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The savings and loan crisis of the 1980s and 1990s (commonly referred to as the S&L crisis) was the failure of 747 savings and loan associations (S&Ls) in the United States. The ultimate cost of the crisis is estimated to have totaled around $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government—that is, the U.S. taxpayer, either directly or through charges on their savings and loan accounts¹—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. Between 1986 and 1991, the number of new homes constructed per year dropped from 1.8 million to 1 million, the lowest rate since World War II. ²

Background

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Savings and loan associations (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 late 1970s.^{citation needed} For example, there was a ceiling on the interest rates they could offer to depositors.^{citation needed}

In the 1970s, many banks, but more particularly S&Ls, were experiencing a significant outflow from low-interest rate deposits, as interest rates were driven up by the high inflation rate of the late 1970s and as depositors moved their money to the new high-interest money market funds.^{citation needed} At the same time, the institutions^clarify had much of their money tied up in long-term mortgage loans at fixed interest rates, and with market rates rising, these were worth far less than face value. That is, to sell a 5 percent mortgage to pay requests from depositors for their funds in a market asking 10 percent, a savings and loan would have to discount its asking price on the mortgage. This meant that the value of these loans, which were the institutions'^clarify assets, was less than the deposits used to make them, and the savings and loan's net worth was being eroded.

Under financial institution regulation, which had its roots in the Civil War era, federally chartered S&Ls were only allowed to make a narrowly limited range of loan types. Late in the administration of President Jimmy Carter, caps were lifted on rates and the amounts insured per account to $100,000. In addition to raising the amounts covered by insurance, the amount of the accounts that would be repaid was increased from 70 percent to 100 percent.^{citation needed} Increasing Federal Savings and Loan Insurance Corporation (FSLIC) coverage also permitted managers to take more risk to try to work their way out of insolvency so the government would not have to take over an institution.

Carter left office in January 1981, a year in which 3,300 out of 3,800 S&Ls lost money.^{citation needed} In 1982 under Ronald Reagan, the combined tangible net capital of the industry was $4 billion. The chartering of federally regulated S&Ls accelerated rapidly with the Garn-St. Germain Depository Institutions Act of 1982, which was designed to make S&Ls more competitive and more solvent. S&Ls could now pay higher market rates for deposits, borrow money from the Federal Reserve, make commercial loans, and issue credit cards. They were also allowed to take an ownership position in the real estate and other projects to which they made loans and they began to rely on brokered funds to a considerable extent. This was a departure from their original mission of providing savings and mortgages.

Causes

Tax Reform Act of 1986

By enacting 26 U.S.C. § 469 (relating to limitations on deductions for passive activity losses and limitations on passive activity credits) to remove many tax shelters, especially for real estate investments, the Tax Reform Act of 1986 significantly decreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability. This contributed to the end of the real estate boom of the early to mid '80s and facilitated the Savings and Loan crisis. Prior to 1986, much real estate investment was done by passive investors. It was common for syndicates of investors to pool their resources in order to invest in property, commercial or residential. They would then hire management companies to run the operation. TRA 86 reduced the value of these investments by limiting the extent to which losses associated with them could be deducted from the investor's gross income. This, in turn, encouraged the holders of loss-generating properties to try and unload them, which contributed further to the problem of sinking real estate values. This turmoil and repositioning in real estate markets was caused not by changes in market conditions.^{citations needed}

Deregulation

Although the deregulation of S&Ls (aka thrifts) gave them many of the capabilities of banks, it did not bring them under the same regulations as banks, and the new legislation allowed them to enter new lending businesses with very little oversight. Savings and loan associations 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 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.^{citation needed}

Imprudent real estate lending

In an effort to take advantage of the real estate boom (outstanding US mortgage loans: 1976 $700 billion; 1980 $1.5 trillion)^{citation needed} and high interest rates of the late 1970s and early 1980s, many S&Ls lent far more money than was prudent, and to risky ventures which many S&Ls were not qualified to assess. L. William Seidman, former chairman of both the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation, stated, "The banking problems of the '80s and '90s came primarily, but not exclusively, from unsound real estate lending."³

Keeping insolvent S&Ls open

Whereas insolvent banks in the United States were typically detected and shut down quickly by bank regulators, Congress sought to change regulatory rules so S&Ls would not have to acknowledge insolvency^{citation needed} and the Federal Home Loan Bank Board (FHLBB) would not have to close them down.

