SAVINGS AND LOAN CRISIS IN RELATION TO MARKET REGULATIONS
Introduction
In the early 1800s groups of people who wished to buy their own homes and had insufficient savings to do so pooled their savings and lend them to a few of their members to finance the buying of their home. After repaying their loan, these funds were lend to other members. This led to the invention of the savings and loans industry (S&L) also called thrifts, whose main aim was to pursue homeownership. The first S&L was established in Pennsylvania in 1831. (Robinson). In 1980 almost 4000 thrifts and $600 billion in total assets were discovered in the S&L industry whereby $480 billion were mortgage loans. (Robinson)
After the crisis, nearly a third of their S&L associations failed out of 3,234. (Kenton). $160 billion was the approximate cost of the crisis and a failure cost of $185 million. (Amadeo)
Key Role Players From The Inception To The Demise Of The S&L Market.
1. S&L
The distinctive features of S&Ls were that they paid lower-than-average interest rates on deposits and offered lower-than-average fixed mortgage rates. This meant that S&L associations were vulnerable to interest rate hikes.
In S&L, interest rates paid on the deposits were set by the federal government. Due to inflation the interest rate rose and many S&L suffered great losses because they had to pay these interest rates to attract more depositors through the money they earned from the long-term fixed-rate mortgage, which did not change. This, in turn, meant the mortgage value was reduced. (Robinson)
2. Federal Savings and Loan Insurance Corporation (FSLIC) and
Federal Home Loan Bank Board (FHLBB)
FSLIC was established in 1934 by congress as part of the National Housing Act to stimulate the economy out of the great depression. (Kagan). This was meant to restore confidence in the S&L accounts where up to $100,000 depositors’ funds were insured instead of the earlier $40,000.(Konar)
The FSLIC was regulated by the FHLBB which had a smaller staff and weaker authority to govern the S&L industry. In 1983, it would cost $25 billion to pay off the insured deposits of failed institutions while FSLIC had only $6 billion in reserve. In its insolvency state, the congress decided to recapitalize it, but FSLIC became insolvent once again. (Jayson). Clearly its failure as the insurer to the S&L market played a key role in the collapse of the S&L industry.
3. The Congress
The congress under the leadership of President Ronald Reagan signed the Garn-St. Germain Depository Institutions Act and S&L market were no longer governed by Regulation Q which sets “minimum capital requirements and capital adequacy standards for board regulated institutions in the United States.” (Kenton).
This granted S&L market power to lend more than 30% of their assets to consumer loans and 40% to commercial loans. This led to S&L involvement in riskier speculative investments, paying higher rates to attract funds. The returns did not materialize leading to the collapse of the S&L industry(Luwogo).
4. U.S. Federal Reserve Bank
The Federal Reserve Bank allowed double-digit inflation, which led to the rise of interest rates, which led to the loss in value of mortgages wiping out S&L industry net-worth.
Shortfalls Of The Regulation Which Affected The S&L Market
1. Federal Deposit Insurance
This was extended to the S&L industry in 1934 through the FSLIC which insured depositors’ funds. A combination of deregulation and increased coverage of depositors’ funds by the insurance company led to S&L investing in highly speculative and riskier investments. It also charged the same amount of the “same flat-rate premium for every dollar of deposits, thus ignoring the riskiness of individual S&Ls.”(Ely). This meant both those who were risk-averse paid the same as those who took on risky investments.
2. Use Of Long-term Investment To Fund Short-term Debt
After the great depression, the Federal government forced the S&L markets to lend for the long-term while borrowing for the short term as their financial structure. Due to maturity mismatch, the rise in interest rates saw the S&L market participants pay a higher amount to the depositors than they were making from the mortgage. (Ely)
3. Federal Mortgage Banking Act of 1932, the National Housing Act of 1934 and Interest Rate Control Act of 1966
Due to over-regulation, the S&L industry was now “perceived as risk-free”.(Konar). With time thrifts lost their competitiveness Money Market Mutual Funds (MMMFs) created and developed in the 1970s due to the continuous development of the financial market.
4. Deregulation
The Depository Institution Deregulation and Monetary Control Act of 1980 (DIDMCA) which deregulated banks, gave more control to Feds over non-bank members (such as S&L) and increased insurance coverage from $40,000 to $100,000. However, this did not turn out well since by 1982 the number of problem thrifts reached 744 with 76 failures (Konar).
The government-insured thrifts without asking for or getting anything in return. This meant the government had to pay the depositors’ funds in case the high-risk investments failed. (Konar).
The Garn-St. Germain Depository Institutions Act of 1982, eliminated loan-to-value ratios and interest rate caps for S&Ls. The Act also allowed “them to hold 30% of their assets in consumer loans and 40% in commercial loans.”(Kenton). This led to the failure of 27 thrifts in 1984 and 54 in 1983.
5. Incompetent Supervision
Federal Home Loan Bank Board (FHLBB) allowed insolvent S&Ls to continue operating to an extent of even allowing excessive lending to any borrower. In some cases, both the lender and the borrower were the same person, which is proof of conflict of interest. (Ely)
Levels Of Regulation That Garn-st.Germain Depository Institutions Act Was.
The Garn-St. Germain Depository Institutions Act of 1982 purposely deregulated the S&L market and increased the competitiveness of savings and loan institutions making this an industry-specific and direct regulation.
Additionally, this Act was passed by the United States Congress and was meant to affect the S&L market in the US economy, making it a domestic and government regulation.
Conclusion
Both deregulation and over-regulation played a part in the demise and collapse of the S&L market in the US. We also find out the key role players in the demise and collapse of the S&L market included the government, congress, and other regulatory and oversight bodies within the economy.
Further study into the S&L crisis could help in future regulations and oversight of policies.
References
KENTON, WILL. “Garn-St. Germain Depository Institutions Act”. Investopedia , 2019.
KENTON, WILL. “Savings And Loan Crisis — S&L Crisis Definition”. Investopedia , 2019.
KENTON, WILL. “Regulation Q”. Investopedia , 2019.
Konar, Anna. “SAVINGS AND LOAN CRISIS AND MARKET REGULATIONS”. Research Gate , 2019.
AMADEO, KIMBERLY. “The Difference Between Savings And Loans And Other Banks”. The Balance , 2019.
