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Savings and Loan Association

SAVINGS AND LOAN ASSOCIATION

A financial institution owned by and operated for the benefit of those using its services. The savings and loan association's primary purpose is making loans to its members, usually for the purchase of real estate or homes.

The savings and loan industry was first established in the 1830s as a building and loan association. The first savings and loan association was the Oxford Provident Building Society in Frankfort, Pennsylvania. As a building and loan association, Oxford Provident received regular weekly payments from each member and then lent the money to individuals until each member could build or purchase his own home. Building and loan associations were financial intermediaries, which acted as a conduit for the flow of investment funds between savers and borrowers.

Savings and loan associations may be state or federally chartered. When formed under state law, savings and loan associations are generally incorporated and must follow the state's requirements for incorporation, such as providing articles of incorporation and bylaws. Although it depends on the applicable state's law, the articles of incorporation usually must set forth the organizational structure of the association and define the rights of its members and the relationship between the association and its stockholders. A savings and loan association may not convert from a state corporation to a federal corporation without the consent of the state and compliance with state laws. A savings and loan association may also be federally chartered. Federal savings and loan associations are regulated by the office of thrift supervision.

Members of a savings and loan association are stockholders of the corporation. The members must have the capacity to enter into a valid contract, and as stockholders they are entitled to participate in management and share in the profits. Members have the same liability as stockholders of other corporations, which means that they are liable only for the amount of their stock interest and are not personally liable for the association's negligence or debts.

Officers and directors control the operation of the savings and loan association. The officers and directors have the duty to organize and operate the institution in accordance with state and federal laws and regulations and with the same degree of diligence, care, and skill that an ordinary prudent person would exercise under similar circumstances. The officers and directors are under the common-law duty to exercise due care as well as the duty of loyalty. Officers and directors may be held liable for breaches of these common-law duties, for losses that result from violations of state and federal laws and regulations, or even for losses that result from a violation of the corporation's bylaws.

The responsibilities of the officers and directors of a savings and loan association are generally the same as the responsibilities of officers and directors of other corporations. They must select competent individuals to administer the institution's affairs, establish operating policies and internal controls, monitor the institution's operations, and review examination and audit reports. Furthermore, they also have the power to assess losses incurred and to decide how the institution will recover those losses.

Prior to the 1930s, savings and loan associations flourished. However, during the Great Depression the savings and loan industry suffered. More than 1,700 institutions failed, and because depositor's insurance did not exist, customers lost all of the money they had deposited into the failed institutions. Congress responded to this crisis by passing several banking acts. The Federal Home Loan Bank Act of 1932, 12 U.S.C.A. §§ 1421 et seq., authorized the government to regulate and control the financial services industry. The legislation created the Federal Home Loan Bank Board (FHLBB) to oversee the operations of savings and loan institutions. The Banking Act of 1933, 48 Stat. 162, created the federal deposit insurance corporation (FDIC) to promote stability and restore and maintain confidence in the nation's banking system. In 1934, Congress passed the National Housing Act, 12 U.S.C.A. §§ 1701 et seq., which created the National Housing Administration (NHA) and the Federal Savings and Loan Insurance Corporation (FSLIC). The NHA was created to protect mortgage lenders by insuring full repayment, and the FSLIC was created to insure each depositor's account up to $5,000.

The banking reform in the 1930s restored depositors' faith in the savings and loan industry, and it was once again stable and prosperous. However, in the 1970s the industry began to feel the impact of competition and increased interest rates; investors were choosing to invest in money markets rather than in savings and loan associations. To boost the savings and loan industry, Congress began deregulating it. Three types of deregulation took place during this time.

The first major form of deregulation was the enactment of the Depository Institutions Deregulation and Monetary Control Act of 1980 (94 Stat. 132). The purpose of this legislation was to allow investors higher rates of return, thus making the savings and loan associations more competitive with the money markets. The industry was also allowed to offer money-market options and provide a broader range of services to its customers.

The second major form of deregulation was the enactment of the Garn-St. Germain Depository Institutions Act of 1982 (96 Stat. 1469). This act allowed savings and loan associations to diversify and invest in other types of loans besides home construction and purchase loans, including commercial loans, state and municipal securities, and unsecured real estate loans.

The third form of deregulation decreased the amount of regulatory supervision. This deregulation was not actually an "official" deregulation; instead it was the effect of a change in required accounting procedures. The Generally Accepted Accounting Principles were changed to Regulatory Accounting Procedures, which allowed savings and loan associations to include speculative forms of capital and exclude certain liabilities, thus making the thrifts appear to be in solid financial positions. This resulted in more deregulation.

In the 1980s, the savings and loan industry collapsed. By the late 1980s at least one-third of the savings and loan associations were on the brink of insolvency. Eight factors were primarily responsible for the collapse: a rigid institutional design, high and volatile interest rates, deterioration of asset quality, federal and state deregulation, fraudulent practices, increased competition in the financial services industry, and tax law changes.

In an effort to restore confidence in the thrift industry, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) (103 Stat. 183). The purpose of FIRREA, as set forth in Section 101 of the bill, was to promote a safe and stable system of affordable housing finance; improve supervision; establish a general oversight by the treasury department over the director of the Office of Thrift Supervision; establish an independent insurance agency to provide deposit insurance for savers; place the Federal Deposit Insurance System on sound financial footing; create the Resolution Trust Corporation; provide the necessary private and public financing to resolve failed institutions in an expeditious manner; and improve supervision, enhance enforcement powers, and increase criminal and civil penalties for crimes of fraud against financial institutions and their depositors.

