent, but the
average rates on agricultural loans reported by banks to an economist
studying usury were 6.6 and 8.3 percent. Even these were not the true
rates, and adding in ``discounts, bonuses, and any other extra
charges'' the rates became 10.2 and 10.5 percent.$^{37}$

   Studying an earlier period, Lance Davis found that the average
interest rate charged by mutual savings banks in New England from
1840 to 1860 was 5.8 percent, compared to the 6.6 percent charged by
commercial banks.$^{38}$ His explanation is that mutuals obeyed usury
laws while commercial banks found ways around them.  By obeying,
mutual managers could choose who would receive the loans at the low
legal rate and avoid the personal inconvenience of getting around the
laws. The Uninformed Depositor Model adds a third reason: the
managers were not interested in finding ways to make riskier loans at
higher interest rates.

\section{Historical Evidence.}
 The Uninformed Depositor Model implies that the mutual banks attract
small savers, that mutual banks are safer than stock banks, and that
increases in the safety of stock banks erode the mutuals' advantage.
These implications can be matched against historical evidence.

 \subsection{Uninformed Depositors.}
    An important part of the Uninformed Depositor Model is that
depositors are unable to monitor the bank portfolio, since otherwise
they just withdraw their deposits when the bank invests in a
portfolio too risky for their tastes, the form of control suggested
by Fama and Jensen.$^{39}$ Monitoring need not be literally
impossible for the model to be valid. If monitoring is possible, but
costly, the depositors still prefer a mutual bank, and many people,
especially those who are undiversified and unsophisticated, wish to
save amounts too small to justify the fixed cost of monitoring.

    The first mutual banks were founded with the stated intention of
serving small savers. In the 1830's the proportion of unskilled
laborers among new depositors at the largest savings bank in the
United States varied from forty to fifty percent.$^{40}$
 The trustees of many mutual savings banks actively discouraged large
deposits.  Frequently there were upper limits on deposits, and large
deposits commonly received an interest rate one percent lower than
small deposits.$^{41}$ Olmstead gives two reasons why the early
mutuals were hostile towards large depositors. The first is that the
trustees did not like donating their time and energy to help the
rich. The second is that large depositors were quickest to withdraw
their deposits during panics, precisely when the banks needed
liquidity. During the 1837 panic the average size of withdrawals
from the Bank for Savings was \$216, much larger than \$133, the
average account size.$^{42}$ Large depositors make the
bank riskier for the managers and the other depositors.

   Regardless of the size of deposits, if ignorant depositors can
rely on other depositors being equally ignorant, they are safer in
staying uninformed during crises. Being the only ignorant depositor
means being last in line during a bank run, and excluding large
deposits is a way of excluding informed depositors.  

         The Uninformed Depositor Model explains why small savers
would be attracted to mutuals, but also why mutuals prefer small
savers. Large depositors threaten the manager, because despite their
lack of formal authority, they can at least threaten to withdraw
their deposits if they disagree with the manager, or during bank
runs.

%WHY DID MUTUALS NOT ISSUE DEMAND DEPOSITS?  Maybe they did.

\subsection{Mutuals Were Safer than Stocks.}
         The Uninformed Depositor Model implies that deposits in
mutuals earned a return lower but less risky than stock banks could
offer. I have not discovered data on deposit returns, but information
is available on bank portfolios and bankruptcies.

         In the early days of mutual savings banks, New York
restricted bank portfolios, but Maryland did not, so the investments
of its banks show the attitude of managers towards risk. The Savings
Bank of Baltimore was generally conservative, the bulk of its
portfolio from 1830 to 1860 consisting of real estate mortgages, bank
deposits, state and Federal bonds, and secured business loans. Only
about ten percent consisted of utility stocks, bank stocks, and
railroad bonds.$^{43}$ Massachusetts had no portfolio restrictions
until 1834, and its early savings banks invested in state and Federal
bonds, local bank stock, and bank deposits.$^{44}$

%The years before 1921 cannot be trusted. I think most of the mutual
%bank failures are Iowa stock savings banks.
%footnote{ Of 1185
%stock savings banks in the United States in 1917 reporting to the
%Comptroller, 892 were in Iowa (Preston, p. 155).} Also, I think lots
%more private banks failed than are listed. I could compare national
%with mutuals savings banks.
%In the
%panic of 1873, in New York state, no savings bank failed, but
%      xx out of yy national banks failed in that state. In thepanic of
%1893, no savings bank and xx national bnks out of 274.
%    footnote{Welfling, p. 18,25,}

 Throughout the nineteenth century, mutual savings banks had a
reputation for safety. In New York only one failed before the Civil
War, and it was closely affiliated with a bankrupt commercial
bank.$^{45}$
 Two fifths of the commercial banks chartered in the United States
before 1860, on the other hand, had failed by that year.$^{46}$
 Failure rates for commercial banks declined after the Civil War, but
whereas no mutual savings bank failed in New York State in the panics
of 1873 and 1893, in those years 4 of 1968 and 69 of 3807 national
banks ( generally safer than state-chartered stock banks)
failed.$^{47}$

