What was the Savings and Loan (S&L) Crisis?
A slow-moving financial catastrophe was the Savings and Loan (S&L) Crisis. Nearly a third of the 3,234 savings and loan organizations in the U.S. failed between 1986 and 1995 due to the peak of the crisis.
The problem cost $160 billion in total, of which $132 billion came from taxpayers, and it started with the erratic interest rate environment, stagflation, and subpar development of the 1970s. 1 The adoption of greatly laxer and broader lending standards, which drove desperate banks to take far too much risk balanced by far too little capital on hand, speculation, moral hazard brought about by the combination of taxpayer guarantees along with deregulation, as well as outright corruption and fraud, were critical factors in the S&L crisis.
Understanding the Savings and Loan Crisis
When the economy slowed and inflation took hold, the Federal Home Loan Bank Act of 1932’s restrictions, which included ceilings on interest rates on loans and deposits, severely hindered S&Ls’ ability to compete with other lenders. For example, S&Ls could not compete with conventional banks when depositors poured money into recently established money market funds in the early 1980s because of their lending limitations.
When you factor in a recession brought on by the Fed’s decision to raise interest rates to stop double-digit inflation, all that was left for the S&Ls was a steadily declining portfolio of low-interest mortgage loans. Their source of income has become quite limited.
S&Ls’ fortunes had changed by 1982. Despite making a good profit in 1980, they lost up to $4.1 billion annually.
The Way the Crisis Started
President Ronald Reagan signed the Garn-St. Germain Depository Institutions Act in 1982 in response to the dire economic conditions facing S&Ls. This act removed interest rate caps and loan-to-value ratios for S&Ls and permitted them to retain 30% of their assets in consumer loans and 40% in commercial loans. The difference between the cost of financing and the rate of return on assets narrowed due to Regulation Q’s removal from S&Ls.
Since reward was no longer correlated with risk, zombie thrift stores started offering ever-higher interest rates to draw capital. S&Ls started making significantly riskier junk bond and commercial real estate investments. This approach to investing in riskier ventures and financial products was predicated on the expectation of greater profits. Naturally, taxpayers [via the Federal Savings and Loan Insurance Corporation (FSLIC)] would be left carrying the bag if such returns never materialized by bank or S&L officials. That’s precisely what transpired in the end.
A taxpayer-funded guarantee backstop combined with deregulated lending and capital restrictions led to a massive moral hazard in the S&L sector. S&Ls were encouraged to take excessive risks and were given more latitude. Consequently, the business saw tremendous expansion, and speculative risk skyrocketed.
Initially, the procedures seemed effective for a few S & Ls. S&L assets increased by about 50% by 1985—a far quicker expansion rate than banks. In Texas, S&L growth was robust. Some state lawmakers permitted S&Ls to increase their bets by making risky real estate investments. As of 1985, more than half of S&Ls were not profitable.
Even failed S&Ls were permitted to continue lending, even though strain was growing on the FSLIC’s finances. The FSLIC ran out of money by 1987. The federal government recapitalized the FSLIC, putting taxpayers in even greater danger, rather than letting it and S&Ls collapse as they were sure to. The S&Ls could keep taking on more risk for a bit longer.
S&L Deception
Insider fraud directly resulted from certain S&Ls’ “Wild West” mentality. In one popular scam, two partners worked with an appraiser to purchase land using S&L loans, which they then flipped for enormous profits. Partner 1 would pay for a parcel at its estimated market value. After that, the two would work with an appraiser to reassess it at a much greater value. After that, Partner 2 purchased the property with the help of a loan from an S&L that eventually went into default. The appraiser and partners would split the earnings. Certain S&Ls were aware of these fraudulent transactions and permitted them to occur.
Even after becoming aware of fraud, law enforcement was sluggish to act on it because of problems with personnel, workload, and the intricacy of these investigations.
Resolution to the Savings and Loan Crisis
Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) in response to the S&L crisis, resulting in a comprehensive revision of S&L industry laws. The establishment of the Resolution Trust Corporation, whose objective was to wind down the failing S&Ls that regulators had taken over, was one of FIRREA’s most important initiatives.
George H.W. Bush signed FIRREA into law, providing $50 billion to offset crisis-related expenses and losses.
In addition, the legislation increased insurance rates, set a 30% limitation on S&L non-mortgage and mortgage-related assets, and mandated the sell-off of trash bonds. It also established minimum capital requirements. All in all, Resolution Trust Corp. had liquidated over seven hundred S&Ls.
Crisis in Savings and Loans: Repercussions
Since the Great Depression, the S&L crisis was perhaps the most disastrous banking sector collapse. By 1989, over 1,000 S&Ls had collapsed nationwide, thus destroying what had been one of the safest sources of house mortgages.
Before the crisis, S&L’s market share for residential mortgages was 45% (1980); during the crisis, it dropped to 27% (1990).
New housing starts hitting a level not seen since the one-two blow to the financial sector and the real estate market most certainly caused World War II and the 1990–1991 recession. According to some economists, the financial and regulatory incentives that produced a moral hazard and caused the subprime mortgage crisis in 2007 are strikingly similar to those that caused the S&L catastrophe.
