Savings and Loan Crisis

The savings and loan crisis of the 1980s and 1990s was the failure of 1,043 out of the 3,234 savings and loan associations (S&Ls) in the United States from 1986 to 1995: the Federal Savings and Loan Insurance Corporation (FSLIC) closed or otherwise resolved 296 institutions from 1986 to 1989 and the Resolution Trust Corporation (RTC) closed or otherwise resolved 747 institutions from 1989 to 1995.

An S&L or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members (a cooperative venture known in the United Kingdom as a building society). By 1995, the RTC had closed 747 failed institutions nationwide, worth a total possible book value of between $402 billion and $407 billion. In 1996, the General Accounting Office (GAO) estimated the total cost to be $160 billion, including $132.1 billion taken from taxpayers. The RTC was created to resolve the S&L crisis.

In 1979, the Federal Reserve of the United States raised the discount rate that it charged its member banks from 9.5 percent to 12 percent in an effort to reduce inflation. The building of S&Ls had issued long-term loans at fixed interest rates that were lower than the interest rate at which they could borrow. In addition, the S&Ls had the liability of the deposits which paid higher interest rates than the rate at which they could borrow. When interest rates at which they could borrow increased, the S&Ls could not attract adequate capital, from deposits to savings accounts of members for instance, and they became insolvent. Rather than admit to insolvency, lax regulatory oversight allowed some S&Ls to invest in highly speculative investment strategies. This had the effect of extending the period where S&Ls were likely technically insolvent. These adverse actions also substantially increased the economic losses for the S&Ls than would otherwise have been realized had their insolvency been discovered earlier. One extreme example was that of financier Charles Keating, who paid $51 million financed through Michael Milken's "junk bond" operation, for his Lincoln Savings and Loan Association, which at the time had a negative net worth exceeding $100 million.

Others, such as author and financial historian Kenneth J. Robinson or the account of the crisis published in 2000 by the Federal Deposit Insurance Corporation (FDIC), give multiple reasons as to why the S&L crisis came to pass. They identify the rising monetary inflation beginning in the late 1960s spurred by simultaneous domestic spending programs of President Lyndon B. Johnson's "Great Society" programs coupled with the military expenses of the continuing Vietnam War that continued into the late 1970s. The efforts to end the rampant inflation of the late 1970s and early 1980s by raising interest rates brought on a recession in the early 1980s and the beginning of the S&L crisis. Deregulation of the S&L industry, combined with regulatory forbearance, and fraud worsened the crisis.

• May 25 – July 22, 1932
  Federal Home Loan Bank Act creates S&L system to lower cost of home ownership
  The Federal Home Loan Bank Act is introduced in the House of Representatives on May 25, 1932. It passes Congress on July 16 and is signed into law by President Herbert Hoover six days later, on July 22. The act is intended to lower the cost of home ownership. It establishes the Federal Home Loan Bank Board (FHLBB) to charter and supervise federal savings and loan associations (S&Ls). It also creates Federal Home Loan Banks, which lend to building and loan associations, cooperative banks, homestead associations, insurance companies, savings banks, community development financial institutions, and insured depository institutions in order to finance home mortgages. (1)

• July 27, 1934
  FSLIC formed to administer deposit insurance for S&L institutions
  The Federal Savings and Loan Insurance Corporation (FSLIC) is established on June 27, 1934. It is administered by the Federal Home Loan Bank Board (FHLBB), which was formed by the Federal Home Loan Bank Act of 1932. The FSLIC is created as part of the National Housing Act of 1934, New Deal legislation passed amid the ongoing Great Depression in order to make housing and home mortgages more affordable. The act, which also establishes the Federal Housing Administration (FHA), is signed into law by President Franklin D. Roosevelt. Upon the creation of the FSLIC, it is assigned a capital stock of $100 million. All federal savings and loan associations (S&Ls) will be required to apply for insurance through the FSLIC; other building and loan associations whose capital are not impaired will also be allowed to apply. The FSLIC is given certain regulatory powers over insured institutions, requiring each institution to accumulate reserves over several years, and assesses an annual insurance premium, calculated at 0.25 percent of the total amount of all accounts of insured shareholders or members, plus any creditor obligations. The FSLIC will routinely suspend insurance premiums whenever its reserve fund is greater or equal to five percent of all insured accounts and creditor obligations of all insured institutions. (2)