  Although commercial banks generally became safer over time, they
failed in unusually large numbers in the 1920's. The average
percentage of national banks suspended during 1900-1909 was .22, and
during 1920-1929 was .97. Table 2 shows failure rates for the period
after 1921. Both mutual saving banks and S\&L's had lower failure
rates than commercial banks.  In the Great Depression, S\&L's and
commercial banks were more likely to fail than mutual savings banks.
Commercial banks went bankrupt at a very high rate from 1930 to 1933,
and in the worst year, 27.70 percent of commercial banks failed, but
only .80 percent of S\&L's and .01 percent of mutual savings banks.
S\&L's failed less often than commercial banks in the early years of
the Depression, but continued to have an unusual rate of failure
throughout the 1930's. The numbers are deceptive since many S\&L's
which froze deposits early in the Depression did not formally fail
until later, but even over the entire decade a smaller percentage of
S\&L's failed than commercial banks. Very few mutual savings banks
failed.

\begin{center}
            Insert Table 2 here.
\end{center}

                                        
%1863-18090, about 28 commerical banks a year failed, and 1860-1890,
%168
%mutuals failed. All banks were pretty safe.     (Blyn Krnonthx, p.
%115).
%footnote{During 1920-1929 suspensions average 77.3
%nd number of national banks averaged 7978, while the numbers for
%900-1909, which includes the Panic of 1907. were 11.8 and 5452.7.
%{\it Historical Statistics}, pp. 1025, 1038). 
%
%    I provide the data only for national banks because of the
%reliability
%of the Comptroller of the Currency's reports; data on state
%banks and mutuals is not as trustworthy.}
%The rising failure rate of commercial banks probably made the mutual
%The argument:
%1. savings banks had a structure which conduced to safety.
%2. SAvers did not know this, but they could see that the savings bnaks
%were safe. Moreover, they could see the simple fact that shareholders
%could not cheat them, and that management was stable. The only thing
%they %might misunderstand is WHY management was stable and
%risk-averse.

\subsection{Mutuals Declined in Importance as Information Improved.}
        If the business environment becomes less risky the advantage
of mutuals over stocks decreases. Even if the business environment
does not otherwise change, stock banks which survive can acquire a
reputation for safety over time, which they are reluctant to lose by
making risky investments.$^{48}$ Stock banks did become safer and
gain market share over time.

         The first mutual savings banks were founded in 1817, and
they increased rapidly in numbers up to the Civil War. Throughout the
nineteenth century, commercial banks had little success in attracting
deposits.  The close connections between commercial and mutual banks
mentioned earlier indicates the difficulty commercial banks had in
attracting deposits.

       Although mutuals were more successful, they did acknowledge
the possibility of competition from stock banks.  Wishing to
distinguish themselves from risky commercial banks in the minds of
both legislators and depositors, neither the Philadelphia Saving Fund
Society nor the Provident Institution for Savings (in Boston), the
first two mutuals, used the word ``bank'' in their titles.$^{49}$ In
1868 Keyes notes with approval a state law forbidding any bank but a
mutual to call itself a ``savings bank,'' but he also tells of an
advertisement by a national bank calling itself a saving bank and
promising six percent interest. Keyes called for prohibition of
interest-bearing deposits in commercial banks because of their
risk.$^{50}$

After the Civil War the rate of creation of mutual savings banks
slowed, and of the 514 which still existed in 1960, four fifths had
been founded before 1875.$^{51}$ Savings and loan associations
started to become more important, but before 1900 the mutual S\&L's
were usually self-terminating, consisting of a group of people who
would pool their savings and loan it to individual members one at a
time. The first S\&L in the United States, the Oxford Provident
Building Association, was founded in 1831 and terminated in 1841, by
which time there were more than fifty S\&L's in Pennsylvania.$^{52}$
 The self-terminating S\&L was a way to borrow rather than a way to
lend, overcoming the problems of moral hazard and adverse selection
by pooling the resources of acquaintances.  The Uninformed Depositor
Model is not needed to explain these early S\&L's, but it does
explain why some of them were able to evolve into permanent and
impersonal banks in which people deposited their savings even when
they did not wish to borrow.

      The historical development of mutuals shows how they overcame
the problem of raising initial capital. The mutual savings banks were
founded from altruistic motives, and amidst little competition in the
market for safe banking services, while the S\&L's were founded as
small organizations of acquaintances.

    The National Banking Act of 1863 established ``national banks'',
which were safer than state banks since they were subject to
inspection by the newly created Comptroller of the Currency. The act
also shifted the banks' sources of capital to deposits by
discouraging the issue of banknotes, but mutuals continued to hold
the bulk of time deposits.$^{53}$

%departments.
%footnote{ As quoted by Lintner (p. 130), this ruling
%stated ``There does not appear to be anything in the National Banking
%Act which authorizes or prohibits a savings department by a national
%bank... Engaging in the business of a savings bank is one for the
%determination of the Board of Directors.''}
%LOTS OF CAUTIONS IN LINTNER"S BOOK: EXTRAPOLATIONS, INTERPOLATIONS.

Table 3 shows the percentages of time deposits held in different
savings institutions from 1880 to 1935.$^{54}$ The category
``commercial banks'' aggregates a wide variety of institutions, not
all of which would have been interested in attracting savings
deposits, but the table shows that in 1880 commercial banks held only
11.7 percent of time deposits, but their share had increased to 52.2
percent by 1925. As we would expect, with the passage of time some
banks could develop reputations for safety and better compete with
mutuals.