Brokered deposits

One of the most important contributors to the problem was deposit brokerage.^{citation needed} 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 CDs.^{citation needed} 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. To make money off this expensive money, it had to lend at even higher rates, meaning that it had to make more, riskier 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 he would steer a large amount of deposits to that thrift if the thrift would lend 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.^{neutrality disputed} Michael Milken of Drexel, Burnham and Lambert packaged brokered funds for several S&Ls on the condition that the institutions would invest in the junk bonds of his clients.

End of inflation

Another factor was the efforts of the federal government to wring inflation out of the economy, marked by Paul Volcker's speech of October 6, 1979, with a series of rises in short-term interest rates. This led to increases in the short-term cost of funding to be higher than the return on portfolios of mortgage loans, a large proportion of which may have been fixed rate mortgages (a problem that is known as an asset-liability mismatch). This effort failed and interest rates continued to skyrocket, placing even more pressure on S&Ls as the 1980s dawned and led to increased focus on high interest-rate transactions. Zvi Bodie, professor of finance and economics at Boston University School of Management, writing in the St. Louis Federal Reserve Review wrote, "asset-liability mismatch was a principal cause of the Savings and Loan Crisis".[1]

Major causes according to United States League of Savings Institutions

The following is a detailed summary of the major causes for losses that hurt the savings and loan business in the 1980s:⁴

1. Lack of net worth for many institutions as they entered the 1980s, and a wholly inadequate net worth regulation.
2. Decline in the effectiveness of Regulation Q in preserving the spread between the cost of money and the rate of return on assets, basically stemming from inflation and the accompanying increase in market interest rates.
3. Absence of an ability to vary the return on assets with increases in the rate of interest required to be paid for deposits.
4. Increased competition on the deposit gathering and mortgage origination sides of the business, with a sudden burst of new technology making possible a whole new way of conducting financial institutions generally and the mortgage business specifically.
5. Savings and Loans gained a wide range of new investment powers with the passage of the Depository Institutions Deregulation and Monetary Control Act and the Garn-St. Germain Depository Institutions Act. A number of states also passed legislation that similarly increased investment options. These introduced new risks and speculative opportunities which were difficult to administer. In many instances management lacked the ability or experience to evaluate them, or to administer large volumes of nonresidential construction loans.
6. Elimination of regulations initially designed to prevent lending excesses and minimize failures. Regulatory relaxation permitted lending, directly and through participations, in distant loan markets on the promise of high returns. Lenders, however, were not familiar with these distant markets. It also permitted associations to participate extensively in speculative construction activities with builders and developers who had little or no financial stake in the projects.
7. Fraud and insider transaction abuses were the principal cause for some 20% of savings and loan failures the past three years^clarify and a greater percentage of the dollar losses borne by the Federal Savings and Loan Insurance Corporation (FSLIC).
8. A new type and generation of opportunistic savings and loan executives and owners—some of whom operated in a fraudulent manner — whose takeover of many institutions was facilitated by a change in FSLIC rules reducing the minimum number of stockholders of an insured association from 400 to one.
9. Dereliction of duty on the part of the board of directors of some savings associations. This permitted management to make uncontrolled use of some new operating authority, while directors failed to control expenses and prohibit obvious conflict of interest situations.
10. A virtual end of inflation in the American economy, together with overbuilding in multifamily, condominium type residences and in commercial real estate in many cities. In addition, real estate values collapsed in the energy states — Texas, Louisiana, Oklahoma particularly due to falling oil prices — and weakness occurred in the mining and agricultural sectors of the economy.
11. Pressures felt by the management of many associations to restore net worth ratios. Anxious to improve earnings, they departed from their traditional lending practices into credits and markets involving higher risks, but with which they had little experience.
12. The lack of appropriate, accurate, and effective evaluations of the savings and loan business by public accounting firms, security analysts, and the financial community.
13. Organizational structure and supervisory laws, adequate for policing and controlling the business in the protected environment of the 1960s and 1970s, resulted in fatal delays and indecision in the examination/supervision process in the 1980s.
14. Federal and state examination and supervisory staffs insufficient in number, experience, or ability to deal with the new world of savings and loan operations.
15. The inability or unwillingness of the Bank Board and its legal and supervisory staff to deal with problem institutions in a timely manner. Many institutions, which ultimately closed with big losses, were known problem cases for a year or more. Often, it appeared, political considerations delayed necessary supervisory action.

