savings & loan crisis historical perspective

8/14/2019 Savings & Loan Crisis Historical Perspective

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Insolvent at Inception, Expensive atRebirth

How Myopia at the Establishment of the FederalSavings and Loan Industry, and Failures to AdaptRegulations thereof Forced George H.W. Bush to

Implement the Largest Government Bailout of the Twentieth Century

Andrew S. Terrell

Dr. James Kirby MartinHIST 6363 - Fall 2009Department of History


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University of Houston

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EPIGRAPH

While we have the quick exposure here, let me just thank you all,Mr. Speaker, Leader Mitchell, Dole, Bob Michel, for coming downhere. This is a listening session. We've got a big problem in thissavings and loan. There are no easy answers and no worrying

about the blame -- plenty to go around. I want to see the problemsolved. We've had a lot of consultation up on the Hill, and good

consultation. And Treasury will come, I think, to meet me tomor-row to present their views, but they're not being presented herewith this stacked deck. We need ideas, and if we're overlooking

something, we want to know what it is.

But I think we all agree that it's time to get on with the problem.And so, what I wanted to do this morning is simply ask your ad-vice and listen. And whatever we come up with will not be popu-

lar. And I expect then whatever you come up with will not be pop-ular, but we've got to get on and get the problem solved. And Iappreciate your coming down here early to discuss this today,

and then I'll be meeting, as I say, some more today. And then to-morrow I think we have more final recommendations. I'll go out

with it publicly probably early next week -- I think that's the plan --and see where we go from there.

George Herbert Walker Bush

Public Papers of the Presidents of the United States

Remarks on the Savings and Loan Crisis

8:04 a.m. Cabinet Room

3 February 1989

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ABSTRACT

The Savings and Loan thrift industry (S&L) has a cyclical history of under and over regula-

tory periods. When the market crashed in 1929, hundreds of millions of dollars vanished, includ-

ing investments in individual S&Ls. Presidents Herbert Hoover and Franklin Roosevelt first ad-

dressed the problem by creating the S&L federal pyramid and establishing federal insurance on de-

posits. With federal regulation and insurance, S&Ls thrived in their limited real estate market. Be-

cause S&Ls were originally locked into long term, residential mortgage loans, market rate hikes

caused individuals S&Ls to pay out more in interest to depositors than they received in interest

payments from existing loans. In the 1960s and 1970s, successive administrations failed to address

adequately the industry's expanding vulnerability. Unfortunately, escalating inflation rates coupled

with decreasing deposits further threatened to bankrupt many S&Ls. Deregulation of the S&L in-

dustry in the 1980s allowed for subsequent lines of questionable investments by a once fiscally

conservative and sturdy entity. When George H.W. Bush entered the White House in 1989, S&Ls

were failing in record numbers. Merely eighteen days into his presidency, Bush introduced the Fi-

nancial Institutions Reform Recovery and Enforcement act (FIRREA) which aimed to solve the

crisis through what has become known as the S&L bailout.

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Introduction

The Savings and Loan Crisis of the 1980s and early 1990s was a direct result of corporate

and state myopia in addition to failures to adapt regulations to the changing economy. Shortsight-

ed regulations that ruined the thrift industry included slow, reactive policies during the aftermath of

the 1929 market crash, a failure to implement policy that made S&Ls less susceptible to the ex-

panding economy of the mid-twentieth century, and deregulation policies amid a period of inflation

and rising interest rates in the 1970s and 1980s. 1 President George Herbert Walker Bush inherited

a fifty-year-old economic crisis and became the first executive to propose and follow through on a

comprehensive solution.

The proposal was too little, too late, however. By 1989, an inclusive bailout of the S&L

depositors seemed to be the only resolution to the S&L crisis .2 Federal insurance caps on S&Ls

had increased incrementally since the establishment of the Federal Savings and Loan Insurance

Corporation (FSLIC) in 1934 from five thousand to one hundred thousand in 1982. Because of

the increases in the amount insured in S&L deposits, Bush faced the largest federal insurance gap

in U.S. history. To make things worse, the country elected Bush on a platform of no new taxes

while decreasing the federal deficit. The deficit issue was significant because it doubled in the

eight years of Ronald Reagans administration from 1981 to 1989. In order to secure the desired

comprehensive solution, the Bush administration enacted the Financial Institutions Reform, Recov-

ery, and Enforcement Act of 1989 (FIRREA). The plan was expensive, nonetheless, necessary by

11 Thrift Industry is often used synonymously with savings institutions. For our purposes, the U.S. thrift in-dustry in the twentieth century is the Savings and Loan institution.22 In some conservative accounts, the bailout is construed as a cleanup. See Timothy Curry and Lynn Shibut,The Cost of the Savings and Loan Crisis: Truth and Consequences, FDIC Bankings Review 13, no. 2 (2000).