 The only two downturns in the share of the stock banks during this
period were in 1890-95 and 1925-35, which can perhaps be explained by
the substantial increases in bank failures in the 1890's and the
1920's shown in Table 4.$^{55}$ The two downturns show that more than
just a time trend was at work; the increase in the market share of
the stock banks is correlated with their safety. 

% By 1912 about forty-five percent of national banks had savings
%departments.
%footnote{Lintner
%p. 130.} In 1913 the Federal Reserve Act
%%allowed
%banks to hold much smaller reserves for time deposits than for
%demand deposits.
\begin{center}
Insert Table 3 here.

Insert Table 4 here.
\end{center}

\subsection{The Present.}
         We have already seen how the New Deal favored mutuals.  The
deregulatory mood of the 1970's and pressures within the industry
resulted in two major banking acts, the Depository Institutions
Deregulation and Monetary Control Act of 1980 and the Garn-St.
Germain Depository Institutions Act of 1982, which eliminated many of
the regulatory differences between banking institutions. All
institutions were given access to the services of the Federal Reserve
at uniform prices, were required to adhere to the same reserve
requirements, and were allowed to offer checking accounts. 
Portfolio and product restrictions on  mutuals were eased,
and Regulation Q, the ceiling on interest rates, was phased out.  

    If the regulatory advantage given to mutual banks is removed, but
deposit insurance is retained, the Uninformed Depositor Model
predicts that mutuals will be unable to compete effectively with
stock banks. The advantage of mutuals lies in the attractiveness of
their safe portfolios to small depositors, an advantage removed by
deposit insurance, so the model predicts the gradual disappearance of
mutual banks.

         Mutual banks are indeed diminishing in importance, although
banking deregulation is not the only reason. In the 1970's, even
before deregulation, many S\&L's ran into financial difficulty
because of outstanding low-interest mortgages and new competition for
deposits from money market funds. Mutuals were in particular
difficulty, perhaps because their costs were higher, but also because
they found it difficult to raise new capital. From 1975 to 1983 the
percentage of all S\&L deposits in stock S\&L's rose from 21 to
40.$^{56}$ Part of the change happened because after a twelve year
moratorium the FHLBB began in 1976 to allow federally chartered
mutual S\&L's to convert to stock charters in states where stock
charters were authorized. The number of insured S\&L's has fallen
from 4365 in 1970 to 3040 in 1983, and since 1976 there have been
over 205 conversions.$^{57}$

         The pattern of the mutual conversions is consistent with the
Uninformed Depositor Model. Masulis found empirically that the mutual
S\&L's most likely to convert were those that were large, highly
leveraged, and located in markets with greater competition and
growth.$^{58}$ I would expect the incentives for mutual managers to
convert to be highest in those banks because perks do not rise in
proportion to bank size. If a mutual is large, or is expected to grow
if it can raise capital by a conversion, its managers derive more
benefit from a conversion, but do not suffer much more loss of perks
than if the bank were small. Their benefit is in the form of rights
to purchase the new stock, which are valuable because the new issues
are consistently underpriced. Moreover, by no means all mutual
managers are incompetent, and conversion allows the bank to expand
more easily and grant executive stock options which are valuable to
skilled managers.

  The present financial difficulties of many  mutuals illustrates another
feature of the mutual manager's portfolio choice. It is not quite true
that managers always  avoid risk. If their bank is likely to fail
otherwise, the mutual manager, like stockholders in a failing  company
with debt, will take large risks to try to restore  solvency. His
liability is limited, so he is willing to exchange large downside risks
for small possible gains. The manager does not willingly risk failure,
but if failure is likely he does not care about the extent of the
depositors'   losses. We should expect, if government regulation does
not prevent it  that mutuals will make many exceptionally risky loans
during the coming years in which they are being outcompeted by stock
banks.
      
   Ironically, much of the competition mutuals face for deposits has
come from money market mutual funds, which are organized as mutuals,
but in which the disadvantages of mutuals are mitigated by the
limited range for managerial discretion. The money market mutuals
provide simpler services than banks, doing little more than buying
publicly traded assets and processing checks. Their expenses are
publicly disclosed, and the nature of the assets does not provide
managers with opportunities for perks like friendly loans and the
diversion of title insurance business. An advisory company, not the
shareholders, controls the mutual fund, but the advisory company is
itself a diversified stock company rather than an undiversified team
of managers. The company is organized as a mutual association rather
than a stock company because people who save in a mutual fund desire
a return that fluctuates with the stock market. The depositors in
these open-end mutual funds are truly the residual claimants, able to
sell their shares for a price equal to the value of the mutual's
assets.

 \newpage
\begin{center}
{\bf Footnotes for Rasmusen: ``Mutual Banks and Stock Banks.''}
\end{center}

   \begin{enumerate}
 \item 
 Mutuals are as important in the insurance industry as in banking.
See David Mayers \& Clifford Smith, Ownership Structure Across Lines
of Property-Casualty Insurance, UCLA GSM working paper \#8-86, April,
1986; and Henry Hansmann, The Organization of Insurance Companies:
Mutual versus Stock, 1 Journal of Law, Economics, and Organization
125 (1985).