Failures

The United States Congress granted all thrifts in 1980, including savings and loan associations, the power to make consumer and commercial loans and to issue transaction accounts. Designed to help the thrift industry retain its deposit base and to improve its profitability, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20 percent of their assets, issue credit cards, accept negotiable order of withdrawal (NOW) accounts from individuals and nonprofit organizations, and invest up to 20 percent of their assets in commercial real estate loans.

The damage to S&L operations led Congress to act, passing a bill in September 1981⁵ 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 amortized over the life of the loan, and any losses could also be offset against taxes paid over the preceding 10 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 Ginnie Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls were one group buying these bonds, holding $150 billion by 1986, and being charged substantial fees for the transactions.

In 1982, the Garn-St Germain Depository Institutions Act was passed and increased the proportion of assets that thrifts could hold in consumer and commercial real estate loans and allowed thrifts to invest 5 percent of their assets in commercial loans until January 1, 1984, when this percentage increased to 10 percent.⁶

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.

The U.S. government agency FSLIC, 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. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency’s resolution by mid-1995 of an additional 747 thrifts. ⁷

A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up being even larger than it would have been because moral hazard and adverse selection incentives that compounded the system’s losses. ⁸

There also were state-chartered S&Ls that failed. Some state insurance funds failed, requiring state taxpayer bailouts.

Home State Savings Bank of Cincinnati

In March 1985, it came to public knowledge that the large Cincinnati, Ohio-based Home State Savings Bank was about to collapse. Ohio Gov. Dick Celeste declared a bank holiday in the state as Home State depositors lined up in a "run" on the bank's branches 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 Federal Deposit Insurance Corporation were allowed to reopen. ⁹ Claims by Ohio S&L depositors drained the state's deposit insurance funds. A similar event took place in Maryland.

Lincoln Savings and Loan

The Lincoln Savings led to the Keating five political scandal, in which five U.S. senators were implicated in an influence-peddling scheme. It was named for Charles Keating, who headed Lincoln Savings and made $300,000 as political contributions to them in the 1980s. Three of those senators – Alan Cranston (D-CA), Don Riegle (D-MI), and Dennis DeConcini (D-AZ) – found their political careers cut short as a result. Two others – John Glenn (D-OH) and John McCain (R-AZ) – were rebuked by the Senate Ethics Committee for exercising "poor judgment" for intervening with the federal regulators on behalf of Keating.¹⁰

Silverado Savings and Loan

Silverado Savings and Loan collapsed in 1988, costing taxpayers $1.3 billion. Neil Bush, son of then Vice President of the United States George H. W. Bush, was Director of Silverado at the time. Neil Bush was accused of giving himself a loan from Silverado, but he denied all wrongdoing.[2]

The US Office of Thrift Supervision investigated Silverado's failure and determined that Neil Bush had engaged in numerous "breaches of his fiduciary duties involving multiple conflicts of interest." Although Bush was not indicted on criminal charges, a civil action was brought against him and the other Silverado directors by the Federal Deposit Insurance Corporation; it was eventually settled out of court, with Bush paying $50,000 as part of the settlement, the Washington Post reported.¹¹

As a director of a failing thrift, Bush voted to approve $100 million in what were ultimately bad loans to two of his business partners. And in voting for the loans, he failed to inform fellow board members at Silverado Savings & Loan that the loan applicants were his business partners.^{citation needed}

Neil Bush paid a $50,000 fine and was banned from banking activities for his role in taking down Silverado, which cost taxpayers $1.3 billion. A Resolution Trust Corporation Suit against Bush and other officers of Silverado was settled in 1991 for $26.5 million.

