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new risk management structures, around the world. By 1980, with


skills and tools. But as interest rates interest rates on US government
Timeline continued
became more volatile, particularly debt hitting 16 per cent, many S&Ls November 1980 Following the
in the late 1970s, the S&L industry had already been fatally wounded. March enactment of the
failed to tackle the risk inherent in Luckily for the owners of thrifts, Depository Institutions
the funding of long-term, fixed- regulators in the early 1980s lacked Deregulation and Monetary
interest mortgages by means of the political, financial or human Control Act of 1980 (DIDMCA),
short-term deposits. resources to close large numbers of which allowed the Bank Board
One problem was that regulation institutions. Rigorous enforcement to ease the previous statutory 5
intended to help the S&L sector in would have meant paying out per cent of net worth
the 1960s had put a ceiling on the much more money to insured requirement to anywhere
interest rate that S&Ls could offer to depositors than was held in the between 3 per cent and 6 per
depositors. This measure succeed- industry-funded FSLIC insurance cent, FHLBB eases ‘net worth’
ed for a while in dampening com- fund. It would also have meant rules to only 4 per cent of
petition for depositor funds working with literally hundreds of insured accounts. DIDMCA also
between banks and S&Ls. But as insolvent institutions, and overcom- raises the bar on federally
new money market funds began to ing numerous political obstacles at insured deposits from $40,000 to
compete fiercely during the 1970s a federal and state level to radical $100,000 and allows some S&Ls
for depositors’ money by offering S&L industry reform. to put money into property
interest rates set by the market, S&Ls Instead, between 1980 and 1982, development and other risky
suffered significant withdrawal of regulators, industry lobbyists and activities.
deposits during periods of high inter- legislators put together various leg- 1981 Changes in federal tax
est rates, a process known as disin- islative and regulatory mechanisms regulations under the
termediation. to postpone the threatened insol- Economic Recovery Tax Act of
The biggest problem, though, vency of the sector in the hope that 1981 help spark the beginnings
was more fundamental. When S&Ls interest rates would quieten down of the real estate boom of the
tried to compete for funds by offer- and S&Ls would be able to engi- early to mid 1980s.
ing relatively high rates or (after neer themselves back into prof- September 1981 FHLBB
deposit interest rate ceilings were itability. introduces rules and
eliminated between 1980 and 1982) As we recount in our accompa- accounting changes to make
by offering interest rates in line with nying timeline, the sum effect of the financial condition of S&Ls
or above market rates, an unsus- these mechanisms was to loosen look better, including allowing
tainable gap opened up between S&L capital restrictions, while offer- the deferral of losses from the
the cost of their funding liabilities ing S&Ls new freedom to extend sale of impaired assets over a
(short-term interest rates) and the their activities into potentially lucra- 10-year period, and the
income generated by their assets tive (and therefore risky) areas. issuance of capital ‘certificates’
(long-term, fixed-rate mortgage In particular, regulatory rules on that artificially boost apparent
repayments). ‘net worth’ (the amount left over capitalisation.
Worse, as interest rates moved when S&L liabilities were subtracted January 1982 Net worth rules
higher, the economic value of exist- from assets and taken as a key indi- eased again to only 3% of
ing S&L portfolios of long-term, low cator of solvency) were changed insured accounts.
interest rate residential mortgages so that thrifts could continue to July 1982 FHLBB allows S&Ls to
moved sharply lower, threatening operate even when their net worth amortise ‘supervisory goodwill’
institutions with insolvency. reached historically low levels4. over a period of up to 40 years,
The trigger for the closing shut of The loosening of the solvency up from an original 10-year
this asset/liability trap was the shock and risk capital regime surrounding restriction. Garn-St Germain
rise in oil prices in 1979, pushing up S&Ls also included important Depository Institutions Act of
inflation and headline interest rates changes to the treatment of an continued overleaf

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accounting concept known as traditional means. In particular, S&Ls


‘supervisory goodwill’. Supervisory began to access increasing
Timeline continued
goodwill helped to compensate amounts of their funding via bro- 1982 allows easing of capital
any institution that, in a regulator- kered deposits. In this market, which rules, and greatly eases
agreed merger, took on the eco- emerged through the 1980s, brokers restrictions on the proportion of
nomically impaired tangible assets gathered together deposits from a property’s value that S&Ls
of another, insolvent institution (such individual savers and channelled can loan to a property
as mortgages paying low rates of these to institutions that offered developer. Deposit interest rate
interest). Although largely meaning- higher rates of interest, significantly ceilings (Regulation Q) phased
less at an economic level, supervi- increasing the rate at which S&Ls out for S&Ls, enabling them to
sory goodwill could be used to bal- could take in deposits and build compete for wholesale funds
ance out the thrift’s books in terms their business. by offering high rates of
of its capital requirements and its But the loosening of regulatory interest.
