The Garn-St. Germain Depository Institutions Act was enacted by Congress in 1982. The primary purpose was to ease pressures on banks and savings and loans, which had escalated after the Federal Reserve raised rates in an effort to combat inflation. Financial institutions that had taken on interest rate risk by lending at low rates in earlier years faced negative spreads when the Fed drove deposit interest rates higher in the early 1980s.
The act followed the establishment of the Depository Institutions Deregulation Committee by the Monetary Control Act (MCA), which had begun phasing out interest rate ceilings on bank deposit accounts. Together, these acts are widely understood to have contributed to the subsequent Savings & Loan Crisis (S&L Crisis) of the 1980s and ’90s.
Key Takeaways
- The Garn-St. Germain Depository Institutions Act eased bank pressure and was intended to combat inflation.
- This act was named after Congressman Fernand St. Germain and Senator Jake Garn. Congressman Steny Hoyer and Senator Charles Schumer were co-sponsors.
- Title VIII of the Garn-St. Germain Act allowed banks to offer adjustable-rate mortgages.
Understanding the Garn-St. Germain Depository Institutions Act
Inflation in the United States had spiked significantly in the mid-1970s after the last links between the U.S. dollar and gold were severed under the Nixon administration. Again, in the late 1970s, inflation broke above 10% by early 1980. The Federal Reserve, under Chairman Paul Volcker, aggressively began raising rates into the 1980s, eventually reversing the trend and keeping inflation lower.
Traditional banks were caught in the middle as they were paying more for their deposits than they were earning on mortgage loans made in earlier years at much lower interest rates. They had taken on enormous interest rate risk through maturity mismatching, lending long-term at low rates for home mortgages and borrowing very short-term at variable rates on bank deposits. Unable to escape the fixed rates of interest on their long-term holdings, banks found themselves becoming illiquid.
At the same time, Fed Regulation Q, which had previously restricted banks and savings and loans (known as S&L or thrifts) from raising their deposit interest rates, was phased out for deposit accounts other than checking accounts under the MCA. Investors and depositors flocked to money market mutual fund accounts, CDs, and savings accounts to obtain higher interest rates, and corporations developed alternatives like repurchase agreements. As deposit rates rose while the interest from existing mortgages remained fixed, banks were caught in a financial squeeze.
On the lending side, Title VIII of the Garn-St. Germain Act, “Alternative Mortgage Transactions,” authorized banks to offer adjustable-rate mortgages. However, the act also benefited consumer real estate owners. It allowed consumers to place their mortgaged real estate in inter-vivos trusts without triggering the due-on-sale clause that permits banks to foreclose and collect the balance due on a mortgaged property when ownership of that property is transferred. This made it easier for property owners to pass real estate to minors and heirs and allowed the wealthy to protect their real estate holdings from creditors or lawsuit settlements.
Many analysts believe that the act was one of the contributing factors to the Savings and Loan (S&L) Crisis, leading to one of the largest government bailouts in U.S. history, costing approximately $124 billion.
Passage of the Act
The Garn-St. Germain Depository Institutions Act was named after sponsors Congressman Fernand St. Germain, a Democrat from Rhode Island, and Senator Jake Garn, a Republican from Utah. Co-sponsors also included Congressman Steny Hoyer and Senator Charles Schumer. The bill passed the House with a substantial margin of 272-91 and later passed the Senate. It was signed by President Reagan in October 1982.
Unintended Consequences
The Garn-St. Germain Depository Institutions Act removed the interest rate ceiling for banks and thrifts, allowed them to make commercial loans, and gave federal agencies the ability to approve bank acquisitions. Once regulations were loosened, S&Ls began engaging in high-risk activities to mitigate losses, such as commercial real estate lending and investments in junk bonds.|
Depositors in S&Ls continued to funnel money into these risky ventures because their deposits were insured by the Federal Savings and Loan Insurance Corporation (FSLIC).
Ultimately, many analysts believe the act was a contributing factor to the S&L Crisis, which resulted in one of the largest government bailouts in U.S. history, costing approximately $124 billion. Long-term consequences included the prevalence of 2/28 adjustable-rate mortgages, which may have contributed to the subprime loan crisis and the Great Recession of 2008.
Related Terms: Savings and Loan Crisis, Monetary Control Act, Regulation Q, adjustable-rate mortgages.
References
- Federal Reserve Economic Data. “Consumer Price Index for All Urban Consumers”.
- Federal Reserve History. “Garn-St Germain Depository Institutions Act of 1982”,
