Savings and Loan crisis
The
Savings and Loan crisis of the
1980s was a wave of
savings and loan association failures in the
United States in which over 1,000 savings and loan institutions failed. The ultimate cost of the crisis is estimated to have totaled around USD$150 billion, about $125 billion of which was directly borne by the U.S. government, which contributed to the large
budget deficits of the early
1990s. The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the
1990-1991 economic recession.
Savings and loan institutions (also known as S&Ls or thrifts) have existed since the
1800s. They originally served as community-based institutions for savings and mortgages. In the United States, S&Ls were tightly regulated until the 1980s. For example, there was a ceiling on the interest rates they could offer to depositors.
In the late
1970s, many
banks, but particularly S&Ls, were experiencing an outflow of low-rate deposits, as depositors moved their money to the new high-interest
money-market funds. At the same time, the institutions had much of their money tied up in long-term
mortgages which, with interest rates rising, were worth far less than face value.
Under financial institution regulation which had its roots in the Depression era, federally-chartered S&Ls were only allowed to make a narrowly limited range of types of loans. Late in the administration of president
Jimmy Carter, this range was expanded when the
Federal Home Loan Bank Board eased up on some of its restrictions pertaining to S&Ls. Also in
1980, Congress raised the limits on
deposit insurance from $40,000 to $100,000 per account. Early in the
Reagan administration, the deregulation of federally-chartered S&Ls accelerated rapidly (see the
Garn - St Germain Depository Institutions Act of 1982), putting them on a more equal footing with commercial banks. S&Ls could now pay higher market rates for deposits, borrow money from the
Federal Reserve, make commercial loans, and issue credit cards. This was a departure from their original mission of providing savings and mortgages.
Although the deregulation of S&Ls gave them many of the capabilities of banks, it did not bring them under the same regulations as banks. First, thrifts could choose to be under either a state or a federal charter. Immediately after deregulation of the federally-chartered thrifts, the state-chartered thrifts rushed to become federally chartered, because of the advantages associated with a federal charter. In response, states (notably,
California and
Texas) changed their regulations so that they would be similar to the federal regulations. States changed their regulations because state regulators were paid by the thrifts they regulated, and they didn't want to lose that money. This is similar to the concept of a
race to the bottom.
In an effort to take advantage of the
real estate boom (outstanding US mortgage loans: 1950 $55bn; 1976 $700bn; 1980 $1.2tn) and high interest rates of the early
1980s, many S&Ls lent far more money than was prudent, and in risky types of ventures in which many S&Ls were not competent. Whereas insolvent banks in the United States were typically detected and shut down quickly by bank regulators, the S&L regulators were apparently surprised by deregulation, and not sufficiently competent or staffed to perform the
due diligence needed to regulate effectively.
One of the most important contributors to the problem was
deposit brokerage. Deposit brokers, somewhat like stockbrokers, are paid a commission by the customer to find the best
certificate of deposit (CD) rates and place their customers' money in those CDs. These CDs, however, are usually short-term $100,000.00 CDs. Previously banks and thrifts could only have five percent of their deposits be brokered deposits; the race to the bottom caused this limit to be lifted. A small one-branch thrift could then attract a large number of deposits simply by offering the highest rate. In order to make money off this expensive money, it had to lend at even higher rates, meaning that it had to make more risky investments. This system was made even more damaging when certain deposit brokers instituted a scam known as "linked financing." In "linked financing" a deposit broker would approach a thrift and say that they would steer a large amount of deposits to that thrift if the thrift would loan certain people money (the people however were paid a fee to apply for the loans and told to give the loan proceeds to the deposit broker). This caused the thrifts to be tricked into taking on bad loans.
Another factor was the efforts of the federal government to slow the economy, marked by
Paul Volcker's speech of October 6, 1979, with a series of rises in short-term interest. This led to borrowing money and paying interest on deposits costing a thrift more than it could make by lending its money as home-loans. The damage to S&L operations led Congress to act, passing a bill in September 1981 allowing S&Ls to sell their mortgage loans and use the cash generated to seek better returns; the losses created by the sales were to be amortised over the life of the loan and any losses could also be offset against taxes paid over the preceding ten years. This all made S&Ls eager to sell their loans. The buyers - major Wall Street firms - were quick to take advantage of the S&Ls lack of expertise, buying at 60-90% of value and then transforming the loans by bundling them as, effectively, government backed bonds (by virtue of GNMA, FHLMC, or FNMA guarantees). S&Ls were one group buying these bonds, holding $150bn by 1986, and being charged substantial fees for the transactions.
A large number of S&L customer's defaults and
bankruptcies ensued, and the S&Ls that had overextended themselves were forced into insolvency proceedings themselves. In 1980 there were 4002 S&Ls trading, by 1983 962 of them had collapsed
For example, in March 1985, it came to public knowledge that the large
Cincinnati, Ohio-based
Home State Savings Bank was about to collapse.
Ohio Gov.
Richard F. Celeste declared a bank holiday in the state as
Home State depositors lined up in a "run" on the bank's branches in order to withdraw their deposits. Celeste ordered the closure of all the state's S&Ls. Only those that were able to qualify for membership in the
FDIC were allowed to reopen. Claims by Ohio S&L depositors drained the state's deposit insurance funds. A similar event also took place in
Maryland.
The U.S. government agency
Federal Savings and Loan Insurance Corporation, which at the time insured S&L accounts in the same way the
Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost.
The
Federal Home Loan Bank Board reported in
1988 that fraud and insider abuse were the worst aggravating factors in the wave of S&L failures. The most notorious figure in the S&L crisis was probably
Charles Keating, who headed
Lincoln Savings of
Irvine, California. Keating was convicted of
fraud,
racketeering, and
conspiracy in
1993, and spent four and one-half years in prison before his convictions were overturned. In a subsequent
plea agreement, Keating admitted committing bankruptcy fraud by extracting $1 million from the parent corporation of Lincoln Savings while he knew the corporation would collapse within weeks.
Keating's attempts to escape regulatory sanctions led to the
Keating five political scandal, in which five U.S. senators were implicated in an influence-peddling scheme to assist Keating. Three of those senators —
Alan Cranston,
Don Riegle, and
Dennis DeConcini — found their political careers cut short as a result. Two others —
John Glenn and
John McCain — were exonerated of all charges and escaped relatively unscathed.
*
Fractional-reserve banking*
Tax Reform Act of 1986*
FDIC: The S&L Crisis: A Chrono-Bibliography*
The Cost of Savings & Loan Crisis: Truth & Consequences*
Classic Financial and Corporate ScandalsInside Job, by Steven Pizzo, Mary Fricker, and Paul Muolo. ISBN 0-07-050230-7
