Savings and Loan Association

What It Means

Savings and loan associations are institutions that were originally established to allow ordinary people to deposit their savings and take out loans, primarily for the purpose of buying homes. They are similar to banks but are more limited in their functions; banks use the deposits of account holders to finance a wider range of loans and other investments. Another characteristic of most savings and loan associations is that they are owned and operated by their members (the people who deposit money in them) and for their members’ benefit.

In the 1980s, for a complex set of reasons, large numbers of savings and loan associations became insolvent (they could no longer meet their expenses and were going bankrupt), and bungled government attempts to deal with this developing crisis worsened its ultimate outcome. The savings and loan industry collapsed, and the eventual government cost of repairing the financial damage caused by the collapse was more than $150 billion, most of which was shouldered by taxpayers. The savings and loan crisis was the most significant banking-industry failure since the Great Depression (1929?39).

When Did It Begin

Businesses called building societies established in England in the early 1800s enabled communities to pool their money to finance the building of homes. The first savings and loan association in the United States, a direct descendent of these building societies, was the Oxford Provident Building Association of Frankfort, Pennsylvania, established in 1831. Meant to serve as an intermediary between people who wanted to save money and people who wanted to borrow money, Oxford Provident accepted regular payments from its members, with the eventual goal of enabling all the members, through loans, to build or purchase their own homes. Though the terminology and operational details of savings and loan associations changed over time, this remained the basic model and purpose for the institutions, which spread all over the United States in the years after the Civil War (1861–65).

The savings and loan industry flourished during the post-World War II housing boom in America (this occurred primarily in the 1950s and 1960s), when savings and loan associations had a reputation for being community-building tools for ordinary citizens. From their beginnings and until the latter part of the twentieth century, most savings and loan associations only gave loans to members buying houses within strict geographical boundaries (often only residential real estate located within 50 miles of the association’s office qualified for a loan).

More Detailed Information

The savings and loan association business model ran into serious trouble in the 1970s, and it reached crisis stage in the 1980s. Many factors contributed to the difficulties the industry faced, but most of these factors were tied to one glaring issue: rising interest rates.

Like banks, savings and loans are able to make loans in proportion to the amount of money they take in through deposits. If you open an account at a savings and loan association, the money you deposit will be used to finance home loans for other people. The association makes money by charging borrowers interest (a fee paid to borrow money) on these loans. Because the depositors are essentially loaning the association money, they are paid interest as well. To remain profitable, a savings and loan association has to maintain a balance between the interest it takes in from borrowers and the interest it pays to depositors. This can be a delicate balance to maintain, however, because savings deposits are short-term loans, with an interest rate that fluctuates daily; whereas mortgages are long-term loans (usually 30 years), and the home owner usually pays an interest rate that does not change (called a fixed rate). Normally these two interest rates are not that far apart, but if interest rates rise dramatically, a business whose profits depend on making more on mortgage-loan interest than it pays out in savings-account interest cannot remain profitable.

To understand how this situation played out in the savings and loan industry, consider that in 1965 a savings and loan association member might have received interest at a rate of around 2 percent on a savings account and might have been able to get a 30-year fixed-rate mortgage loan at an interest rate of around 6 percent. Once that loan went into effect, the interest rate was fixed, or locked in; the member could never be required to make payments based on a higher interest rate, no matter what happened to interest rates in the wider economy over time. In the late 1970s, though, interest rates climbed to double-digit numbers before peaking at more than 20 percent. During this time the savings and loan association member with the 1965 loan would still be paying interest at the 6 percent rate even though the depositors were being paid interest at current rates. A business that brings in money at a rate of 6 percent while paying money out at nearly 20 percent is clearly in a vulnerable financial position. Because the savings and loan industry’s profits depended almost entirely on long-term home loans, it had no way of breaking this stranglehold imposed on it by rising interest rates. The fact that savings and loan associations’ business prospects were limited to strict geographical areas made it even harder for the industry to find options for coping with these financial difficulties.

Recent Trends

Government attempts to bail out the savings and loan industry were ineffectual, partly because economists underestimated the severity of the problem and partly because politicians did not want to take responsibility for such an overwhelming problem. The U.S. government pinned its hopes on deregulation (the removal of government restrictions): savings and loan associations were allowed to invest the money of their depositors more broadly, and they were permitted to fudge the rules of general accounting.

The accounting tricks the industry was authorized to use essentially made it appear that savings and loan associations were profitable when they were not, thus relieving the federal government of any immediate responsibility to take over numerous failing associations. Additionally, the riskier investments the associations began making were essentially subsidized (financially supported) by the U.S. government, which insured association deposits (promising to pay back the depositors in case of loss) but did not charge the associations higher insurance rates for riskier investments, as a for-profit insurance company would have done. The savings and loan associations, desperate for money, could (and did) gamble on risky ventures, knowing their losses would be paid for by the government. Even though interest rates dropped in the mid-1980s and there seemed to be hope of recovery, changes in the economy affecting the housing market hurt the savings and loan industry further.

When President George H. W. Bush (b. 1924) took office in 1989, he immediately took action to repair the problems, reorganizing the government offices that regulated the industry and imposing tougher financial and accounting standards, but large numbers of savings and loan associations could not meet these standards. With hundreds of associations bankrupt and the U.S. government responsible for repaying depositors (who were all repaid), roughly 80 percent of the total bill (estimated at around $150 billion) was eventually passed on to the taxpayers.