Financial Institutions Reform, Recovery, and Enforcement Act of 1989

As a result,^clarify the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) dramatically changed the savings and loan industry and its federal regulation. The highlights of the legislation, signed into law August 9, 1989, were:¹²

1. The Federal Home Loan Bank Board (FHLBB) and the Federal Savings and Loan Insurance Corporation (FSLIC) were abolished.
2. The Office of Thrift Supervision (OTS), a bureau of the Treasury Department, was created to charter, regulate, examine, and supervise savings institutions.
3. The Federal Housing Finance Board (FHFB) was created as an independent agency to oversee the 12 federal home loan banks (also called district banks).
4. The Savings Association Insurance Fund (SAIF) replaced the FSLIC as an ongoing insurance fund for thrift institutions (like the FDIC, the FSLIC was a permanent corporation that insured savings and loan accounts up to $100,000). SAIF is administered by the Federal Deposit Insurance Corp.
5. The Resolution Trust Corporation (RTC) was established to dispose of failed thrift institutions taken over by regulators after January 1, 1989. The RTC will make insured deposits at those institutions available to their customers.
6. FIRREA gives both Freddie Mac and Fannie Mae additional responsibility to support mortgages for low- and moderate-income families.

Consequences

While not part of the savings and loan crisis, many other banks failed. Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance.¹³

From 1986 to 1995, the number of US federally insured savings and loans in the United States declined from 3,234 to 1,645.⁷ This was primarily, but not exclusively, due to unsound real estate lending.¹⁴

The market share of S&Ls for single family mortgage loans went from 53% in 1975 to 30% in 1990.² U.S. General Accounting Office estimated cost of the crisis to around USD $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government from 1986 to 1996.¹ That figure does not include thrift insurance funds used before 1986 or after 1996. It also does not include state run thrift insurance funds or state bailouts.

The U.S. government ultimately appropriated 105 billion dollars to resolve the crisis. After banks repaid loans through various procedures, there was a net loss to taxpayers of 40 billion dollars by the end of 1999.¹⁵

The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990–1991 economic recession. Between 1986 and 1991, the number of new homes constructed dropped from 1.8 to 1 million, the lowest rate since World War II. ²

Some commentators believe that a taxpayer-funded government bailout related to mortgages during the savings and loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans during the 2007 subprime mortgage financial crisis.¹⁶

See also

• Financial crisis
• Fractional-reserve banking
• Resolution Trust Corporation
• Tax Reform Act of 1986
• Cottage Savings Association v. Commissioner, a United States Supreme Court case dealing with the tax consequences of the S&L crisis
• United States v. Winstar Corp., a US Supreme Court case that gives a concise but useful history of the crisis and the accounting practices that aggravated that crisis.

Notes

References

• Black, William K. (2005). The Best Way to Rob a Bank is to Own One. Austin: University of Texas Press. ISBN 0292706383. 
• Lowy, Michael (1991). High Rollers: Inside the Savings and Loan Debacle. New York: Praeger. ISBN 027593988X. 
• Mayer, Martin (1992). The Greatest Ever Bank Robbery : The Collapse of the Savings and Loan Industry. New York: C. Scribner's Sons. ISBN 0684191520. 
• Pizzo, Steven; Fricker, Mary; Muolo, Paul (1989). Inside Job: The Looting of America's Savings and Loans. New York: McGraw-Hill. ISBN 0070502307. 
• Robinson, Michael A. (1990). Overdrawn: The Bailout of American Savings. New York: Dutton. ISBN 0525249036. 
• Tolchin, Martin (1990-09-27). "Legal Scholars Clash Over Neil Bush Actions", New York Times. 
• White, Lawrence J. (1991). The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. New York: Oxford University Press. ISBN 0195067339. 
• Cassell, Mark K. (2003). How Governments Privatize: The Politics of Divestment in the United States and Germany. Washington: Georgetown University Press. ISBN 1589010086. 

External links

• FDIC: The S&L Crisis: A Chrono-Bibliography
• The Cost of Savings & Loan Crisis: Truth & Consequences
• Classic Financial and Corporate Scandals
• (Mis)Understanding a Banking Industry in Transition by William K. Black, from Dollars & Sense Nov/Dec 2007