• 1966 – 1979
  Market interest rates fluctuate with increasing intensity; S&Ls experience difficulty with each interest rate rise
  Fluctuating market interest rates cause many savings and loan associations (S&Ls) to struggle financially. The problems stem from changes made to the Federal Reserve's "Regulation Q" policy in 1966. Regulation Q was created in accordance with the 1933 Banking Act, with the goal of prohibiting banks from paying interest on deposits in checking accounts. By limiting speculative behavior by banks competing for customer deposits, they would be prevented from seeking risky means of profit to be able to pay the interest on said deposits. Under the 1966 changes, interest rate ceilings are imposed on thrift institutions, including both mutual savings banks and S&Ls. Recently, the volume of funds raised by business firms in the financial markets has risen sharply relative to the funds by households in the form of residential mortgages. The slowing in the rate of increase in residential mortgage credit is especially pronounced at thrift institutions. The changes made to the Regulation Q policy reflect policymakers' interpretation of this decline. (3) (4) Since the interest rate ceilings prevent S&Ls from paying competitive interest rates on deposits, every time the market interest rates rise, substantial amounts of funds are withdrawn by consumers for placement in other financial instruments with higher rates of return, such as money market funds. This process of deposit withdrawal, known as disintermediation, and the subsequent deposit influx when rates rise, known as reintermediation, leaves S&Ls highly vulnerable. S&Ls are also restricted at this time by not being allowed to enter into any business venture other than accepting deposits and granting home mortgage loans. As money market funds emerge as a source of competition for S&L deposits, these restrictions become increasingly challenging for S&Ls to deal with. (5)

• 1967
  Texas approves major liberalization of S&L powers
  In 1967, the state of Texas approves a major liberalization of savings and loan associations' (S&Ls) powers, allowing property development loans of up to 50 percent of their net worth. This will be compounded in 1982, when, in response to massive defections of state-chartered S&Ls to the federal system, California, then Texas and Florida, allow S&Ls to invest 100 percent of deposits in any kind of venture. In addition, while S&Ls operating under state charters are allowed to obtain federal insurance under the Federal Savings and Loan Insurance Corporation (FSLIC), states with the softest standards can still qualify on the same basis. (6) (7) More than one-half of all S&L losses nationwide, including 14 of the 20 largest losses, will be in Texas. (5)

• August 15, 1971
  Nixon takes US dollar off gold standard
  President Richard Nixon officially announces the end of the gold standard system of monetary policy for international exchange of gold deposits in an evening address to the country. Nixon's move to sever the link between the dollar's value and gold reserves effectively ends the Bretton Woods system of monetary exchange and changes the dollar to a "floating" currency whose value is to be determined largely by market influences. Nixon's decision results from a run on gold exchanges and rampant speculation in gold markets in Europe, and he changes the United States' monetary policy after receiving advice from Treasury Secretary John Connally, Under Secretary for Monetary Affairs Paul Volcker, and others in a special working group. The dollar becomes a fiat currency, causing a brief international panic before other countries follow suit and also allow their currencies to "float." (8)

• December 22, 1971
  Hunt Commission promotes federal savings banks over S&Ls
  The Hunt Commission, established by President Richard Nixon in 1970 to "review and study the structure" of the nation's private financial system, submits its findings to President Nixon. Officially known as the President's Commission on Financial Structure and Regulation, the commission is chaired by Reed O. Hunt, a former board chairman of the pulp and paper conglomerate Crown Zellerbach, as well as Robert H. Stewart III, chairman of the First National Bank in Dallas. The commissioners are or once were high-ranking officials at major American businesses or financial institutions, including American Express President William H. Morton and United Virginia Bankshares President K. A. Randall, as well as Ohio Senator Ralph Regula and future Chair of the Federal Reserve Alan Greenspan. In its report, the commission claims that limiting deposit interest prevents banks from competing with rising money market funds that are relatively unregulated and are able to provide higher returns by investing client funds directly in unsecured commercial paper and repurchase agreements. The commission ultimately recommends that federal savings banks be created to replace savings and loan associations (S&Ls). The commission suggests S&Ls and mutual savings banks be granted "a widespread range of loan and investment powers," including the ability to make mortgage loans on all types of properties "without statutory or regulatory restrictions," "make construction loans in the same manner as commercial banks," "make loans on mobile homes, without restrictions on sizes and types," "make direct investment in real estate and participate directly with other organizations in the ownership of real estate, including participation through stock ownership," "participate directly in real estate through loan agreements," "make secured and unsecured consumer loans," and invest in a "full range" of investment-grade US government, state and municipal, and private debt instruments "of all maturities." The commission also notes, "Without changes in their operations, there is serious question about the ability of deposit thrift institutions to survive." The commission recommends allowing S&Ls to offer third-party payment services, while also urging mandatory membership in the Federal Reserve System for all S&Ls and mutual savings banks that offer third-party services. The commission also recommends the establishment of a new agency, the Office of the Administrator of State Banks, to supervise and examine insured S&Ls. (9) The Federal Deposit Insurance Corporation (FDIC) will later state that the Hunt Commission's recommendations "would have created federal savings banks to replace S&Ls." (5) The term "deregulation" does not appear in the commission's report. Even so, submitting its final report to President Nixon in December 1972, the Hunt Commission claims to have proposed a "number of fundamental changes" that it hopes will "produce a structural and regulatory system which will efficiently and equitably serve the financial needs of the country in the coming decades." (9) The United States League of Savings Institutions, the largest trade association for thrifts, will oppose the report's recommendations, believing they reflect a desire to phase S&Ls out of existence. (10) Fordham University Professor Fred E. Case, writing for the Fordham Law Review, will say that the S&L industry's "shortcoming" is a lack of competition, but calls the extent of deregulation proposed by the Hunt Commission "an invitation to disaster." (11) Nixon will state in a special message to Congress on August 3, 1973, "As the government tries to play its proper role in building a better financial system, we must proceed with one basic assumption: the public interest is generally better served by the free play of competitive forces than by the imposition of rigid and unnecessary regulation." (12) The Nixon administration will ultimately propose expanding the asset powers of S&Ls into new lending markets with the Financial Institutions Act of 1973. The legislation will be unsuccessful; it will merely be introduced to Congress, which will not vote on it. (13)
  