FIRREA increased the enforcement powers of the federal banking regulators and conferred a wide array of administrative sanctions. FIRREA also granted federal bank regulators the power to hold liable "institution-affiliated parties" who engage in unsound practices that harm the insured depository institution. The institution-affiliated parties include directors, officers, employees, agents, and any other persons, including attorneys, appraisers, and accountants, participating in the institution's affairs. FIRREA also allows federal regulators to seize the institution early, before it is "hopelessly insolvent" and too expensive for federal insurance funds to cover.

Criminal penalties were also increased, in 1990, by the crime control act, 104 Stat. 4789, which included the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990 (104 Stat. 4859). This act increased the criminal penalties "attaching" to crimes related to financial institutions.

FIRREA created the Office of Thrift Supervision (OTS) and the Resolution Trust Corporation (RTC). FIRREA eliminated the FHLBB and created the OTS to take its place. The RTC was created solely to manage and dispose of the assets of thrifts that failed between 1989 and August 1992. In addition, the FSLIC was eliminated, and the FDIC, which oversaw the banking industry, began dealing with the troubled thrifts.

The RTC was in existence for six years, closing its doors on December 31, 1996. During its existence, it merged or closed 747 thrifts and sold $465 billion in assets, including 120,000 pieces of property. The direct cost of resolving the failed thrifts amounted to $90 billion; however, analysts claim that it will take approximately 30 years to fully bail out the savings and loan associations at a cost of approximately $480.9 billion.

further readings

American Bar Association. 1995. "How a Good Idea Went Wrong: Deregulation and the Savings and Loan Crisis." Administrative Law Review 47.

——. The Committee of Savings and Loan Associations Section of Corporation, Banking, and Business. 1973. Handbook of Savings and Loan Law. Chicago: American Bar Association.

Calavita, Kitty, Henry N. Pontell, and Robert H. Tillman. 1999. Big Money Crime: Fraud and Politics in the Savings and Loan Crisis. Berkeley: Univ. of California Press.

Gorman, Christopher Tyson. 1994–95. "Liability of Directors and Officers under FIRREA: The Uncertain Standard of §1821(K) and the Need for Congressional Reform." Kentucky Law Journal 83.

Turck, Karsten F. 1998. The Crisis of American Savings & Loan Associations: A Comprehensive Analysis. New York: P. Lang.

U.S. House. 1989. 101st Cong., 1st sess. H.R. 54 (I). United States Code Congressional and Administrative News.

cross-references

Banks and Banking.

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savings and loan association

savings and loan association (S&L), type of financial institution that was originally created to accept savings from private investors and to provide home mortgage services for the public.

The first U.S. S&L was founded in 1831. In 1932, the Federal Home Loan Bank System was created to oversee the S&Ls, with deposits to be insured by the Federal Savings and Loan Insurance Corporation (FSLIC). In 1933 the federal government began chartering S&Ls, although they generally were not required to be federally chartered. After World War II, the associations began a period of rapid expansion. Historically, S&Ls could be organized in two ways: either as a mutual or a capital stock institution. A mutual organization would be similar in operation to a mutual savings bank.

S&Ls went through many changes in the late 20th cent., primarily due to deregulatory measures instituted in the 1980s by the U.S. federal government, allowing them to offer a much wider range of services than ever before. The deregulatory measures allowed S&Ls to enter the business of commercial lending, trust services, and nonmortgage consumer lending. The Depository Institutions Deregulation and Monetary Control Act of 1980 began these sweeping changes, one of which was to raise deposit insurance from $40,000 to $100,000. Many contend that this extension of insurance coverage encouraged S&Ls to engage in riskier loans than they might otherwise have sought.

Two years later, the Depository Institutions Act gave S&Ls the right to make secured and unsecured loans to a wide range of markets, permitted developers to own S&Ls, and allowed owners of these institutions to lend to themselves. Under the new laws, the Federal Home Loan Bank Board (FHLBB) was given a number of new powers to secure the capital positions of S&Ls. The FHLBB allowed S&Ls to print their own capital, and escape charges of insolvency through such measures as "goodwill," in which customer loyalty and market share were counted as part of a capital base. As a result, an S&L that was technically insolvent could resist government seizure.

S&Ls began to engage in large-scale speculation, particularly in real estate. Financial failure of the institutions became rampant, with well over 500 forced to close during the 1980s. In 1989, after the FSLIC itself became insolvent, the Federal Deposit Insurance Corporation took over the FSLIC's insurance obligations, and the Resolution Trust Corporation was created to buy and sell defaulted S&Ls. The S&L crisis ultimately cost the government some $124 billion. The Office of Thrift Supervision (1989; functions transferred to the Office of the Comptroller of the Currency, 2011) also was created, in an attempt to identify struggling S&Ls before it was too late, but the largest S&Ls were among the institutions at the core of the financial crisis of 2008.

See A. Teck, Mutual Savings Banks and Savings and Loan Associations (1968); F. E. Balderston, Thrifts in Crisis: Structural Transformation of the Savings and Loan Industry (1985).

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savings and loan association

savings and loan association US financial institution that is organized as a mutual, issuing shares or ownership certificates to its depositors. Savings and loan associations (S&Ls) take deposits, on which the shares are based, and provide mortgage loans, as well as real estate and business loans. High-risk loan policies in the early 1980s led to many bankruptcies in the recession of the late 1980s, and the US government was forced to bail them out, at a high price.

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Savings and Loan Association

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.

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