Control & Prediction: Reexamining the 2008-2009 US Banking Crisis

Abstract

US banks experiencing losses during the 2008-2009 financial crises quickly returned to profitability. What does managerial control contribute to re-establishing performance? Return on equity (ROE) for 1200 banks that survived the crisis is evaluated by degree of control and leverage from 2001 through 2011. We estimate a performance equation and find that both control, measured as the coefficient of variation of ROE, and leverage have significant effects on ROE: control negative, leverage positive. Control affects the patterns of ROE across time; leverage does not. The ability of the estimate to account for and predict ROE holds up well through the crisis but only for banks with tight managerial control. As control loosens, the performance of the estimate deteriorates. During the financial crisis, tightening control improved profitability. The persistent influence of managerial control on ROE is discriminating. Prior performance predicts future performance but only for tightly controlled banks.