The Savings and Loans Associations Bailout
Below is a MRR and PLR article in category Finance -> subcategory Loans.
The Savings and Loans Associations Bailout
Summary
Asset bubbles in the stock exchange, real estate, or commodity markets often burst and lead to banking crises. One notable example occurred in the USA between 1986 and 1989. The proactive approach of the administration and Congress is worth examining, especially compared to modern responses. Although the crisis primarily impacted banking and real estate rather than capital markets, similarities exist.
The Savings and Loans Crisis
Savings and loans associations, or "thrifts," were hybrids similar to UK building societies. They could accept deposits but mainly operated as mortgage banks. The 1980 Depository Institutions Deregulation and Monetary Control Act required S&Ls to match interest rates with commercial banks, ending their advantage in deposit interest rates.
However, the Act did not fully allow them into commercial and consumer lending or trust services, leaving them heavily dependent on regional real estate markets. Any economic downturn in these areas hit them hard. As interest rates fluctuated, the mismatch between their assets and liabilities worsened, reducing their operating margins.
The 1982 Garn-St. Germain Depository Institutions Act enabled mutual associations to become stock companies, accessing capital markets to boost their net worth. Unfortunately, this change came too late. Thrifts could no longer support real estate prices through refinancing, and mismanagement worsened their plight.
The Fallout
Thousands of depositors rushed to withdraw their savings, and many of the 3,000+ savings and loans became insolvent. Mass closures disrupted financial systems, damaged businesses, and destabilized communities. The crisis escalated, threatening the entire banking sector.
The Federal Savings and Loans Insurance Corporation (FSLIC), responsible for insuring deposits, went bankrupt. Despite not being underwritten by the Treasury, its perceived connection to the federal government shocked the public, adding a political dimension to the crisis.
The Bailout and Reforms
A swift $300 billion bailout was arranged, injecting liquidity via a special agency, the FHFB. Regulatory supervision shifted away from the Federal Reserve, expanding the Federal Deposit Insurance Corporation's (FDIC) role.
Post-1989, Congress eliminated the FSLIC, placing thrift insurance under the FDIC, which managed separate insurance funds to limit the crisis's impact. The FDIC, funded independently from Congress, preemptively regulated banks to prevent depositor insurance claims.
The Resolution Trust Corporation (RTC) was created to manage "special risk" savings and loans until August 1992. It sold or closed these institutions, using federally guaranteed bonds from the Resolution Fund Corporation (RefCorp).
The Office of Thrift Supervision (OTS) took over thrift supervision from the Federal Home Loan Board. Though part of the Treasury Department, OTS functioned with significant independence. The Federal Housing Finance Board (FHFB), an independent entity, regulated liquidity through the Federal Home Loan Bank System (FHLBS).
This established a robust regulatory framework, clarifying roles among agencies: the FDIC managed insurance, OTS provided supervision, and FHLB ensured liquidity.
Industry Transformations
Efforts encouraged healthy thrifts to acquire weaker ones, straining their balance sheets. By 1989, thrift numbers dropped from over 2,800 to under 1,000, yet surviving institutions grew stronger and more capitalized. By 1998, many thrifts obtained bank charters, improving their equity-to-assets ratio from less than 1% to almost 10% by 1994.
Positive interest rate spreads boosted profits as thrifts paid low deposit interest and invested in high-yield bonds. The stock market boom enabled thrifts to issue stock at high prices.
Repealing Great Depression-era laws like the Glass-Steagall Act allowed banks to enter new markets, diversifying offerings and enhancing financial health.
Lessons Learned
The crisis demonstrated the importance of effective collaboration between politicians and regulators. The Federal Reserve's autonomy and professionalism, combined with the political class's support, were crucial. This cooperation remains a significant takeaway from the crisis.
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