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1989. The bailout and FIRREA were the inevitable culminations of an industry mismanaged for

five decades .3

Administrations before the Great Depression failed to grant early S&Ls the same securitygiven banks with the creation of the Federal Reserve System in 1913-insurance on deposits for

consumer confidence. As a result, over 1,700 thrifts failed when the market crashed in 1929. Up

to $200,000,000 in savings dissolved. Though there were 12,000 individual S&Ls in operation

during the 1920s, they were not integrated into a sole industry; they were largely regulated by indi-

vidual states if regulated at all. This calamity prompted President Herbert Hoover to sign the Fed-

eral Home Loan Bank Act of 1932 that created a federal S&L pyramid and developed the Federal

Savings and Loan Associations. Under the bank act, Hoover appointed five citizens to the Federal

Home Loan Bank Board (FHLBB) which supervised twelve district Federal Home Loan Banks

(FHLB). To help launch newer S&Ls, the Treasury Department agreed to contribute up to

$125,000,000 dollars. At the bottom of the federal S&L pyramid structure were local, individual

institutions located within communities. 4

The Great Depression caused many savings to be lost, and moreover, it devastated the

housing market. As Franklin Delano Roosevelt (FDR) entered office in 1933, part of his first New

Deal legislation was the National Housing Act of 1934. For the S&L industry, FDRs act created

the Federal Savings and Loan Insurance Corporation (FSLIC) that insured thrift deposits much like

the FDIC did for bank accounts. Because S&Ls were federally insured then, tight regulations con-

33 Dwight M. Jaffee, Symposium on Federal Deposit Insurance for S&L Institutions, The Journal of Economic Perspectives 3, no. 4 (Autumn, 1989): 3-7; U.S. Senate Republican Policy Committee, Dealingwith the S&L Bailout, William L. Armstrong, Chairman, 101 st Congress. 16 July 1990 and Briefing Material:

The Savings and Loan Crisis, George H.W. Bush Presidential Library: White House Chief of Staff Collection,John Sununu Files, Box 86, Folder: Savings and Loan Industry(1990).44 J.E. McDonough, The Federal Home Loan Bank System, The American Economic Review 24, no.4 (December, 1934): 668-671; Stephen Pizzo, Mary Fricker and Paul Muolo, Inside Job: The Looting of Amer-ica's Savings and Loans (New York: McGraw-Hill Publishing Company, 1989), 9-12.

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trolled the industry. S&Ls were mostly limited to making home loans, and individual branches

were confined to issuing these mortgages only to properties within a fifty-mile radius of the S&L

office. In addition to the obvious limitations to future expansionist investments was the acceptance

of short-term deposits while offering fixed-rate, long-term loans. As the real estate market recov-

ered and grew after WWII, S&Ls began paying more in interest to their depositors than they re-

ceived in interest payments from their loans .5 These cases composed the first cycle of the thrift in-

dustry from under regulation to over regulation in the twentieth century. It is important to recog-

nize that the shortsighted regulations were quintessential of most new deal legislation; the early en-

actments were temporary fixes.

The 1950s housing boom, caused by increasing family incomes and stable employment, al-

lowed real estate prices to soar. By the mid-1950s long-term savings of individuals within the

S&L associations increased exponentially. S&Ls marked the second largest dollar increase from

1945-1953 among savings, bonds, and life insurance reserves ($15.5 billion). Such a large growth

demonstrated how extensive postwar demand for housing was. Additionally, FSLIC liability in-

creased from five to ten thousand dollars per account by 1951. Confidence in S&L deposits grew

along with the increases in federal insurance. Home mortgages reached a new high at $19.7 billion

during 1953, and S&Ls provided 37% of this figure .6 These were the golden days of S&Ls. The

industry was still vulnerable to any increase in interest rates, but the economic boom after WWII

concealed the threat for another decade. Proactive adaptation to the changing real estate market

and rising interest rates did not occur during this period, however. In essence, because of the ex-

55 Henry N. Pontell and Kitty Calavita, The Savings and Loan Industry, Crime and Justice 18 (1993):203-6; Briefing Material: The Savings and Loan Crisis, George H.W. Bush Presidential Library: WhiteHouse Chief of Staff Collection, John Sununu Files, Box 86, Folder: Savings and Loan Industry(1990).66 Harold W. Torgerson, Developments in Savings and Loan Associations, 1945-1953, The Journal of Fi-nance 9, no. 3 (September, 1954): 283-93; James R. Barth, The Great Savings and Loan Debacle , Ameri-can Enterprise Institute for Public Policy Research Special Analysis, (Washington, D.C.: AEI Press, 1991), 17.