accounting numbers. restrictions on S&L activity meant Late 1982 FHLBB starts to count
Indeed, changes to the account- that institutions could use these new equity capital as part of an
ing and capital treatment of super- funds to gamble their way into S&L’s reserves
visory goodwill in 1982 made it pos- profit. The S&L industry’s focus January 1983 Restrictions lifted
sible for acquiring thrifts to post began to shift away from mortgage on state-chartered S&Ls in
stronger apparent accounting and assets and towards assets that California with regard to
capital numbers for up to 10 years offered better apparent margins. investments in property and
after merging with a failing institu- In particular, from the early 1980s, service companies, as state
tion, even though their underlying S&Ls began to both lend to real legislators compete with
economic situation had deterio- estate developers and to invest in federal legislators to ease
rated5. real estate, construction and serv- restrictions on S&Ls.
The legislative moves of the early ice companies. In key regions, such 1983 Interest rates fall,
1980s also included the raising of as Texas and Florida, S&L lenders temporarily making some
the level of insured deposits from competed with other lenders such (though not all) of the S&L
$40,000 to $100,000. The issue of as commercial bankers to fuel a industry solvent on an
deposit insurance is critical to the real estate boom, as US investors economic basis. But the
S&L scandal. In an uninsured envi- queued to take advantage of a opportunity for rational closure
ronment, depositors would have 1981 change in federal tax laws of institutions and reform of
been wary of continuing to fund the that rewarded investments in con- healthy institutions is missed.
industry, whatever the rate of inter- struction. Late 1984 and after Regulators
est paid by the S&Ls, for fear of los- But although this lending sector begin to tighten up regulations
ing their savings in a collapsed insti- offered sweet upfront fees and rela- to try to prevent weaker
tution. tively high interest rate margins, it institutions making rash loans
But because savers knew their was a honey trap that could be and investments following a
deposits were insured by govern- sprung by any marked downturn in number of attention-grabbing
ment guarantees, even badly dam- the commercial real estate market. S&L collapses.
aged institutions could attract funds Furthermore, as both the credit 1984–89 S&Ls pay above-
by paying interest rates marginally quality of developers and the value market rates to attract
above the market rate. The of the bank’s security depended deposits, particularly in hot
increase in the insured amount, and upon the same fundamental risk spots such as the Texas S&L
the phasing out of interest rate ceil- factors – property values, rental industry. It’s clear that the
ings on the interest that S&Ls could income, occupancy rates – the loss industry is in deep trouble but its
pay depositors after 1980, helped rates on commercial real estate regulators lack resources and
the S&Ls to attract depositors loans were likely to prove savage in political backing to close
through both traditional and non- any slump. An additional problem continued overleaf

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was that while the regulations sur- ● The use of untrustworthy property
rounding the S&L industry grew value appraisals that often took lit- Timeline continued
more and more lax, the already-lim- tle account of the likely downward
ited quality of the on-site supervision movements of property prices in insolvent institutions quickly
of individual institutions declined in local markets but sometimes enough.
the early to mid-1980s, partly due to included speculative assumptions 1986 FSLIC, itself clearly
regulator budgetary restraints6. about upward movements (misval- insolvent by year-end 1986,
With the restrictions eased, super- uation of assets with uncertain val- resolves 54 thrifts with total
vision at a low ebb, and little fund- ues is a common theme in failed assets of around $16 billion.
