THE SAVINGS AND LOAN CRISIS 1

The Savings and Loan Crisis

Financial Markets (C19-S2) – Module 2

MScFE 560

Worldquant University
THE SAVINGS AND LOAN CRISIS 2

One of the biggest crises that hit the US economy, from the 1929 Great Depression, was

the collapse of banks and of S&L industry of 1980.

(1) Identify key role players from the inception to the demise of the S&L market.

S&Ls institutions have their origins in Building and Loans associations, a sort of not-for-profit

cooperative organizations with the same simple goal of helping the working-class on home

ownership.

S&L institution was officially founded in 1932 with the Federal Home Loan Bank Act. These

entities were supposed to provide the same services of commercial banks with a strong focus on

residential mortgages. The President Herbert Hoover government policy goal was to provide a

social aid of pursuing homeownership for US residents. At that time, the 1929 Great Depression

effects destroyed savings of most US citizens letting them without sufficient savings to purchase

homes.

The so formed S&L structure allowed littles consortium of shareholders creating and controlling

these small but generally more locally oriented companies. The main advantage was the

possibility to offer a stable and low mortgages rate for borrowers and higher interest rates on

savings accounts than commercial banks.

By the 1940, during New Deal programs, the strong industry expansion provided the perfect

background for S&L business. They became, in 1950, the dominant provider of residential

mortgages.

With the advent of deregulation, inflation rising and low rates restrictions, S&L were

experiencing some difficulties in attracting investors and in paying competitive interest rates on
THE SAVINGS AND LOAN CRISIS 3

deposits. Investors started looking away for new more lucrative money products and S&Ls

started cumulating debts.

The problem growth in the 1970 stagflation period, where slow growth, high unemployment

rate and low salaries destroyed completely the S&Ls business model. The combination between

regulation restrictions and the reducing number of demands for residential mortgages decreased

considerably S&L potential clients.

In the attempt of stimulating the economy and bringing down inflation, Fed moved into a

contractionary monetary policy. In 1980, the doubling of oil prices moved inflation above 10%.

Raise of inflation and de-regulations for the new money market let S&L stuck with long-term

mortgages assets with low returns. It began impossible to attract capital at that rates and soon,

most all S&Ls became insolvent.

THE SAVINGS AND LOAN CRISIS 4

In the attempt of saving these companies, the DIDMCA, under the Carter Administration

allowed them to increase the borrowed capital (from 40k to 100k) but at the same time it was

recommended to remain primarily involved in housing finance. The requirement percentage of

total deposits passed from 5 to 4%. The situation was still difficult.

One year later, in 1981, the Administration, in the attempt of creating a boom in real estate,

passed a powerful tax incentives for real-estate investment by individuals.

The situation did not change and in 1983 35% of S&Ls were not profitable and 9% were

bankrupt.

Due to the high losses, in 1987 the FSLIC fund declared itself insolvent by $3.8 billion.

The situation ended 2 years later, during George H.W. Bush term; The Financial Institution

Reform, Recovery and Enforcement Act provided $50 billion to close failed institutions, stop

further losses and resell bank assets.

(2) Identify and analyze shortfalls of the regulation which affected the S&L market. Your answer

does not need to be contained to the crisis years.

The most important decisions that affected S&L market lie in the establishing of these

institutions and their regulations approved by Federal Home Loan Bank. Two restrictions played

a relevant role in S&L policy during their entire life; these are the regulation on product types

allowed, mainly mortgages assets, and on low interest rates for borrowers. In addition, FDIC was

guaranteeing on these assets.

➢ Regulation on product & assets types

Administration was forcing S&L companies to have at least 65% of their assets invested in

residential mortgages and other consumer-related asserts, denying access to commercial loans.
THE SAVINGS AND LOAN CRISIS 5

As long as interest rates were not rising, S&L were performing good results. The profit was on

the spread between the higher long-term interest rates received from mortgages and short-term

they had to pay out to depositors.

On the other side, absence of a diversification strategy let S&L stuck with billions of dollars of

30 years fixed rate loans in their books.

➢ Regulations on Interest rate for mortgages

The second restriction, imposed interest rates on mortgages at 6%.

The 1980 deregulation on interest rates had an indirect effect on S&L who lost their advantage in

providing favorable interest rate on guaranteed deposits. Investors and savers were forced to

choose more profitable financial products in a period of the high inflation that the US economy

was experiencing. Interest rates on new deposits were not higher than 5.5% letting S&L without

profit margin.

➢ Money market deregulation

Reagan administration, in the attempting of facing the collapse and insolvency of these

companies, decided that the “self-regulating mechanisms of the free market” should determine

the industry’s fate. Deregulation gave to S&L the possibility to engaged in commercial lending

and to invest in high-risk, high-yield assets to bolster earnings. Within a few years, S&Ls were

deeply involved with acquisitions, development and construction loans and other speculative

vehicles.

Many S&Ls were missing necessary skills, workers and competences in commercial lending or

high-risk portfolio management. They lacked the management expertise, the information

systems, and the infrastructure to monitor and control their investment portfolios. Also FHLBB
THE SAVINGS AND LOAN CRISIS 6

lacked the internal resources to adequately monitor S&Ls. Companies were unable to manage

such interest rate risk exposure.

➢ Guarantee on assets

FSLIC increases insurance for S&L from 40k to 100k per deposit; the inadequate information

system and unskilled management let the industry exposed to a risk-free fraud.

(3) In reference to article 2, make an argument for which level of regulation the article describes

(see Lecture 2 M2) the Garn-St.Germain Depository Institutions Act was.

According to the article the Garn-St.Germain Depository Institutions Act of 1982 is a domestic,

governmental, industry specific and direct deregulation act.

➢ Domestic: because it is applied to the US market and to US entities

➢ Governmental: the deregulation is implemented by the Reagan government.

➢ Industry specific: the deregulation is applied mainly to banks and S&L entities, removing

the restriction on interest rate and assets type to hold into portfolios.

➢ Direct: the idea and consequent effect was specific for the S&L industry.
THE SAVINGS AND LOAN CRISIS 7

References

The CPA Journal Online, Primoff Walter M. : The S&L crisis – putting things in perspective.
http://archives.cpajournal.com/old/08033828.htm

Wikipedia. Saving and loan crisis

https://en.wikipedia.org/wiki/Savings_and_loan_crisis

Alice Echols: Shortfall: Family Secrets, Financial Collapse, and a Hidden History of American
Banking

The balance. Kimberly Amadeo, How Interest rates are determined? (04.2019)
https://www.thebalance.com/how-are-interest-rates-determined-3306110

The balance. Kimberly Amadeo, Stagflation and Its Causes (11.2018)

https://www.thebalance.com/what-is-stagflation-3305964

Investopedia. Troy Segal, How are savings & loan companies different from commercial
banks?(03.2019)
https://www.investopedia.com/ask/answers/041015/what-difference-between-savings-loan-
company-and-bank.asp

Investopedia. Julia Kagan, Federal Savings and Loan (04.2019)

https://www.investopedia.com/terms/f/federal-savings-and-loan.asp

Investopedia. Will Kenton, Savings and Loan – S&L – Crisis Definition (02.2019)
https://www.investopedia.com/terms/s/sl-crisis.asp

The Social Studies Help Center. Banking Crisis and Reform (2018)
http://www.socialstudieshelp.com/Eco_Deregulation.htm

The federal Reserve History. Kenneth J. Robinson, Federal Reserve Bank of Dallas. Savings and
Loan Crisis
https://www.federalreservehistory.org/essays/savings_and_loan_crisis