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panding economy, regulations remained untouched. This may be attributed to the rationale that

warns to avoid fixing things that are not broken.

The S&L Crisis that faced President Bush in 1989 was not solely a result of deregulationand risky investments throughout the 1980s, but also was a product of corporate and state misman-

agement. For example, federal enforcement of regulations were lax because S&Ls had histories of

safe investing. Furthermore, examiners had restricted compensation and limits on allowable per-

sonnel numbers. Interest hikes hurt profit margins throughout the industry. The few demand de-

posits that had variable interest rates were limited by federal regulations; only a small amount of

variable interest accounts could be offered at each individual S&L. Once President James Carter

deregulated the industry in 1980, thrift executives looted their institutions and exploited the new

regulations by indulging in risky ventures formerly forbidden. 7

The S&L industrys evolution can be likened to that of a maturing human. S&Ls were born

out of Great Depression legislation and nurtured into initial success. As the industry graduated into

the postwar era, additional insurance monies allotted to deposits fostered a false sense of confi-

dence and security. During the 1960s and 1970s, S&Ls saw how inflation and rising interest rates

could negate capital revenue from long-term, fixed-rate loans. S&Ls ended up paying more in in-

terest to depositors than they were receiving from loan interest. Like so many industries before it,

S&Ls deregulated in 1980. Carter hoped this move would allow the industry to fix itself. Howev-

er, deposits in the failing industry were federally insured. As long as the FSLIC had funds to help

in the recovery of insolvent S&Ls, there was minimal risk. Unfortunately, deregulation allowed

S&Ls to invest in higher risk loans, such as 100% financing for commercial real estate develop-

77 Federal Deposit Insurance Corporation, The Savings and Loan Crisis and Its Relationship toBanking, History of the 80s, Volume 1, Chapter 4 (1997): 170-171, Available On-line,http://www.fdic.gov/bank/historical/history/vol1.html.

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ments. Not many banks rendered such loans. The common practice was for banks to finance the

short-term building on commercial property, then sell to insurance companies who would finance

the long-term repayment. Those in places of power splurged in risky ventures, mostly in commer-

cial real estate. S&Ls wanted to diversify and exploit their new freedom because inflation was

rampant and the traditional home mortgage investments were not profitable enough to compete

against commercial real estate revenue. 8

The federal S&L industry was insolvent at inception and a victim to unchanging regula-

tions. Bush recognized how regulations since the 1930s had not addressed the core problem with

the S&L industry: the vulnerability of institutions based on long-term, fixed-rate mortgages that ac-

cepted short-term deposits. S&Ls had never been allowed a diversified portfolio because they

were federally insured. Bush had chaired a task force in 1984 that investigated the regulations of fi-

nancial institutions. Reagan disregarded Bushs recommendations, probably because Reagan--like

his predecessors--knew how large a comprehensive solution would be and thus did not want it oc-

cur on his watch. Bush, however, had a track record of going against popular opinion as his con-

science dictated. Thereby, he felt a moral obligation to interdict and protect the innocent deposi-

tors who were afraid the FSLIC would not be able to reimburse insured monies.

Ergo, we will first explore the extent to which the federal governments interjection into the

S&L industry in the 1930s introduced shortsighted regulations that limited thrift revenue. Second,

this paper will briefly address S&Ls vulnerability to interest rate hikes, inflation, and the expand-

ing economy in the postwar United States. Furthermore, one will engage how deregulation in the

1980s exacerbated an already failing industry which culminated in the mass insolvency crisis as

Bush entered office in January 1989. Ultimately, the governments largest bailout in the twentieth

88 Ibid, 168-177; Pontell and Calavita White-Collar Crime in the Savings and Loan Scandal, 33.

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century was that of the S&L industry which resulted in the federal government essentially usurping

regulatory authority in 1932 yet failed to address the escalating problems for the subsequent five

decades. Bush was forced to act in 1989 with FIRREA because the severity of the S&L industry-

wide insolvency was exposed.

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Savings and Loan Inaugurations

...a long habit of not thinking a thing wrong, gives it a superficial appearanceof being right, and raises at first a formidable outcry in defense of custom. 9

From 1831 to the early 1930s, thrifts were loosely regulated by individual state inspectors.