ing market discipline (as a result of bank risk management); But far more thrifts are
deposit insurance), the sector’s ● The practice of adding unpaid insolvent according to their
main bulwark against poor deci- interest payments to the capital to book values, while many
sions became the integrity and be repaid on a loan, and a host of others hover on the brink of
internal risk management practices similar practices designed to prop book insolvency. The
of individual S&Ls. up apparent asset quality and rev- economic reality is even
In too many cases, these proved enue streams even as an S&L’s asset worse, with perhaps half the
feeble defences. In particular, the portfolio began to deteriorate; and industry now underwater.
traditional risk management skills of ● ‘Churning’ impaired loans by 1986-1992 During the later
mortgage lenders, where credit risk using bank credit to persuade 1980s, the real-estate bubble
is relatively low and predictable, developers to purchase shaky bank bursts in regions around the
and property and collateral prices collateral and investments at US, partly prompted by the
relatively stable, did not equip most inflated values (from the bank itself, passing of the Tax Reform Act
S&Ls to venture into the strongly or the impaired credit). in 1986, which removes
cyclical commercial real estate Out-and-out corruption also federal tax incentives to invest
market. played its part, both in terms of in commercial real estate.
Across the S&L industry, many direct economic losses – it is esti- 1987 The passing of the
institutions allowed bad practices to mated to account for at least 15 Competitive Equality Banking
evolve that allowed economic risks per cent of the total S&L loss, some Act, and the setting up of a
to be underestimated and lie put the figure much higher – and in Financing Corporation (FICO)
unrecorded, while dubious and setting the scene for reckless deci- to fund FSLIC resolution of
fraudulent revenues were recorded sion making, misvaluation and failing thrifts by means of
up-front. In relation to commercial deliberately obscure financial issuing bonds, channel some
real estate lending, these practices reporting and documentation7. limited resources to the
included: From 1982, the FHLBB jettisoned programme of S&L closure,
● Over-emphasis on the up-front many regulations concerning S&L but the emphasis remains on
fees generated from advancing ownership, so that individuals and keeping wounded S&Ls afloat.
commercial real-estate loans (fees small powerful groups of sharehold- 1988 Regulators resolve 185
that were often paid from the ers could more easily gain control of thrifts with total assets of $96
money that the bank itself loaned institutions. But the opportunity to billion, but it’s not enough to
to the developer); grow a financial institution fast from stabilise the industry and many
● Loosening of underwriting stan- a minimal capital base – leveraging resolutions continue to be by
dards that should have ensured the risk and potential return of any means of regulator-agreed
creditors were likely to possess initial investment – attracted the acquisition: sharing rather
robust cashflows from the develop- wrong style of management and than ending the economic
ment, and that should have limited owner to the industry. woe.
the size of any loan to a fraction of Even while the underlying eco- February 1989 George Bush,
the value of any property used as nomics of the S&L industry remained newly elected in November
security; poor, the relaxed rules meant that continued overleaf

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between late 1982 and late 1985 was accomplished through encour-
many new thrifts entered the mar- aging mergers and acquisitions
Timeline continued
ket (133 in 1984 alone) and the total between S&Ls (rather than by con- 1988, announces a programme
asset-base of the thrift industry grew fronting the fundamental problem for rescuing the S&L industry
by 56 per cent8. that much of the sector was insol- using taxpayers’ money.
After a short respite in 1983 to vent). 1989 Congress passes the
1984, as a more favourable interest S&L owners and managers gener- Financial Institutions Reform,
rate environment helped ease the ally opposed moves to restructure Recovery and Enforcement Act
original cause of the S&L malaise, the industry through the wholesale of 1989 (FIRREA), which as part
the mid to late-1980s saw S&Ls lurch closure of financially precarious of a programme of reform sets
back into crisis again. This time a institutions, and proved to be pow- up the Resolution Trust
series of US regional crises, triggered erful political lobbyists. Corporation to liquidate
by collapses in the oil, property and In one incident in 1987 that has hundreds of insolvent
farming sectors, acted to realise the come to be seen as symbolic of institutions.
credit and investment risks now dubious lobbying during the S&L cri- 1989–1990 In terms of public
embedded in S&L portfolios. sis, the chairman of the FHLBB and expense, the S&L crisis is at its
By 1984, for example, the oil other key regulators were taken to height. RTC resolves 318 thrifts
price-inspired boom of the early task by five leading senators over with total assets of $135 billion
1980s in Texas was faltering, and by the pressure that regulators were in 1989 and 213 thrifts with total
1987, that state’s oil and real estate exerting on the activities of a spe- assets of $130 billion in 1990.
sectors were in deep recession. A cific S&L, Lincoln Savings & Loan. 1990–92 RTC continues to
similar process of increasing rates of The meeting had been set up by resolve large numbers of thrifts,
default and falling collateral values the controller of the S&L, Charles but the annual figure for 1992
remorselessly undermined S&L asset Keating, a politically well-con- falls to 59 institutions with $44
around the US, right through until nected developer, and his assem- billion assets.
