The Savings and Loan Crisis was the worst bank collapse since the Great Depression. It destroyed 1,000 of the nation's savings and loans by 1989, costing $160 billion. Taxpayers paid $132 billion, and the S&L industry paid the rest. The Federal Savings and Loan Insurance Corporation (FSLIC) also went bankrupt. It was create to bail out depositors of the S&Ls. It collapsed after paying out $20 billion Another 500 S&Ls were insured by state-run funds, which collapsed after paying out $185 million to depositors.
The crisis ended what had once been a secure source of home mortgages. It also destroyed the idea of state-run bank insurance funds.
What Caused It?
In 1932, the federal government created savings and loan banks to promote homeownership for the working class. They paid low interest rates on deposits in return for low-interest mortgage rates.
In 1934, Congress created the FSLIC to insure the S&L deposits. It provided the same protection that the Federal Deposit Insurance Corporation does for regular banks. By 1980, the FSLIC insured 4,000 S&Ls with total assets of $604 billion. State-sponsored insurance programs insured 590 S&Ls with assets of $12.2 billion.
In the 1970s, stagflation combined low economic growth with high inflation. The Federal Reserve raised interest rates to end double-digit inflation. That caused a recession in 1980. This devastated S&Ls, because they were forced to offer low interest rates for deposits and loans. Depositors bailed because they found higher returns in other banks.
S&Ls also suffered because fewer people could afford homes, and hence didn't apply for mortgages. The S&Ls were stuck with a dwindling portfolio of low-interest mortgages as their only income source.
In the 1980s, money market accounts appeared. They offered high interest rates on savings. When depositors switched, it depleted the banks' source of funds. S&L banks asked Congress to remove the low-interest rate restrictions. The Carter administration allowed them to raise interest rates on savings deposits. It also increased the insurance level from $40,000 to $100,000 per depositor. By 1982, S&Ls were losing $4 billion a year. It was a significant reversal of the industry's profit of $781 million in 1980.
To save the industry, Congress passed the Garn-St. Gerrmain Depository Institutions Act of 1982. This deregulation:
- Eliminated the interest rate cap on S&Ls so they could compete.
- Allowed banks to have up to 40% of their assets in commercial loans and 30% in consumer loans. It l\
- Loosened restrictions on loan-to-value ratios.
- Allowed banks to use federally-insured deposits to make risky loans.
At the same time, President Ronald Reagan cut the budgets of the regulatory staff at the FHLBB. This impaired its ability to investigate bad loans.
Between 1982 and 1985, S&L assets increased by 56%. Legislators in California, Texas, and Florida passed laws allowing their S&Ls to invest in speculative real estate. In Texas, 40 S&Ls tripled in size.
Banks used historical accounting. They only listed the original price of real estate they bought. They only updated this price when they sold the asset. When oil prices dropped in 1986, the values of property held by Texas S&Ls also fell. But the banks kept the value on their books at the original price. That made it seem the banks were in better financial shape than they were. In other words, they hid the deteriorating state of their declining assets.
Despite this deregulation, 35% of the country's S&Ls still weren't profitable by 1983. Nine percent went bankrupt. As banks went under, the FSLIC started running out of funds. For that reason, the government allowed bad S&Ls to remain open. They continued to make bad loans, and the losses kept mounting.
In 1987, the FSLIC fund declared itself insolvent by $3.8 billion. Congress kicked the can down the road by recapitalizing it in May. But that just delayed the inevitable.
In 1989, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). It provided $50 billion to close failed banks. It set up the Resolution Trust Corporation to resell bank assets. The proceeds were used to pay back depositors. FIRREA also changed S&L regulations to help prevent further poor investments and fraud.
Scandal
The Senate Ethics Committee investigated five U.S. Senators for improper conduct. The "Keating Five" included John McCain, R-Ariz., Dennis DeConcini, D-Ariz., John Glenn, D-Ohio, Alan Cranston, D-Calif., and Donald Riegle, D-Mich.2345
The Five were named after Charles Keating, head of the Lincoln Savings and Loan Association.6 He had given them $1.5 million in total in campaign contributions. In return, they put pressure on the Federal Home Loan Banking Board to overlook suspicious activities at Lincoln. Its mandate was to investigate possible fraud, money laundering, and risky loans.
Empire Savings and Loan of Mesquite, Texas was involved in illegal land flips and other criminal activities. Empire's default cost taxpayers $300 million. Half of the failed S&Ls were from Texas. The crisis pushed the state into recession. When the banks' bad land investments were auctioned off, real estate prices collapsed. That increased office vacancies to 30% when oil prices fell 50%. (Sources: Federal Deposit Insurance Corporation. "The S&L Crisis: A Chrono-Bibliography." Federal Deposit Insurance Corporation. "The Savings and Loan Crisis The Savings and Loan Crisis and Its Relationship and Its Relationship to Banking.")