After the market crash of 1929 that liquidated most commercial banks, many S&L members with-

drew their savings. S&Ls were largely invested in home mortgage loans, but if members could not

make their payments, S&Ls could not meet withdrawal requests. This was the atmosphere that

threatened individual S&Ls at the onset of the Great Depression. While the S&L industry faltered,

President Herbert Hoover and Franklin Roosevelt enacted two key pieces of legislation in 1932

and 1934 respectively. The acts established the federal S&L structure and regulatory board that

lasted until 1989. Roosevelt went so far as to offer federal insurance to deposits to help revitalize

confidence in the thrift industry. However ambitious and well-intended these early attempts were

at regulating S&Ls, they lacked foresight in encouraging and insuring an industry largely based on

long-term, fixed-rate mortgage loans.

Before expounding on the fallacies of the early federal S&L structure, it seems appropriate

to explain what S&Ls are, and how they operate. S&Ls are savings institutions where depositors

create the cash flow needed for loans. Interest payments on existing loans supply revenue for the

S&L and depositors. Before 1932, S&Ls were often known as building and loan institutions be-

cause they supplied mortgage loans for community development. S&Ls largely dealt in residential

real estate. Early mortgage loans from banks were short-term contracts that concluded with a large

balloon payment to secure the property. If a borrower could not pay off the mortgage loan with the

99 Thomas Paine, Common Sense (1776; repr., New York: Willey Book Co., 1942), 1.

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balloon payment, the property was foreclosed. S&Ls, thus, were friendlier alternatives when a

borrower decided to build a house or remodel because the institution dealt with 15-30 year mort-

gages, mostly with low, fixed-rate interest. S&Ls offered limited variable interest rate loans--espe-

cially in the 1980s--but variable-interest rates hurt depositors and the institution both as the latter

half of the century unfolded. In most cases, the variable interest loans were offered when mort-

gage applications were more risky. The rating system used by most S&Ls when calculating vari-

able against fixed-rates took into consideration the type of proposed construction, age of the prop-

erty, its location, and the moral and financial risk elements inherent in the borrower. 10 Working

with variable-interest rates was a gamble at any point. For instance, if one signed a $10,000 fif-teen-year mortgage in 1945 at 6% fixed APR, minimum payments would net the loan institution

50% of the initial loan amount: $5,000 in revenue, just from interest payments. Variable-rate loans

would produce even more profit, but they could also net less which left their long-term loans at the

mercy of the economy and the real estate market .11

Prior to 1932, individual states regulated thrifts within their boundaries. The collapsed

housing market in the early 1930s, however, motioned the federal government to enter S&L man-

agement. President Hoover signed the Federal Home Loan Bank Act on 22 July 1932 that estab-

lished the Federal Home Loan Bank System. The new system consisted of twelve Federal Home

Loan banks directly under one Federal Home Loan Bank Board (FHLBB). Hoover wanted to give

S&Ls access to funds to promote the housing market. The system was a pyramid structure. The

101 Aid to Home Owner Sped by Roosevelt, New York Times, 13 April 1933; Cities Benefits in HomeLoan Act, New York Times, 7 August 1932; David Lawrence Mason, From Buildings and Loans to Bail-Outs: A History of the American Savings and Loan Industry, 1831-1995 (Cambridge: CambridgeUniversity Press, 2004), 17-63; Fred T. Greene, Significant Post-Depression Changes in Savings and Loan Prac-tices, The Journal of Land & Public Utility Economics 16, no. 1 (February, 1940): 32-33.111 This hypothetical scenario is calculated by monthly direct reduction loan practices rather than fixed month-ly payment practices. Direct reduction loans became more popular by the mid 1930s because it constantly recalcu-lated the amount of interest owed the lender after each months payment. For more information see Greene, Signif-icant Post-Depression Changes in Savings and Loan Practices, 30-33.

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Bank Board supervised the regional banks which then advanced funds to individual S&Ls at low

interest rates. In essence, the board received $125,000,000 of initial capital to distribute among in-

dividual S&Ls. Hoover recognized that many citizens could make either interest or principal pay-

ments on their mortgages, not both. Foreclosing property was not benefitting any institution.

