Savings and Loan crisis

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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 totalled 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.

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Background

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.

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Nature of the Deregulation

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. Firstly, 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 bottomTemplate:Citation needed.

In an effort to take advantage of the real estate boom 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.

The most important contributor 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.

A large number of S&L customers' defaults and bankruptcies ensued, and the S&Ls that had overextended themselves were forced into insolvency proceedings themselves.

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 orders the closures of all the states S&Ls. Only those who are able to qualify for membership in the FDIC are allowed to reopen. Claims by Ohio S&L depositors drain the state's deposit insurance funds. A similar event takes 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 — escaped relatively unscathed.

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See also

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External links

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References

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