S&L Crisis: Why and Why Not

Workings prior to Inflation

In 1932 President Herbert Hoover's administration passed a bill created by Congress called the Federal
Home Loan Bank Act (FHLBA). The FHLBA's mission was to make home ownership affordable. This Act
created the Federal Home Loan Bank Board (FHLBB). The FHLBB created, funded, and managed a type of
bank called the Federal Savings and Loan Bank (FS&LB). There were at least 12 of these FS&L Banks
regionally distributed across the United States. The FS&LB's gave that money to retail banks, insurance
companies, and loan associations, herein called Retail Banks (RB). The RB's used that money to originate
and service mortgages for mortgagors and hold depositor’s money in saving deposit accounts. In 1933
Congress passed the Banking Act and the Federal Reserve created Regulation Q In 1934 Congress created
the Federal Savings & Loan Insurance Corporation (FLSIC) to insure the FS&LB's deposits.

Federal Government regulations limited how much FS&LB's could pay in interest to depositors to keep and
use depositor’s money and limited how much profit FS&LB's could earn to loan money to mortgagors
seeking home ownership. These regulations worked for about 40 years until the 1970's when inflation
quickly and significantly increased due to many factors not presented in this reading. The Federal Reserve
raised interest rates to decrease this high inflation. It worked, but problems ensued.

Deregulations and the Garn-St.Germain Act

Because inflation had increased so much and depositor's FS&LB's savings accounts interest rates were
limited the money in these accounts decreased in value. So, depositors looked at other savings vehicles to
find higher rates of return. The Money Market Mutual Fund (MMMF) was growing in popularity and
because this type of savings paid more in interest than the FS&LB's deposit accounts, people moved their
money out of the FS&LB's and into the MMMF's. No longer were banks the preferred place for people to
save their money.

The FS&LB's asked Congress to remove these regulations. President Jimmy Carter's administration amended
these regulations to both allow FS&LB's to increase interest rates on savings deposits and increase the
amount insurance depositors were guaranteed. But this did not solve the problem.

This (and many other factors) caused a recession in 1980. And it was in 1982 that President Ronald Regan's
administration passed the Garn-St.Germain Depository Institution Act that removed any interest rate cap.
This allowed FS&LB's to pay as much as they wanted to depositors to keep their money in their bank. This
Act also allowed the FS&LB's to loan out a larger percentage of their assets, thus allowing for lower loan-to-
value ratio reserves. This Act also decreased funding and staff for the FHLBB thereby decreasing loan
origination regulatory oversight.

The Garn-St.Germain Act was a clear example how regulation at the highest level does not implement
higher-standards of practice, nor enforce adherence to regulations at the local level. For a higher level of
regulation to propagate down to the everyday actions of local institutions separate enforcing role players
must be well funded and managed to ensure these well-intentioned rules are followed. Decreasing the
FHLBB’s supervisory and enforcing powers prevented the oversight needed to successfully implement,
monitor, and continuously improve the behaviors at local institutions.
Insolvency, then a Bailout

Yet, again this did not help. It made the situation worse. Now FS&LB's could write bad loans, pay higher
savings interest to their depositors, and continue to misstate the value of their assets due to the wide-
spread use of historic accounting methods that lacked the fidelity and transparency of today's modern mark-
to-market accounting methods.

Then in 1987 the price of crude oil and real estate prices both decreased quickly and significantly, and along
with other factors, caused more problems for FS&LB's. The FS&LB Crisis had come to an end. More and
more FS&LB's went bankrupt and in 1987 the FSLIC declared itself insolvent. Finally, the bailout came. In
1989 President George H.W. Bush's administration passed the Financial Institutions Reform, Recovery, and
Enforcement Act (FIRREA) to closed failed banks and stop future losses. This act also created the Resolution
Trust Corporation whose purpose was to resell FS&LB's assets to payback depositors who lost their savings.

Comparisons with the Enron Crisis

Both the S&L Crisis and the Enron Crisis exhibit clear reasons to establish higher ethical standards. Had
these been in the form of more restrictive regulations and more limited deregulation's the severity of fraud,
inequality, injustice, and loss to the consumer would have been mitigated. It was profit over consumer
protection by the leaders of both Enron and the FS&LB's, as well as their influenced regulatory co-
conspirators, that caused these crises. Had accountability and consumer protection been woven into the
financial products, regulations, and decisions of those involved as fundamental values, then undoubtedly
the 'rules of the game' would have been in favor of the protection of the consumer’s savings despite all
other unethical ‘priorities’.

The difficulty of 'fixing' the S&L Crisis would have been more complex due its much longer time-span, more
involvement from players distributed across more levels of government, and the presence of the everyday
consumer's involvement at retail banks. The Enron crisis was limited to investors, the investment sector,
and government institutions at the federal level. From the consumers point-of-view, and setting aside the
concept of greed, it was the poor architecting, engineering, and implementing of the security deposit and
reserve requirements, interest rate allowance correlations among types of banking institutions, and worst-
case-scenario risk mitigation planning that ultimately was to blame for both the Enron and S&L Crisis's.

References

https://www.investopedia.com/terms/f/federal-home-loan-bank-act.asp
https://www.thebalance.com/savings-and-loans-crisis-causes-cost-3306035
https://www.federalreservehistory.org/essays/savings-and-loan-crisis
https://en.wikipedia.org/wiki/Money_market_account
https://www.nelsoncapitalmgmt.com/2018/06/12/brief-history-money-market-funds/
https://www.latimes.com/archives/la-xpm-1989-03-05-fi-95-story.html
https://www.fdic.gov/bank/historical/sandl/