\item
 The government-owned postal savings system (significant during the
1930's and 40's) and private banks, so-called because they lack
government charters and are owned by individuals or partnerships, are
neither stock companies nor mutual associations. For the purposes of
this paper, private banks  can be included with stock companies, the
chief differences being that their ownership is more concentrated and
the owners' liability is greater.
\item
  In 1947 the states authorizing mutual savings banks were Maine, New
Hampshire, Vermont, Massachusetts,Rhode Island, Connecticut, New
York, New Jersey, Pennsylvania, Delaware, Maryland, Ohio, Indiana,
Wisconsin, Minnesota, Washington, and Oregon. Only 15 of 531 mutual
savings banks existing in that year were west of Pennsylvania. John
Lintner, Mutual Savings Banks in the Savings and Mortgage Markets
(1948) at 42.

\item
See Alfred Nicols,  Management and Control in the Mutual Savings and
Loan Association (1972) for a full exposition.

\item
 See Armen Alchian and Harold Demsetz, Production, Information
Costs and Economic Organization, 62 American Economic Review 777
(1972); Eugene Fama and Michael Jensen,Separation of Ownership and
Control, 26 Journal of Law and Economics 301 (1983); Eugene Fama and
Michael Jensen, Agency Problems and Residual Claims, 26 Journal of
Law and Economics 327 (1983); Michael Jensen and William Meckling,
The Theory of the Firm: Managerial Behavior, Agency Costs, and
Ownership Structure, 3 Journal of Financial Economics 305 (1976).

In Section 4.3 I will discuss the explanation for mutuals in the more
recent papers on insurance by David  Mayers and Clifford  Smith,
Ownership Structure and Control: the Mutualization of Stock Life
Insurance Companies. 16 Journal of Financial Economics 73 (1986);  {\it
supra} note 1; Hansmann, {\it supra} note 1.               

\item
 Nicols, {\it supra} note 4; Maureen O'Hara, Property Rights and the
Financial Firm, 24 Journal of Law and Economics 317 (1981).

\item
  David Easley and  Maureen O'Hara, The Economic Role of the
Nonprofit Firm, 14  Bell Journal of Economics 531 (1983);
Henry  Hansmann, The Role of Nonprofit Enterprise, 89  Yale Law
Journal 835 (1980).

\item
       I will speak of ``the manager'' as if the mutual's management
were monolithic. In reality it is not, but the simplification is
useful because disputes over the division of managerial perks are
tangential to the central issues and I have not found evidence that
disputes among managers allowed depositors to exert influence.
Disputes within management only strengthen the argument for stock
banks, because they incur costs that the stock bank would avoid.

\item
Daurelle v. Traders Federal Savings and Loan Assn. of Parkersburg, 104
S.W. 2d 320 (1958).  

\item
Nicols, {\it supra} note 4 at 75.

\item
National Association of Mutual Savings Banks,  Mutual
Savings Banking: Basic Characteristics and Role in the National
Economy (1962) at 24.
 A typical example from a later period is Prudential, which in 1968
had 18,704,879 policyholders, of which 593 voted J.A.C. Hetherington,
Fact v. Fiction: Who Owns Mutual Insurance Companies?, Wisconsin Law
Review 1068 (1969), at 1079.  Admittedly, one would also expect low
participation in a non-controversial stock company vote. 

\item
 Charles Allen, Legal Actions Against S\&L Directors and Officers,
FHLBB Journal 6 (1976).  The charges in one case were that the
managers of an S\&L hired inexperienced relatives, that three
directors were too old to serve, and that five of the directors were
trying to push through a merger for personal benefit. Directors of
another S\&L were accused of violating their fiduciary duty in taking
its business to an insurance company they operated. In a third case
two officers were indicted for accepting payments from borrowers to
make loans.

\item
Concerning the trustees of mutual savings banks:
`` The true role is that such trustees are bound to the exercise of
ordinary care and prudence, that degree of care and prudence that men
prompted by self-interest generally exercise in their own affairs.''
David Garland and Lucius McGehee, eds.,  The American and
English Encyclopedia of Law (1903), Vol. 24, at 1248 under the article
Savings Banks.

Another authority says, ``The prohibitions and limitations fixed
against the officers and directors of savings banks, forbidding them
from borrowing any of the deposits or other funds of such
corporations fully establishes the principle that they are acting as
trustees, and it is a well-established principle of law that trustees
cannot personally use in any manner, either directly or indirectly,
the funds of their principal, either for profit or otherwise.'' H.
Magee, A Treatise on the Law of National and State Banks (1921), at
553.

\item
Because of income taxes on cash income even  stock banks  provide some
portion of the manager's compensation in fringe benefits. Beyond some
level,however, the marginal dollar spent on a perk like  office
furniture is worth less to the manager than the marginal dollar of
pretax salary. 

\item
 In recent years the manager has been able to effectively sell his
job by converting his mutual S\&L to a stock S\&L.  He benefits from
special treatment in the stock sale, but loses control of the firm,
and the institution is no longer a mutual. See Ronald Masulis,
Changes in Ownership Structure: Conversions of Mutual Savings and
Loans to Stock Charter, 18 Journal of Financial Economics 1 (1987) at
29.

\item
 Laws have often regulated the size of a mutual's reserves. The
original charter of the Bank for Savings, the first mutual in New
York, did not permit it to keep a surplus (an amount in excess of
that promised to depositors). The trustees lobbied to amend the
charter to allow surpluses of first three percent, and later ten
percent, although the limit was not rigorously policed. In 1852 the
New York State Assembly passed a bill (never enacted) that would have
effectively confiscated the reserves of savings banks. The Bank for
Savings had reserves of 12.5 percent at that time, and the threat
prompted them to pay extra dividends to their depositors.  Alan
Olmstead New York City Mutual Savings Banks, 1819-1861, (1976), at
40-43.

