Savings and Loan Crisis

Savings and Loan CrisisAlso known as the S&L crisis, the savings and loans crisis was a series of economic events which transpired during the late 1970’s. The crisis reached its peak in the 1980’s, and finally came to an end in the early 1990’s, nearly 20 years after it began.

A savings and loans institution is a specific type of bank specializing in providing various services aimed at promoting private home ownership among members of the public. When this type of financial institution was first developed, the goal was to enable ordinary people to deposit their savings for safekeeping with the bank, as well as enabling them to obtain loans for various purposes, including personal loans, auto loans, or home mortgages. Also known as a “thrift,” this type of institution quickly became popular not only in the United States, but also in the United Kingdom, where it was referred to as a “Building Society.”

Rising RatesThe problems in the industry arose in the late 1970’s, when more people started putting their funds in the money market, attracted by the lure of higher interest rates. Savings and Loans tried to compete by raising their own interest rates, but their efforts to retain depositors ultimately proved fruitless. These older institutions could not maintain the new higher interest rates, since their only source of income was money made from the interest off of the mortgages and loans that they offered. In an effort to offset their inability to maintain these higher interest rates, S&L institutions began offering other alternative investment opportunities to its members, including riskier products such as bonds and commercial realty mortgages. These investments proved dangerous for the S&L’s, since the institutions did not have enough actual money on hand to sustain these financial activities.

At first, the S&L’s depositors tried to invest in these financial options, attracted by the fact that they are insured and protected by the Federal Savings and Loan Insurance Corp. or FSLIC. However, because of corruption scandals and other illegal activities, the S&L companies were forced to declare bankruptcy and eventually to completely close down their businesses. In an attempt to save the national economy, the government used taxpayers’ money to bailout 747 S&L institutions. This government bailout is widely considered to be one of the major causes of government budget deficits during this time.

What Caused the Savings and Loans Crisis?

Federal Deposit Insurance Premium Policy.

InsuranceOne of the important contributing factors to the savings and loans crisis was the Federal Deposit Insurance Corporation, the FDIC. Through the FDIC, the government offered insurance to savings and loans institutions from 1934 onward. The government required the FDIC to give the same premium to all S&L member institutions, no matter how risky the transaction might be. This practice of providing deposit insurance for all S&L transactions regardless of how unstable they might be continued through 1991, when the government tried to correct the problem by asking the FDIC to increase the premiums for those transactions deemed most likely to be risky and unsafe. However, the FDIC did not accept this recommendation, fearing tremendous complaints, criticisms, and an exodus of members who had made these types of transactions. As a result, each member continued to pay the same insurance premium, regardless of the risks involved.

Regulation Q

Regulation QRegulation Q was a federal regulation imposed in 1933. It stated that any financial institutions, including banks and S&L companies, were prohibited from providing any interest for on demand deposits or for checking accounts. Regulation Q also required financial institutions to give higher interest rates on other kinds of banking transactions, such as time deposit and savings accounts. In 1966, Regulation Q was extended to all S&L companies. The fixed amount of interest imposed by this policy enabled S&L companies to continue on for a few more years, since the deposits made by members were actually used to cover loan and mortgages transactions.

Expansion and Branches Restrictions

ExpansionsA law was imposed preventing banking institutions as well as S&L companies from expanding or opening additional branch locations. This restriction made S&L institutions more susceptible to local economic risks and downturns. Regional crises greatly contributed to the decline in real estate value, since some of these properties were used as collateral by most loans S&L members.

Resuscitation of S&L

Thanks to the impact of the savings and loans crisis, the federal government approved a bill that would help change the banking industry, the federal rules that went with it, and theoretically help people avoid bad credit loans. In 1989, most of the remaining savings and loans companies were merged with larger commercial banking institutions. The federal regulations governing all American banking and financial institutions have also been modified in response to the industry’s needs. In 2004, more than 800 S&L institutions made around one trillion dollars in assets. There are also bank holding institutions that possess two of the biggest S&L companies, namely, World Savings Bank and Washington Mutual Bank. These two major S&L companies made a hundred billion dollars in assets, while some independent S&L companies have assets in excess of one billion dollars.

With the implementation of the financial reform law, S&L companies are thriving today despite the continuous economic recession. Although the number of these companies is decreasing, people will not feel any of the effects since many banking institutions exist today that provide the same service and follow the same regulations of savings and loans companies. The federal government continues to monitor and observe industry regulations as well as the finance and banking policy implementation in order to ensure the stability of the financial industry.