1992 (though Texan S&Ls remained bling of the senators (known in later 1993–95 The number of thrifts
among the worst hit)9. press accounts as the ‘Keating requiring RTC intervention falls
From late 1984, the FHLBB began Five’) was interpreted by some reg- away sharply to only 13 over
to try to tighten up on S&L risk man- ulators as a show of force. Lincoln this three-year period as
agement and to put a brake on Savings & Loan was to become one industry fundamentals begin to
risky investment activities at near- of the largest S&L failures when it improve. The crisis is over, but
insolvent S&Ls. But it was too little, was closed in 1989, sparking a series legal wrangling over the
too late. By the end of 1986 it was of major court cases. restructuring process will
clear that the FSLIC, the safety net Public awareness of the enor- continue into the next
that insured S&L depositors – and mous scale of the S&L crisis contin- millennium.
which regulators depended upon ued to be relatively muted into the
when resolving failed institutions – late 1980s, despite financial scan- that industry-funded measures
was itself insolvent in the face of dals and heated political debate were not enough, and that US tax-
overwhelming sector losses. that had already exposed many of payers would end up paying much
As our timeline recounts, from the key issues10. But this changed of the bill for the S&L fiasco.
1986 onwards, politicians and regu- significantly after President Bush’s Under FIRREA, the discredited
lators struggled with a series of speech in February 1989. Later that FHLBB and the insolvent FSLIC were
measures to fund the restructuring year, Congress passed the Finan- abolished in favour, respectively, of
of the industry, but these failed to cial Institutions Reform, Recovery the new Office of Thrift Supervision
match up to the scale of the prob- and Enforcement Act of 1989 (FIR- and an extended function for the
lem. Although by 1988 the FSLIC was REA), substantially restructuring US FDIC (already responsible for de-
able to resolve thrifts with assets of financial industry regulation. The posit insurance in other US banking
$96 billion, much of the restructuring new laws belatedly recognised sectors)11, while the Resolution Trust

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Notes
1 These numbers apply to losses incurred between 1986 and
1995, the most expensive phase of the crisis. See “The Cost of the
Savings and Loan Crisis: Truth and Consequences”, Timothy Curry
and Lynn Shibut, FDIC Banking Review, volume 13, no 2,
December 2000.
2 Specific parallels are drawn by William Seidman, who headed
up the Resolution Trust Corporation that resolved S&Ls after 1989,
Corporation was set up to liquidate tors, the most intense series of insti- in a recent interview. See “Bill Seidman: The Enforcer”,
hundreds of insolvent institutions. tution failures since the 1930s13. The FastCompany, March 2002.
With new powers and funding, failures prompted an overhaul of 3 Concerns countered, in part, by the raising of the deposit
regulators began to act aggres- the regulatory structure for US insurance limit and extending to S&Ls the deposit interest rate
sively to close down institutions, banking and thrifts, a shake-up in ceiling already applied to banks to dampen down institutional
competition on rates. “A Historical Perspective on Deposit
though it quickly became clear that the system of deposit insurance
Insurance”, Christine Bradley, FDIC Banking Review, volume 13,
the situation in the S&L industry was and implied government guaran-
no 2, December 2000.
even worse than had been imag- tees, and a series of legal battles 4 Net worth calculations were anyway problematic from a
ined. In 1989 and 1990, the S&L crisis and corruption scandals fought capital and risk management point of view, as they took little
reached its height in terms of public out in the courts. account of the present market value or riskiness of assets (as
expense, with the RTC resolving 318 Regulators shifted towards a pol- opposed to their historical book value).
thrifts with total assets of $135 billion icy of earlier intervention in failing 5 FDIC, An Examination of the Banking Crisis of the 1980s and
Early 1990s, volume 1, chapter 4, page 174, footnote 20.