\item
 Keyes claims that private banks made the argument to savers that the
banker's unlimited liability provided security that he would make
safe investments, and some compensation if he did not. Emerson Keyes,
A History of Savings Banks in the United States from their Inception
in 1816 down to 1874 (1876), vol.  1 at 366-368.

\item
 As Jensen \& Meckling, {\it supra} note 6, point out, a major
advantage of limited liability is that it makes the personal wealth
of stockholders unimportant to one another.  Double liability is
still limited liability, and hence retains much of this advantage.
For a discussion, see Susan Woodward, On the Economics of Limited
Liability, UCLA Dept. of Economics working paper \#437 (1984).

 \item
The recent conversions of mutual S\&L's to stock companies might seem
to undercut the argument for stability, but a conversion is a one-time
event and is clearly announced to depositors.

\item
 Sanford Grossman and Oliver Hart, Corporate Financial Structure and
Managerial Incentives, from John McCall, ed., The Economics of
Information and Uncertainty (1982).

\item
Benjamin Klein   and Keith Leffler, The Role of Market Forces in
Assuring Contractual Performance, 89 Journal of Political Economy 615.

Smith says:\\
 ``The wages of goldsmiths and jewellers are everywhere superior
to those of many other workmen, not only of equal, but of much superior
ingenuity, on account of the precious materials with which they are
intrusted. ... When a person employs only his own stock in trade, there
is no trust, and the credit which he may get from other people depends,
not upon the nature of his trade, but upon  their opinions of his
fortune, probity, and prudence. The different rates of profit,
therefore, in the different branches of trade, cannot arise from the
different degrees of trust reposed in the traders.''\\
Adam  Smith, The Wealth of Nations (1776), ch.10, part 1.

\item
Mayers \& Smith (1985), {\it supra}, note 5.

\item
 Hansmann, {\it supra } note 1, repeats this explanation with more
detail, particularly concerning the difference between life insurance
and property insurance.

\item
 Olmstead points out that the personal benefit to those directors was
probably small, and the other directors eventually forced a change of
policy. Olmstead, {\it supra} note 16 at 126-133.

\item
 {\it id.} at 145.  The close connections between commercial banks
and mutual savings banks might be considered practical implementation of the
segregated trust suggested  by Henry Hansmann, The Political Economy
of Cooperative Enterprise, mimeo, Yale University, August 1985 at 54.

\item
{\it id.} at 114.

\item
Keyes, {\it supra } note 17 at 370.

 \item
Mutual savings banks are covered by the FDIC.   

\item
 Tax acts passed in 1969 and 1976 further reduced their tax
advantages.  The relevant bills are the Revenue Act of 1913, the
Revenue Act of 1951, the Revenue Act of 1962, the Tax Reform Act of
1969, and the Tax Reform Act of 1976. Moreover, from 1928 to 1932 up
to \$300 per person of dividends from S\&L's were exempt from the
federal income tax, and until 1942 the distributions of federally
chartered S\&L's were not fully taxable.  (see the Revenue Act of 1928,
the Revenue Act of 1932, and the Public Debt Act of 1942).  

\item
 Masulis, {\it supra }note 15 at 30.  The insurance industry was
showing similar progress by stock companies. The share of new
business written by the fifteen largest stock companies rose from 5.1
percent to 14.5 percent from 1910 to 1965, and the share of the
fifteen largest mutuals fell from 61.8 to 28.5 percent. Nicols, {\it
supra} note 4 at 121.

\item
{\it id.}at 91-101.

\item
Olmstead, {\it supra } note 16 at 75.

\item
{\it id.}at 78-83.

\item
Lack of diversification could also be treated as part of the managers'
perks, since several of the trustees were both promoters and
beneficiaries of the canal.{\it id.}at 83.

 \item
Franklin Ryan,  Usury and Usury Laws (1924), at 28-31.

  A typical usury clause is from Pennsylvania statutes: Sec.  6. VI.
``No Premiums, fines, or interest on such premiums, that may accrue
to the said corporation, according to the provision of this act,
shall be deemed usurious; and the same may be collected as debts of
like amount are now by law collected in the commonwealth,'' p.  669.
Reprinted in: Commissioner of Labor, Ninth Annual Report of the
Commissioner of Labor (1894), at 669.

\item
 Garland and McGehee assert that the usury exemption is dubious, and
cite Citizens' Security, etc. Co. v. Uhler, 48 Md 455. Garland \&
McGehee, {\it supra} note 13, vol. 4 at 1074, under the article Building
and Loan Associations. 

\item
 Ryan, $supra$ note 35 at 103, citing C. Thompson, Bulletin 409, U.S.
Dept. of Agriculture, 1916.

\item
 Lance Davis, The New England Textile Mills and the Capital
Markets: a Study of Industrial Borrowing, 1840-1860, 20 Journal of
Economic History 1 (1960) at 9.
 
\item
Fama \& Jensen, {\it supra} note 5.

\item
Olmstead, {\it supra } note 16 at 51,58.

\item 
 The Bank for Savings. Olmstead, {\it supra } note 16 at 36-38,
59-66.

