The Slow-Burning Financial Catastrophe: The S&L Crisis
The Savings and Loan (S&L) Crisis was a prolonged financial disaster that resulted in the failure of nearly a third of the 3,234 savings and loan associations in the United States between 1986 and 1995.
The crisis was triggered by a volatile interest rate climate, stagflation, and the economic slowdown of the 1970s. These factors, combined with a mismatch of regulations, speculation, taxpayer guarantees, deregulation, and outright corruption, culminated in a total cost of $160 billion, $132 billion of which was borne by taxpayers.
Key Insights from the S&L Crisis
- The buildup and eventual bursting of a real-estate lending bubble caused significant damage from the early 1980s to the early 1990s.
- The crisis led to the collapse of hundreds of savings & loan institutions and the insolvency of the Federal Savings and Loan Insurance Corporation (FSLIC), costing taxpayers billions of dollars and contributing to the recession of 1990-91.
- Excessive lending, speculation, risk-taking fueled by deregulation, and taxpayer bailout guarantees were central to the crisis.
- Rising instances of outright fraud among insiders worsened the scenario.
- Congress’s response to the crisis included the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), overhauling S&L industry regulations.
Origins of the S&L Crisis
The Trigger: Drastic Policy Changes in a Depressed Economy
Regulations like interest rate caps on deposits and loans hindered S&Ls’ competitiveness amid slowing economic growth and rampant inflation. In the early 1980s, as money markets attracted savers away from traditional banks due to higher returns, S&Ls faced dwindling mortgage loan portfolios and tight revenue streams. The early 1980s recession further exacerbated their struggles, leading S&Ls to report significant losses by 1982.
How It All Fell Apart
In response to the dire prospects for S&Ls, the Garn-St. Germain Depository Institutions Act of 1982 removed key lending restrictions, allowed higher-yield lending, and reduced interest rate caps. This deregulation and ensuring moral hazard led S&Ls to invest increasingly in risky ventures like commercial real estate and junk bonds.
Moral Hazard and Its Consequences
Deregulated lending coupled with a taxpayer-funded guarantee backstop created an enormous moral hazard. S&Ls took excessive risks, leading to rapid growth but also speculative unsoundness. Notably, failing S&Ls continued operations despite insolvency due to government recapitalization.
Rampant Fraud
The erosion of standards resulted in fraudulent activities among S&Ls, with insiders exploiting the system for severe personal gain. Law enforcement faced challenges addressing these complexities due to burgeoning caseloads.
Solutions and Repercussions
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) overhauled regulations and established the Resolution Trust Corporation to manage failed S&Ls. FIRREA allocated $50 billion to cover crisis-related costs and enforced stricter capital and investment standards.
Long-term Impacts
The crisis significantly reduced S&Ls’ market share in the residential mortgage sector and its financial turmoil arguably contributed to the early 1990s recession. Comparisons of the S&L crisis with the 2007-2008 subprime mortgage crisis illustrate ongoing regulatory and economic challenges.
Financial Lessons from Texas: A Case Study
The crisis’s severity was especially pronounced in Texas, where speculative land investments and widespread criminal activities exacerbated economic downfall. For example, the collapse of Empire Savings and Loan imposed a $300 million burden on taxpayers.
Post-Crisis Evolutions
The fall of the FSLIC and transitions to the FDIC reshaped the insurance backing of banks. State-run funds largely ended as a consequence. Senatorial controversies, such as the Keating Five scandal, underscored corporate governance and regulatory enforcement failures.
FAQs:
Do Savings and Loans Still Exist?
Yes. There were approximately 659 S&Ls in the U.S. by 2019, reduced from 3,371 in 1989.
How Many People Were Prosecuted for the Crisis?
More than 1,000 bankers were convicted post-crisis.
Comparisons with the 2007-2008 Credit Crisis?
Both crises involved boom-bust cycles, poor risk management, and heavy taxpayer bailout involvements, though differed in pace and nature of bank failures.
Improved Regulatory Interventions?
Better regulations restricting speculative investment and robust investigative capacities for regulatory bodies could have mitigated the crisis’s severity.
Commercial Banks’ Impact?
Both savings and loans and commercial banks experienced heavy taxation post-crisis, leading to restructuring within the industry.
Concluding Thoughts
The Savings and Loan Crisis marked a turning point in financial regulations, shedding light on areas requiring reform to prevent future crises. While the reforms addressed many vulnerabilities, the banking sector remains in constant need of vigilant regulation and preventive measures.
Related Terms: Garn-St. Germain Depository Institutions Act, Regulation Q, Federal Savings and Loan Insurance Corporation, Financial Institutions Reform Recovery and Enforcement Act, Resolution Trust Corporation, Federal Deposit Insurance Corporation.
References
- Federal Deposit Insurance Corporation. “The Savings and Loan Crisis and Its Relationship to Banking”.
- U.S. Government Accountability Office. “Resolving the Savings and Loan Crisis: Billions More and Additional Reforms Needed”.
- Federal Reserve Bank of Chicago. “The Incredible Shrinking S&L Industry”,
- Federal Deposit Insurance Corporation. “The S&L Crisis: A Chrono-Bibliography”,
- Federal Deposit Insurance Corporation. “BankFind Suite: Find Annual Historical Bank Data”.
- Frontline. “Were Bankers Jailed in Past Financial Crises?”