in 1989, and 213 thrifts with total institutions so that the principal costs
6 Budgetary controls, a weak regulatory reporting framework,
assets of $130 billion in 1990. are more likely to be borne by
political lobbying by the S&L industry, and the general anti-
The drain on the public purse shareholders than other stakehold- regulation political orthodoxy of the 1980s have all been blamed.
continued into 1993. But market fun- ers. There was also a shift towards 7 Later, the Financial Institutions Reform, Recovery, and
damentals in the form of the interest more risk-sensitive regulatory Enforcement Act of 1989 specifically required regulators to
rate environment, and the bottom- regimes, with respect to both net- establish and certify standards for appraisers working for federally
ing out of regional economies and worth assessments and the pay- ensured depositaries such as S&Ls.
8 FDIC, An Examination of the Banking Crisis of the 1980s and
real estate markets, were beginning ments made by individual institu-
Early 1990s, volume 1, chapter 4, page 178.
to turn up again for S&L asset port- tions to deposit insurance funds,
9 A later study in the early 1990s gave a flavour of this process. It
folios. From 1993 to 1995 the indus- while deposit insurance reform found that about half of the collateral backing a sample of loans
try began to stabilise, and the por- made it less likely that taxpayers from failed financial institutions in Texas and Louisiana had fallen
tions of the industry that had sur- would shoulder so great a burden in 58 per cent from their original valuation. Quoted in FDIC, An
vived the great S&L crisis moved any future crisis14. Examination of the Banking Crisis of the 1980s and Early 1990s,
steadily back towards profit over At a wider level, the S&L crisis volume 1, chapter 3, page 151.
10 In 1988, for example, Republican Jim Leach was busily warning
the next few years. taught politicians, regulators and
that unless a firm stance was taken, “a $50 billion headache
bankers how misleading rules-driven
today might become a $100 billion migraine tomorrow”. “The
The aftermath regulatory and accounting num- Lure of Leveraging”, Multinational Monitor, February 1988.
For some years the final bill for the bers can be in relation to risky bank 11 In 1989, FIRREA named the FDIC as the sole federal deposit
S&L crisis remained uncertain. activities. insurer of all banks and savings associations. The insolvent FSLIC
However, we know now that, set- At different stages of the crisis, fund, now administered by the FDIC, was renamed the Savings
ting aside ongoing legal action, the and at many different levels from Association Insurance Fund (SAIF). The FDIC’s own pre-1989 fund,
which had been used to insure commercial banks and state-
thrift crisis cost an extraordinary bank executives through to regula-
chartered savings banks rather than S&Ls, was renamed the Bank
$153 billion – one of the most tors and politicians, a formalistic
Insurance Fund (BIF).
expensive financial sector crises the reporting of the financial condition 12 These numbers apply to losses incurred between 1986 and
world has seen. Of this, the US tax- of S&Ls was deliberately selected 1995, the most expensive phase of the crisis. See “The Cost of the
payer paid out $124 billion while by interested parties to cover up Savings and Loan Crisis: Truth and Consequences”, Timothy Curry
the thrift industry itself paid $29 bil- the true economic extent of the and Lynn Shibut, FDIC Banking Review, volume 13, no 2,
lion12. unfolding disaster. It was a risk- December 2000. Various statistics on the number of thrift failures
can also be generated using the FDIC’s Bank and Thrift Failure
The consequences of the S&L cri- reporting failure on a grand scale
reports available through the FDIC web site on www.fdic.gov. For
sis for the structure and regulation that greatly worsened the long-
a direct link to the statistical data, Internet users can click here.
of the US financial industry were term economic consequences for 13 See Curry and Shibut, p26.
profound. The number of institu- the ultimate stakeholder: the US tax- 14 In particular, the Federal Deposit Insurance Corporation
tions in the S&L industry fell by payer. ■ Improvement Act of 1991. For a recent discussion of policy
about half between 1986 and This case study was contributed toward bank deposit insurance premiums since the S&L crisis, see
1995, partly due to the closure of by Rob Jameson, reference editor, George G. Kaufman, “FDIC Reform: Don’t Put Taxpayers Back at
Risk”, Policy Analysis, 16 April 2002.
around 1,000 institutions by regula- ERisk

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