\item
{\it id.} at 62.

\item
 Peter Payne and Lance Davis, The Savings Bank of Baltimore,
1818-1866: A Historical and Analytical Study (1956) at 107.

 \item
 {\it id.} at 112. The law passed in 1834 allowed all of these plus real
estate mortgages.

\item
 Olmstead, {\it supra } note 16 at 142.

\item
 Herman Krooss and Martin Blyn, A History of Financial Intermediaries
(1971) at 75. This is an aggregate statistic; failure rates for
commercial banks in New England, where most of the mutuals were
located, were lower. From 1830 to 1845, 18 of 129 Massachusetts banks
lost their charters, and 4 of 62 Rhode Island banks failed (Naomi
Lamoreaux, Banks, Kinship and Economic Development: the New England
Case, 46 Journal of Economic History 647 (1986)).

\item
 Weldon Welfling, Savings Banking in New York State: A Study of
Changes in Savings Bank Practice and Policy Occasioned by Important
Economic Changes (1939) at 18,25.  U.S. Department of Commerce,
Historical Statistics of the United States: Colonial Times to 1970
(1975), at 1027,1038.

\item
 For a model of the process of reputation acquisition in credit
markets, see Douglas Diamond, Reputation Acquisition in Debt Markets,
U. of Chicago mimeo, (1985).

\item
 The first attempt to obtain a charter in New York State also avoided
the opprobrious term ``bank'' and proposed ``an association by the
name of the savings corporation of the city of New York,'' although
after the first attempt failed the organizers chose the name ``The Bank
for Savings in the City of New York'' for the second try. Olmstead,
{\it supra  } note 16, at 9.

 \item
Keyes, {\it supra } note 17, vol. 1 at 366-368.

\item
Krooss and Blyn, {\it supra }note 46, at 128.

\item
 Alan Teck, Mutual Savings Banks and Savings and Loan
Associations: Aspects of Growth (1968), at 24.

\item
 Banknotes were not prohibited, but national banks were required to
keep interest-bearing reserves with the Comptroller to back their
notes, and a heavy tax was imposed on the notes of banks chartered by
the states.

\item 
 Some of this data was constructed by Lintner using interpolation and
extrapolation. Anyone intending to use it should see Lintner's notes,
{\it supra } note 3, at 461.

\item
Table 4 only includes national banks, for which reliable data is
available. National banks were generally safer than state banks.

\item
Masulis, {\it supra }note 15, at 30.

\item
{\it id.}at 30.

\item
{\it id.}at 29.

