Savings and Loan Failures
The Savings and Loan Disaster of the 1980s
In the latter half of the twentieth century, two separate crises struck the S&L industry. The first was caused by the macroeconomic forces of severe inflation and recession, which impaired S&L income statements and balance sheets in the late 1970s and early 1980s. The second and more damaging crisis was provoked by the response of Congress, the Reagan administration, and the regulatory authorities to the first crisis. We will argue that government policy decisions severely compounded the initial crisis and were largely responsible for the S&L fiasco.
Flaws in the Original S&L Structure
It must be emphasized at the outset that the S&L concept was fundamentally flawed from the beginning. Government fostered savings and loan associations in the 1930s as a way to encourage homeownership among middle-class Americans. The Federal Home Loan Bank Board (FHLBB) was established by Congress to regulate the S&Ls, and its subsidiary the Federal Savings and Loan Insurance Corporation (FSLIC) w as created to insure S&L deposits. The S&Ls were to issue short-term savings deposits to the public and use the proceeds to grant 20- and 30-year mortgages to local homebuyers at interest rates guaranteed to remain constant over the life of the mortgage.
Clearly, if the interest rates paid to depositors were ever to rise above the average interest rate earned on an S&L’s portfolio of mortgages, the institution would lose money. If the situation were to persist for a lengthy period, an S&L’s capital could be wiped out, rendering the institution insolvent. In borrowing short and lending long, S&Ls were inherently vulnerable to rising interest rates and inverted yield curves that is, periods in which short-term yields exceed long-term yields. Because government regulations prevented S&Ls from diversifying their assets, requiring them instead to confine themselves predominantly to fixed-rate mortgages, there was no way for them to get out of this trap.
For approximately four decades, the S&L industry was stable and prosperous. From the 1930s to the mid-1960s, interest rates were low and stable and the yield curve was almost always upward sloping. Life was simple in those stable, low-inflation times. Outsiders joked enviously about the “3-6-3″ lifestyle enjoyed by S&L managers borrow at 3 percent, lend at 6 percent, and head for the golf course at 3:00 P.M.! Unfortunately, in the mid-1970s, interest rates began to trend upw ard. At first the increase was mild and gradual, so S&Ls did not suffer major problems. But then, in the late 1970s, all hell broke loose!