In Texas, Everything Is Bigger
Texas, the home of at least half of the bankrupt S&Ls, faced the brunt of the crisis twice over. The state entered a deep recession due to the collapse of the S&L business. Real estate values fell as a result of auctioning off bad land investments. The price of crude oil fell by half as the number of office openings increased dramatically. Texas institutions that participated in illegal activity, like Empire Savings and Loan, contributed to the state’s economy’s subsequent collapse. The ultimate cost to taxpayers of Empire’s default was estimated to be over $300 million.
Crisis of Savings and Loans: State Insurance
The FSLIC was created to protect those who put their hard-earned money into S&Ls. The FSLIC was left with a $20 billion liability when S&L banks collapsed, which ultimately caused the company to go bankrupt since premiums paid to the insurer were significantly less than its obligations.
Following the FSLIC’s collapse in 1989, the Federal Deposit Insurance Corporation (FDIC), which now regulates and protects deposits, took over the obligations of the former institutions.
State-run funds supported the deposits of almost 500 banks and financial institutions during the S&L crisis, which finished in the early 1990s. The idea of state-run bank insurance funds was all but eliminated with the failure of these banks, which cost at least $185 million.
The Scandal of Keating Five
During this crisis, the Senate Ethics Committee looked into the $1.5 million in campaign donations that five U.S. senators, dubbed the Keating Five, took from Charles Keating, the Lincoln Savings and Loan Association chairman. It was alleged that these senators exerted pressure on the Federal Home Loan Banking Board to disregard questionable actions that Keating had engaged in. Among the Keating Five were:
- John McCain, a Republican from Arizona
- D-Calif. Alan Cranston
- DeConcini Dennis (D-Ariz.)
- John Glenn, a Democrat from Ohio
- Riegle, Jr. Donald W. (D–Mich.)
The Senate committee concluded in 1992 that Cranston, Riegle, and DeConcini had inappropriately meddled in the FHLBB’s Lincoln Savings probe. Cranston was given an official warning.
When Lincoln collapsed in 1989, the government had to bail out the company for $3 billion, leaving over 20,000 clients with worthless junk bonds.
Keating spent time in jail after being found guilty of conspiracy, racketeering, and fraud. In 1996, his sentence was reversed. He was given a time-served sentence in 1999 after entering a guilty plea to lesser crimes.
FAQs about Savings and Loan Crisis
Are loans and savings still available?
Indeed, they do. It is predicted that there were 659 savings and loan organizations in the United States as of 2019. This is a decrease from 3,371 in 1989.
How many people sued in connection with the savings and loan crisis?
Following the Savings and Loan Crisis, the Justice Department found more than 1,000 bankers guilty.
In what ways did the S&L crisis differ from or parallel the 2007–2008 credit crisis?
Boom and bust cycles were the cause of both disasters. Following their involvement in funding the booms, banks, and thrift stores suffered greatly as the economy began to decline. Both crises included speculation, with a significant real estate component, and subpar risk management by the banks.
Since commercial real estate lending requirements were relaxed in the 1980s, commercial real estate has been a significant source of problems. Large banks had difficulties throughout both crises and required government aid, while most bank failures were small. Taxpayer funds were used to rescue these organizations throughout both crises.
However, the 2007–2008 crisis was shorter in duration and only featured one recession, while the Savings and Loan Crisis had three recessions. While bank collapses in the 2007–2008 crisis were swift, those in the Savings and Loan crisis occurred gradually over time.
How Could Regulators Have Addressed the Savings and Loan Crisis More Effectively?
It should not have been permitted for savings and loans to make dangerous loans using federally insured deposits. Reagan also reduced the FHLBB’s regulatory staff’s funding, which made it impossible for them to look into bad loans. Additionally, several states enacted legislation permitting savings and loans to be used for speculative real estate investments, which is against the law.
Additionally, banks did not use mark-to-market accounting at the time, which calls for constant adjustments to asset valuations to represent their actual worth. Therefore, banks were not making their assets seem more lucrative than they were by depreciating them on their books if they lost value.
How Did the Savings and Loan Crisis Affect Commercial Banks?
To compensate for the savings and loan crisis, significant taxes have been placed on both commercial banks and savings and loans. Congress tore down the barriers separating S&Ls from commercial banks by the end of the 1980s, and as a result, the S&L sector has largely been absorbed into the mainstream banking sector.
The Final Word
The first significant banking crisis after the Great Depression occurred in the 1980s and 1990s with the Savings and Loan Crisis. Customers and taxpayers suffered due to the crisis, which led to the closure of hundreds of savings and loan organizations and billions of dollars in losses. Numerous financial reforms were implemented due to the crisis, but more was needed to prevent another crisis that erupted between 2007 and 2008 and resulted in the Great Recession. The S&L Crisis has taught us many lessons, and the banking sector needs more restrictions.
Conclusion
- The United States saw a real estate lending bubble from the early 1980s to the early 1990s, culminating in the savings and loan crisis.
- The Federal Savings and Loan Insurance Corporation’s bankruptcy and the failure of hundreds of savings and loan banks marked the culmination of the S&L crisis, which cost taxpayers billions of dollars and exacerbated the 1990–91 recession.
- The S&L disaster’s foundation was excessive lending, speculation, and risk-taking resulting from deregulation and public bailout guarantees.
- Several S&Ls encouraged blatant insider fraud, and several of these S&Ls were aware of and complicit in these illegal activities.
- Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) in response to the S&L crisis, resulting in a comprehensive revision of S&L industry laws.