• 1972
  Carolyn Jordan joins Senator Cranston's banking staff

• 1973
  FINE Study suggests granting S&Ls same powers as banks

• November 1973 – March 1975
  US experiences economic recession with high unemployment and inflation

• August 1976
  Charles Keating resigns from American Financial, purchases Continental Homes of Arizona

• 1978
  Laurie Sedlmayr starts working for Senator DeConcini full-time

• 1978
  Joy Jacobson begins working for Senator Cranston as staffer

• 1978
  Keating forms American Continental, named chairman

• October 10 – November 10, 1978
  Financial Institutions Regulatory and Interest Rate Control Act becomes law

• Late 1978 – Summer 1979
  Farmers flood Washington to protest high interest rates

• 1979
  Inflation moves into double digits for second time in five years

• July 25, 1979
  President Carter selects Volcker to lead Federal Reserve

• July 27, 1979 – March 28, 1980
  Depository Institutions Deregulation and Monetary Control Act passes Congress

• August 6, 1979
  Volcker becomes chairman of the Federal Reserve

• October 6, 1979
  Federal funds rate increased to combat inflation; helps lead to economic recession

• 1980 – 1982
  US passes laws to encourage Americans to bank with S&Ls

• 1980 – 1984
  Florida enacts liberal S&L laws on 'virtually nonexistent' state-chartered S&L industry

• January – July 1980
  US experiences economic recession as credit becomes more difficult to obtain for car and home loans

• April 1, 1980
  President Carter signs the Depository Institutions Deregulation and Monetary Control Act into law

• Early 1980s
  Tough interest rate environment for thrifts persists
  Efforts are made to improve the interest rate environment in which banks, and especially thrifts, have to operate, such as the Depository Institutions Deregulation and Monetary Control Act of 1980, and numerous changes in the regulatory frameworks at the state and federal levels. Despite all this activity, it remains the case that interest rates on sources of funds to the thrift industry lags behind those that could be paid by commercial banks and nonbanks in new vehicles such as money market accounts. Consequently, thrift bankers find it increasingly difficult to keep their businesses supplied with enough funds to sustain a profitable rate of new lending. The industry therefore cannot avoid a period of higher-than-historical failure levels and voluntary mergers and departures from the industry.

• April 1980
  First Pennsylvania Bank gets aid from federal regulators
  First Pennsylvania Bank, the 23rd largest commercial bank in the United States, gets a package of $1.5 billion in financial assistance, in exchange for close supervision of its operations by the Federal Deposit Insurance Corporation (FDIC). The aid consists of a $1 billion bank line of credit from the Federal Reserve, a $325 million loan from the FDIC written as a subordinated note to be paid off after five years and interest-free for the first year, and $175 million in other notes to a group of commercial banks. The following year, as regulators and the banking industries search for a response to a rising incidence of bank insolvency, the First Pennsylvania agreement will be seen by some as a model.

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