\end{enumerate}

\newpage
\begin{center}
 BIBLIOGRAPHY     \\
\end{center}

 \begin{enumerate}
               \item[]
Alchian, Armen and Harold Demsetz. ``Production, Information
Costs and Economic Organization.'' {\it American Economic Review}
(1972): 777-795.
\item[]
Allen, Charles. ``Legal Actions Against S\&L Directors and
Officers.'' {\it FHLBB Journal} (August,1976): 6-12.
\item[]
Commissioner of Labor. {\it Ninth Annual Report of the
Commissioner of Labor. 1893. Building and Loan Associations.}
Washington: Government Printing Office, 1894.
\item[]
Davis, Lance. ``The New England Textile Mills and the Capital
Markets: a Study of Industrial Borrowing, 1840-1860.'' {\it Journal of
Economic History} 20 (1960): 1-30.
\item[]
Diamond, Douglas. ``Reputation Acquisition in Debt Markets.''U.
of Chicago C.R.S.P. working paper no. 134, July, 1986.
\item[]
Easley, David and  Maureen O'Hara. ``The Economic Role of the
Nonprofit Firm.'' {\it Bell Journal of Economics}, 14 (Autumn,1983):
531-538.
 \item[]
 Fama, Eugene and Michael Jensen. ``Separation of Ownership and
Control.'' 26 {\it Journal of Law and Economics} (June 1983):
301-326.
 \item[]
Fama, Eugene and Michael Jensen. ``Agency Problems and Residual
Claims.'' {\it  Journal of Law and Economics} 26 (June, 1983):
 327-350.
\item[]
Garland, David and Lucius McGehee, eds.. {\it The American and
English Encyclopedia of Law,} 2nd Ed.. Northport , N.Y.: Edward
Thompson Co., 1903.
\item[]
 Grossman, Sanford and Oliver Hart. ``Corporate Financial
Structure and Managerial Incentives,'' from John  McCall, ed., {\it The
Economics of Uncertainty}, Chicago: U. of Chicago Press, 1982.
\item[]
 Hansmann, Henry. ``The Role of Nonprofit Enterprise.''  {\it Yale Law
Journal} 89 (1980): 835-901.
\item[]
Hansmann, Henry. ``The Organization of Insurance Companies: Mutual
versus Stock.'' {\it Journal of Law, Economics, and Organization}
1 (Fall 1985): 125-153.
 \item[]
 Hansmann, Henry. ``The Political Economy of Cooperative Enterprise.''
mimeo, Yale University, August 1985.
\item[]
Hetherington, J.A.C.. ``Fact v. Fiction: Who Owns Mutual Insurance
Companies?'' {\it Wisconsin Law Review} (1969): 1068-1092.
 \item[]
 Jensen, Michael and William Meckling.``The Theory of the Firm:
Managerial Behavior, Agency Costs, and Ownership Structure.'' {\it
Journal of Financial Economics} 3 (October, 1976):305-360.
\item[]
Keyes, Emerson. {\it A History of Savings Banks in the United States
from their Inception in 1816 down to 1874.} 2 volumes. New York:
Bradford Rhodes, 1876.                  
    \item[]
Klein, Benjamin  and Keith
Leffler.``The Role of Market Forces in
Assuring Contractual Performance.'' {\it Journal of Political Economy}
89 (1981):615-641.
\item[]
Krooss, Herman and Martin Blyn.{\it A History of Financial
Intermediaries}. New York: Random House, 1971.
\item[]
 Lamoreaux, Naomi. ``Banks, Kinship, and Economic Development: the New
England Case.'' {\it Journal of Economic History}, 46 (1986):
647-668.
\item[]
Lintner, John. {\it Mutual Savings Banks in the Savings and
Mortgage Markets.} Boston: Graduate
School of Business Administration, Harvard
University, 1948.
\item[]
Magee, H. {\it A Treatise on the Law of National and State
Banks,} 3rd Edition.  Albany, N.Y.:  Matthew Bender and Co.,1921.
\item[]
  Masulis, Ronald. ``Changes in Ownership Structure: Conversions of
Mutual Savings and Loans to Stock Charter.''  {\it Journal of
Financial Economics} 18 (March 1987): 29-60.
  \item[]
 Mayers, David and Clifford Smith. ``Ownership Structure and
Control: the Mutualization of Stock Life Insurance Companies.''
 {\it Journal of Financial Economics} 16 (May 1986) pp. 73-98.
\item[] Mayers, David and Clifford Smith. ``Ownership Structure
Across Lines of Property-Casualty Insurance.'' UCLA GSM working paper
\#8-86, April, 1986.
  \item[] 
National Association of Mutual Savings
Banks. {\it Mutual Savings Banking: Basic Characteristics and Role in
the National Economy}.Englewood Cliffs, N.J.: Prentice-Hall, Inc.,
1962. 
 \item[]
 Nicols, Alfred. {\it Management and Control in the
Mutual Savings and Loan Association}.Lexington, Mass.: Lexington
Books, 1972.
  \item[]
 O'Hara, Maureen. ``Property Rights and the Financial Firm.''  {\it
Journal of Law and Economics} 24 (1981): 317-332.
  \item[] 
 Olmstead, Alan. {\it New York City Mutual Savings Banks,
1819-1861.} Chapel Hill, N.C.: The University of North Carolina
Press, 1976.
  \item[]  
 Payne, Peter and Lance Davis. {\it The Savings Bank of Baltimore,
1818-1866: A Historical and Analytical Study}. Baltimore: Johns
Hopkins Press, 1956. 
 \item[]
 Russell, Horace. {\it Savings and Loan Associations}. Second
edition. New York, N.Y.: Matthew Bender and Co., 1960.
  \item[] 
Ryan, Franklin.  {\it Usury and Usury Laws.}
Boston: Houghton Mifflin Co., 1924. 
  \item[]
 Smith, Adam. {\it The Wealth of Nations}. New York, N.Y.: Penguin
Books Ltd, 1970. First published in 1776.  
 \item[] 
 Teck, Alan. {\it Mutual Savings Banks and Savings and Loan
Associations: Aspects of Growth}. New York, N.Y.: Columbia University
Press, 1968.
 \item[]
U.S. Department of Commerce. {\it Historical Statistics of the
United States: Colonial Times to 1970.} Washington:
Bureau of the  Census, 1975.
 \item[]
 Welfling,Weldon. {\it Savings Banking in New York State: A Study
of Changes in Savings Bank Practice and Policy Occasioned by Important
Economic Changes}. Durham, N.C.: Duke University Press, 1939.
 \item[]
Woodward, Susan. ``On the Economics of Limited Liability,''
UCLA Dept. of Economics working paper \#437, October, 1984.
\end{enumerate}

\newpage
%tables.tex
%Feb. 12, 1987
%\documentstyle[12pt]{knart}
%\pagestyle{blank}
%\begin{document}

%\begin{center}
%{\bf Tables for Rasmusen: ``Mutual Banks and Stock Banks.''}
%\end{center}

\begin{center}
 Table 1: Investment Projects.
\begin{tabular} {|l|lr|c|}
\hline
\ {\bf Project} & {\bf Unit Return}& &{\bf Probability }\\
       \hline
\ Safe Project  & 1.2 & & 1    \\
 \hline
\ Risky Project &   .8& (failure) & .5 \\
\        &  1.7 & (success)& .5 \\
\hline
\ Bad Project &   .1& (failure) & .5 \\
\        &  1.8 & (success)& .5 \\
\hline
\end{tabular}   \\
\end{center}

