1. Introduction

The Savings and Loan Industry

The savings and loan industry is established for the purpose of collecting and accumulating customer savings as well as lending money such as mortgages, personal, and business loans at an established market interest for both parties. Savings and loan institutions are usually shareholder-owned in order to limit a single party of having one direct influence on the institution. (Amadeo, 2018)

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In the United States, the savings and loan industry has been established since the 19th century. After World War II, there was constant growth and demand for savings and loan institutions to fuel even further loans and drive saving deposits (Robinson, 2013). This increase in the establishment of these institutions led to a heated competition between these institutions and retail banks.

Due to the heated competition, the government intervened by imposing an interest rate ceiling. The interest rate ceiling sets a border for both retail banking and savings and loan businesses on the interest rate that they could offer their customers for their deposits (Robinson, 2013). This limited the competitive pressure within the market.

2. Background on the Savings and Loan Crisis

Once the ceiling was imposed and the competitive pressure cooled down, Saving and Loan institutions found it hard to compete efficiently against the retail bank industry. In 1979, As a result of the inability to compete and the unattractive interest rates offered, their customers withdrew their deposits and invested in money market funds (Investopedia, 2018) instead, in order to obtain a better return on their deposits and investments. As a result, a series of governmental regulations were proposed between 1980 and 1982 as a mean to help the institutions, which had a direct effect on who the savings and loan institutions could lend to, as well as their risk practices and financial accounting (The WritePass Journal, 2011).

When the interest rate ceiling was imposed, it led to the dramatic increase in interest rates and inflation. As interest rates rose, the mortgages that the institutions had issued out began to lose their initial value, which had a dramatic effect on the industry’s net worth.  To avoid dealing with the losses, federal regulators took steps to deregulate the industry in the hope that it could grow out of its problems. The industry’s problems, though, grew even more severe with the deregulation, and the burden was then shifted on taxpayers. ‘By the beginning of 1990, approximately 1,000 of the nation’s savings and loans had failed. The total cost of the savings and loan crisis for all stakeholders was  approximately $160 billion.’(Amadeo, 2018). The following table shows the breakdown and distribution of the cost among all suffering stakeholders of the crisis.

Table 1: Cost of Crisis Distribution

Stakeholder

Amount Paid (In Billions)

Tax Payers

132

Savings and Loan Industry

28

Of the total 160 billion, taxpayers paid almost 80% of the crisis cost. An amount of $132 billion was heaved on their incomes while the savings and loan industry paid approximately $28 billion to cover the deficit. On top of the total $160 billion cost of the crisis, other industries suffered the burden of their costs as well. The Federal Savings and Loan Insurance Corporation paid $20 billion to the depositors of the failed savings and loan institutions before they filed for bankruptcy. On top of that, there was about 500 savings and loan institutions that were insured by government funds. Before their collapse, their failures cost the government funds $185 billion. (Amadeo, 2018)

3. Analysis of the Crisis and Effects

The intervening regulations by the United States government played a major part in contributing towards the Savings and Loan Crisis, however, it remains that there are other economic and financial factors that contributed to the falling and shutting down of the countless savings and loan institutions. The factors revolved around the economy of the United States in between the late 1970s and the 1980s, the financial situations in the industry as well as the continuously changing regulatory frameworks that were put in place at the time of the crisis. Overall, it was an asset and liability mismatch that resulted in high margins of loss (The WritePass Journal, 2011).

After the government deregulated the industry, the institutions were able to compete again and offer higher rates to attract deposits.  In order to offer these exaggeratedly high rates, they resorted to high-risk activities to cover their previous losses, including real estate lending and junk bond investments (Amadeo, 2018). These high-risk activities were the main reason that many savings and loan institutions began to report losses. The fault here is not only the institutions who were desperate to gain consumers, but also on the government legislators who passed many new legislations and actions that drove the institutions to these reckless actions

From the government’s role of the deregulations, they failed to implement countermeasures that would have contributed positively to the situation. The new legislations they imposed including asset deregulation, 100% control of consumer deposits to the institutions which meant they could act freely with the money they received, allowed one man ownership of institutions which encouraged these risky activities, and inadequate supervision of the saving and loan institutions actions are key causes of the crisis. (Pyle,1995) 

Moreover, The Federal Savings and Loan Insurance Corporation (FSLIC) deposit guarantee was increased from $40,000 to $100,000 (Laumann & Teske, 2003). This gave incentive for depositors to move their money back to the institutions and gave the institutions more money to engage in risky activities in. The legislators also did not apply the same legislations to retail banks. This preferential treatment has underlying motives of corruption. This widespread corruption and continued deregulation lead to the insolvency of the FSLIC in which it could not aid the losses of the risky investments that the institutions carried out and hence, the burden was then shifted on taxpayers and the government.

4. Lessons Learned

Many takeaways were learned from this crisis. The first and foremost lesson that this crisis teaches us is that there are no innocent victims in the crisis (Barth, Trimbath and Yago, 2004).  There were many stakeholders and third parties involved in this whole debacle. Whether it was a savings and loan operator, a political legislator, or a depositor depending on insurance incentives,  there were no innocent parties. What can be concluded is that constant vigilance is required on all the stakeholders to avoid the existence of other crises. Reckless and irresponsible behavior, risky endeavors, and excessive regulations were the main cause behind the crises.

