THE S & L CRISIS

It’s time for a slight detour, which has some relation to the dismantling of
regulations, and that is the Savings and Loan crisis of the 1980s. First, a brief
history of S & Ls.
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“Thrifts” (which officially had their name changed to Savings & Loans in the late
1930s) were originally non-profit coops managed by their membership and local
institutions. Most often, they only made home loans, primarily to working class
men and women (differing from banks which had a wide array of products and
served both individuals and businesses). S&Ls had their origin in late 18th Century
England, with the British building society movement (aka Buildings & Loans).
The panic of 1893 caused a decline in membership. By the end of the 19th
Century, nearly all B&Ls were out of business. In 1934, the FDIC was extended to
S&Ls. Of note, all S&Ls were charged the same insurance premium regardless of
the richness of each S&L’s particular portfolio. S&Ls were resurrected over time
with a prominent rise in the two decades following WWII, as millions of
servicemen returned from overseas and started families. This new generation was
known as the “baby boomers,” and a surge in home construction resulted, fueling
the development of suburbs. By the 1960s, S&Ls experienced a strong expansion,
largely due to this construction surge.

An important trend emerged which was the raising of interest rates on savings
accounts to attract depositors. This led to rate wars between S&Ls and commercial
banks. Since 1933, the Federal Reserve had limited the interest rates that
commercial banks could pay on deposits (Regulation Q). These rate wars
prompted Congress in 1966 to set limits on savings rates for S&Ls and commercial
banks. S&Ls were hit especially hard in the 1970s during the stagflation period.
The bread and butter of S&Ls were short term deposits, but they were routinely
extending long term loans (fixed mortgages for 15, 20, 30 years). Because
depositors’ savings rates were now capped, when the cost of money would rise,
depositors removed their money and invested in accounts that had higher rates of
return such as money market accounts, CDs, etc. (This removal and reinvestment
process is referred to as “disintermediation”). The S&Ls often wound up paying
more out to depositors than they took in. Also higher interest rates meant home
loan qualifying became much more difficult since less people could afford homes.
These factors all limited S&Ls from making money. S&L managers responded by
offering interest on checking accounts, and alternative mortgage instruments. It’s
worth noting here that, before 1981, adjustable rate mortgages (ARMs) were
barred. Adjustable rate mortgages, also called variable rate mortgages, have their
interest rates periodically adjusted – usually linked to the cost of borrowing money
that the lender experiences within their credit markets.

In October of 1979, then Federal Reserve Chairman Paul Volcker restricted the
money supply. Short term interest rates skyrocketed. In the ten months from June
1979 to March 1980 interest rates rose more than 6% from 9.06% to 15.2%. In
1981 and 1982 combined, the S&L industry reported $9 billion in losses.