\newpage
Table 2: Bank Failures.\\
\begin{tabular}{|l|r|r|r|r|r|r|}
\hline
\ Year & \multicolumn{2}{|c|}{Commercial Banks} &
 \multicolumn{2}{|c|}{M.S.B.'s }     &
 \multicolumn{2}{|c|}{S\&L's} \\
 \hline
\ & Number & Percentage & No. & Per. & No. & Per. \\
%\ 1878 & 140 & 5.5   &  60 & 9.05  & -- & -- \\
%\ 1896 & 155 & 1.35    & 14 & 1.42    & -- & -- \\
%\ 1904 & 128 & .75    & 3 &.48  & -- & --\\
\ 1921 & 505 & 1.69 & 0     & .00  &    6 & .07 \\
\ 1922 & 366 & 1.24 & 0     & .00  &    4 & .04 \\
\ 1923 & 646 & 2.24 & 1     & .00  &  9 & .09 \\
\ 1924 & 775 & 2.75 & 0    &  .00       & 18  &.17 \\
\ 1925 & 618 & 2.24 &  0  &  .00 & 26 & .22 \\
\ 1926 & 976 & 3.65 &       0     & .00        & 12 & .10 \\
\ 1927 & 669 & 2.59& 0     & .00  &   21 & .17 \\
\ 1928 & 498 & 1.99 &  1     & .00  &  23 & .18 \\
\ 1929 & 659 & 2.74 &  0     & .00  &  159 & 1.26 \\
\hline
\ 1930 & 1350 &  6.08 & 2    &  .00       & 190 & 1.54 \\
\ 1931 & 2293 & 11.83 &  1  &  .00& 126 & 1.07 \\
\ 1932 & 1453 & 8.16 & 3    &  .01       & 122 & 1.07 \\
\ 1933 & 4000 & 27.70 & 4    &  .01       & 88 & .80 \\
\ 1934 & 105 & .68 & * &  .00       & 68 & .63 \\
\ 1935 & 42 & .27   &   *  &  .00 & 239 & 2.19 \\
\ 1936 & 47 & .31 & *  &  .00       & 144 & 1.37 \\
\ 1937 & 65 & .44 & *  &  .00       & 269 & 2.62 \\
\ 1938 & 80 & .55   &  * &  .00 & 277 & 3.09 \\
\ 1939 & 70 & .48   &   * &  .00& 183 & 2.20 \\
\hline
\ 1940 &  47 & .33 &   *     & .00        & 129 & 1.67 \\
\ 1941 & 16 & .11 &       0     & .00        & 44 & .61 \\
\ 1942 & 18 & .13 &       0     & .00        & 18 & .26 \\
\ 1943 & 5 & .04 &       0     & .00        & 11 & .17 \\
\ 1944 & 2 & .00 &       0     & .00        & 5 & .08 \\
\ 1945 & 0 & .00 &       0     & .00        & 0 & .00 \\
\ 1946 & 0 & .00 &       0     & .00        & 0 & .00 \\
\ 1947 & 1 & .00 &       0     & .00        & 1 & .02 \\
\ 1948 & 0 & .00 &       0     & .00        & 0 & .00 \\
\ 1949 & 4 & .00 &       0     & .00        & 0 & .00 \\
\hline
\multicolumn{7}{|l|}{*A total of 2 banks failed 1934-40.}\\
\hline
\multicolumn{7}{|l|}{Sources: Russell,p. 654; {\it Historical
Statistics} pp.1027, 1031, 1038.} \\
\hline
\end{tabular}

\newpage

\begin{center}
Table 3: Percentages of Time Deposits.\\
\begin{tabular}{|l|c|c|c|}
\hline
\ Year &Mutual  & S\&L's & Commercial    \\
 \ & Savings Banks& &  Banks \\
\hline
\ 1935 & 40.1 & 16.7 & 42.1 \\
\ 1930 & 31.3 & 17.8  & 47.7 \\
\ 1925 & 31.5 & 16.3 & 52.2 \\
\ 1920 & 36.7 & 13.3 & 49.9 \\
\ 1915 & 50.1 & 10.8 & 39.1 \\
\ 1910 & 56.2 & 9.0  & 34.8 \\
\ 1905 & 65.5 & 9.1 & 25.4 \\
\ 1900 & 69.3 & 12.0  & 18.7 \\
\ 1895 & 69.3 & 15.2 & 15.5 \\
\ 1890 & 73.7 & 10.0  & 16.4 \\
\ 1885 & 82.4. & 4.0 & 13.6 \\
\ 1880 & 87.5 & 0.8  & 11.7  \\
\hline
\multicolumn{4}{|l|}{Source: Lintner, p. 473.}
\\
\hline
\end{tabular}
\\
\newpage

Table 4:Failures of National Banks.\\
\begin{tabular}{|l|c|c|}
\hline
\ Period & Failures & Number of Banks at the Start.\\
\  & & of the Decade.\\
\hline
\ 1930-33 & 1947 & 7247 \\
\ 1920-29 & 773 & 8024 \\
\  1910-19 & 82 & 7138 \\
\ 1900-09 & 118 & 3731 \\
\  1890-99 & 243 & 3484 \\
\ 1880-89 & 50 & 2076 \\
\  1870-79 & 57 & 1612 \\
\hline
\multicolumn{3}{|l|}{Source: {\it Historical Statistics}, pp. 1031,
1038.} \\
\hline
\end{tabular}
\end{center}

\end{document}
 




%hETHERINGTON, P. 1077. IN WISCONSIN, MANAGERS OWULD TRY TO LOOT MUTUAL
%INSRUANCE COMPANIES BY LETTING ALL THE POLICIIES EXPIRE AND THEN
%GETTING THE SURPLUS BY DISSOLVING THE COMPNAY. A LAW WAS PASSED GIVING
%THE SURPLUS TO THE STATE SHCOOL SYSTEM.
