The Savings and Loan Crisis

THE SAVINGS AND LOAN CRISIS

Background

Historically, savings and loan associations (S and Ls) have served a different body of customers than banks. S and Ls made most of their money by providing services to working-class and middle-class people rather than to large businesses or other financial institutions. In 1903 journalist D. A. Tomkins wrote that the building and loan association gave a solution to the problem of financing people's homes that is most essentially advancement by self-help. According to two authorities on banking systems, with the turn of the century the American banking system rested on three legs: (1) deposit-owned mutual savings banks, (2) stock-chartered savings banks that profited investors rather than depositors, and (3) building and loan associations, later known as savings and loans associations. In 1928 the first great banking crisis of the twentieth century began as the American financial system began collapsing in one of the early symptoms of the Great Depression. The result was an extensive set of regulations put in place by New Deal reformers to prevent a similar collapse in the future and to restore the public's confidence in the banking system.

Bailout

Ed Gray, as chairman of the Federal Home Loan Bank Board, was one of the first people to deal with the impending crisis in the savings and loan industry. The Financial Corporation of America (FCA) and its subsidiaries, located in California, experienced a run on its deposits by worried customers. FCA had participated in the merger mania of the 1980s, and for a period it had grown at nearly $1 billion a month. A run on the institution by depositors endangered the bank, and if FCA collapsed it could create a domino effect among other financial institutions that would lead to disaster. The entire Federal Savings and Loan Corporation could have been bankrupted by the collapse of this one large savings and loan. This scenario became a familiar one in the 1980s. By 1988 the savings and loan crisis was rapidly emerging with the projection that $100 billion to $200 billion or more would be needed to bail out hundreds of overextended institutions. As part of the New Deal regulations, federally chartered S and Ls were required to place almost all of their loans in the relatively safe investment in home mortgages. The high interest rates of the late 1970s and early 1980s made low-interest mortgages unprofitable, so new federal laws passed in 1982 gave S and Ls the liberty to invest their funds more freely. S and Ls could invest 100 percent in commercial real estate ventures; before they would have required 10 or 20 percent down from the developer. Like banks in the 1920s, many S and Ls gambled with their federally guaranteed deposits, often charging large fees for their services. Eventually bad investments and poor loan choices took their toll on the industry. By 1990 the estimated cost to the taxpayers for the savings and loans bailout had reached $500 billion.

Sources:

Martin Lowy, High Rollers: Inside the Savings and Loan Debacle (New York: Praeger, 1991);

Paul Zane Pilzer and Robert Deitz, Other People's Money: How Bad Luck, Worse Judgment, and Flagrant Corruption Made a Shambles of a $900 Billion Industry (New York: Simon & Schuster, 1989);

Michael A. Robinson, Overdrawn: The Bailout of American Savings: The Inside Story of the $2 Billion S&L Debacle (New York: Dutton/Penguin Books, 1990).