The second lesson that was observed is that deregulating the industry while no market discipline exists will not be effective. In the savings and loan crisis, the government did not achieve market discipline as it insured all the depositors through the FLIC fund. Giving the market something to lose by abstaining from funding and insuring their investment activities will more likely create a stable market. While the debacle was on the verge of occurring, what drove it further is the risky endeavors that the institutions partook in. “Neither owners nor depositors had something to lose, and both groups resorted to  risk-taking  activities as a result” (England,2018)

Another important lesson for future savings depositors is that the deposit insurance funds themselves can become insolvent (Dotsey and Kuprianov, 1990). Once depositors spend extra money on insurance, the illusion of safety is created around them. This facilitates more and more high-risk investments and increases the chances of high margin losses. The debacle teaches us that even insurance funds can become insolvent, meaning that depositors are not completely safe and riskless, hence, considering their investments wisely while acknowledging the fact that insurance companies are not lifting the responsibility for everything is the safest option they can opt for.

 On top of that, it can be concluded that the burden can be dumped entirely on the taxpayer when insolvency is evident throughout all the related parties (Barth, Trimbath and Yago, 2004). Crises can be very expensive, and it’s quite hard to avoid the consequences of them when they occur. That is why this should be a lesson and an incentive to make depositors as well as institutions more responsible for their actions as well as the government for its failures as innocent people can also suffer the consequences of their actions.

The final takeaway was that the crisis was all down to a mishandled industry restructure (England, 2018). When the government only protects ONE particular industry for the whole“ social good”, legislators will often ignore the market signals about utility from the industry. The lesson is that legislators cannot simply focus on protecting only one industry without affecting the other as the entire economy is interrelated. Hence, singling out one industry was a mistake as such efforts are rarely successful (Willoughby, 2009).  Their efforts at the time were explained by the disruption of closing hundreds of savings and loan institutions. However, in the end, they have closed anyway.

5. Conclusion

In conclusion, the Savings and Loan crisis comes down to multiple drivers. It can be said that if timely, and responsible action was taken that the crisis could have been avoided altogether. The industry structure was flawed, inflation and interest rate volatility was high. It is interesting to see, for once, a government failure rather than a market failure which provides evidence to prove neoclassical market theories.

The lessons learned from this crisis are countless, however, it all comes down to whether regulators will actually learn from and implement on them. It is not very clear whether the United States’ political legislators have absorbed these lessons. The fact still remains that regulatory flexibility still is a problem, particularly in the banking industry.

Nonetheless, there were many reforms taken further on to ensure that the crises would not occur again and preventative legislations were enforced to further fix the industry, For example, “Congress placed new restrictions on both the FDIC and the Federal Reserve for account holders with more than 100,000$ face” (England, 2018)

 These regulations are only as tough as their enforcement. “The S&L debacle was the result of about 46 years (1934–1980) of legislative and regulatory restrictions and incentives. By the end of 1980, the industry’s market value was –$204.32 billion” (Steinreich, 2014). It is quite unimaginable how many jobs were lost, how many could have been created, and how many businesses funded from the funds lost from these institution’s desperate bids of survival. The clearest takeaway of all is that the United State’s government should make this crisis a turning point in order to help them avoid similar problems and situations in the future.

References

Amadeo, K. (2018). How Congress Created the Greatest Bank Collapse Since the Depression. [online] The Balance. Available at: https://www.thebalance.com/savings-and-loans-crisis-causes-cost-3306035 [Accessed 2 Dec. 2018].

Barth, J., Trimbath, S. and Yago, G. (2004). The Savings and Loan Crisis: Lessons from a Regulatory Failure. Boston, MA: Springer Science+Business Media, Inc.

Dotsey, M. and Kuprianov, A. (1990). [online] Richmondfed.org. Available at: https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_review/1990/pdf/er760201.pdf [Accessed 8 Dec. 2018].

England, C. (2018). Lessons from the Savings and Loan Debacle. [online] Pdfs.semanticscholar.org. Available at: https://pdfs.semanticscholar.org/8a5e/e8a7cfd2216a572bc2c5c0115b00b2df42b9.pdf [Accessed 2 Dec. 2018].

Laumann, J. & Teske, P. (2003). Principals, Agents, and the Impact of the Regatory Fedarlism on the Savings-and-Loans Crisis of the 1980s. State Politics & Policy Quartely, 3(2),139-157.https://doi.org/10.1177/153244000300300202

Pyle D.H.(1995)  The U.S. savings and loan crisis, Handbooks in Operations Research and Management Science,  9  (C) , pp. 1105-1125.

Robinson, K. (2013). Savings and Loan Crisis. [online] Federalreservehistory.org. Available at: https://www.federalreservehistory.org/essays/savings_and_loan_crisis [Accessed 2 Dec. 2018].

Staff, I. (INVESTOPEDIA) (2018). Savings And Loan Crisis (S&L). [online] Investopedia. Available at: https://www.investopedia.com/terms/s/sl-crisis.asp [Accessed 2 Dec. 2018].

STEINREICH, D., 2014. THE SAVINGS AND LOAN DEBACLE TWENTY-FIVE YEARS LATER: A MISESIAN RE-EXAMINATION AND FINAL CLOSING OF THE BOOK. Quarterly Journal of Austrian Economics, 17(2), pp. 154-178.

The WritePass Journal. (2011). Savings and Loans Crisis. [online] Available at: https://writepass.com/journal/2011/10/sl-crisisfree-finance-essay-savings-and-loans-crisis/?fbclid=IwAR3wac8o5Bhx3QvB1OfGzr92fICVZ3wVUo60VGOqwbChGXCAaG4dBAreY1E [Accessed 2 Dec. 2018].

Willoughby, J. (2009). The Lessons of the Savings-and-Loan Crisis. [online] WSJ. Available at: https://www.wsj.com/articles/SB123940701204709985 [Accessed 2 Dec. 2018].