Foreclosure rates dropped, but these were only the beginning years of the Great Depression. 12

Among the first New Deal legislation under FDR was the National Housing Act of 1934,

signed 27 June. Pertaining to Savings and Loan was Title IV which established the Federal Sav-

ings and Loan Insurance Corporation (FSLIC). The FHLBB administered the insurance corpora-

tion for S&Ls. The significance of FSLICs establishment was that it created equal protection by

the federal government of commercial banks under the Federal Deposit Insurance Corporation for

S&Ls .13 Insurance coverage on deposits created a greater sense of security and confidence from

S&L members. The chief goal of the Hoover and FDR administrations was to encourage private

deposits so S&Ls could start offering fixed-rate mortgages again at prices the suffering public

could afford. To this end, they were successful.

The early acts that brought S&Ls under the federal umbrella also perpetuated a catastrophic

flaw within the industry. An overwhelming majority of policies and programs enacted during the

Great Depression were geared toward massive spending in hopes of restarting the economy. In the

housing market, S&Ls realized steady rises in investment returns as their capital revenue returned

from the earlier withdrawal phase. As WWII drew to a close, the payments on mortgages from the

Great Depression era did not increase. However, interest rates for the S&Ls to borrow money from

121 Home Loan Banks Open Doors Today, New York Times , 14 October 1932 and Cites Benefits inHome Loan Act, New York Times, 6 August 1932 and Home Loan Measure is Passed by House, New York

Times, 15 June 1932 and Barth, The Great Savings and Loan Debacle , 13-17.131 Aid to Home Owner Sped by Roosevelt, New York Times, 13 April 1933; Summary of Housing Billas Passed by the Senate, New York Times, 16 June 1934 and Savings Shares Insured, New York Times, 12

November 1934.

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their pyramid structure did increase as did dividend payments to depositors. Inflation affected in-

terest rates, and monetary exchange. 14

As the country shifted into the 1960s, the future of S&Ls was questionable at best. Be-cause presidential administrations from Hoover to Eisenhower failed to grasp the vulnerability of

the S&L industry, the threat increased as time passed on. The initial acts that created the federally

regulated S&L industry worked well for the 1930s. Hoover and FDR both recognized the necessi-

ty in expanding a housing market amid the Great Depression. The main problem with the S&L in-

dustry was not a lack of well-intended prospects, but a dereliction of the FHLBB and presidential

administrations to adapt S&L structures to the drastic change in the economy from the Great De-

pression to postwar America. The amount of mortgage loans from S&Ls made many individual

depositors and investors wealthy as the 1950s continued. Nevertheless, the majority of the revenue

for S&Ls were interest payments on 15-30 year loans at fixed interest rates. A point of diminishing

returns for such a market became more apparent as the country coasted into the 1960s.

Interest Spikes Hurt

Although 1959 and 1960 showed considerable growth in public savings accounts and mort-

gages, contemporary economists such as Charles M. Torrance, who also worked for FSLIC at the

time, expected to the see the rising value of S&Ls and other financial institutions level off in latter

1960. The number of S&Ls did level off in 1960, but total assets doubled from 1959 to 1965. See

table below. 15 The FHLB expanded to include forty-six hundred institutions, of whom four thou-

141 Harold W. Torgerson, Developments in Savings and Loan Associations, 1945-1953, The Journal of Fi-nance 9, no. 3 (September, 1954): 283-93.151 Table figures from Savings and Loan Fact Book 1966, (Chicago: United States Savings and LoanLeague, 1966): 92-94.

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sand were members of the FSLIC. 16 This meant that an overwhelming number of S&Ls were fed-

erally insured and entering a period of inflation and rising interest rates.

Year Individual S&Ls Assets

1945 6,149 $8,747,000,000

1952 6,004 $22,585,000,000

1959 6,223 $63,401,000,000

1965 6,071 $129,442,000,000

After three decades (1930-1960) of fostering the American dream of home ownership,

S&Ls were still vulnerable to vagaries of the market. Being federally insured and regulated had its

perks, but it also limited portfolio expansion. Until the 1960s, interest rates and inflation were

generally stable which allowed mortgage loaners to benefit from steady payments. Mortgage rates

were slightly higher than deposit rates in order to keep an S&L solvent. The system in place from

the Great Depression era worked well enough until the recessions of the 1960s and 1970s. In an

attempt to avoid the recessions, the Federal Reserve instituted contractionary fiscal policies or

tight money policies. In such situations, the Federal Reserve raises its funds rate to decrease the

supply of money. Doing so causes higher mortgages rates and diverts inflation. In the case of the

1960s, it did not work. Vietnam exacerbated the tough times and inflated the dollar further leading

to a floating exchange rate and the end of the Bretton Woods system by 1973. This mattered to the

S&L industry because the dollar was no longer fixed in value with gold at $35 an ounce. Stagfla-

tion also contributed to the declining stability of the S&L industry; interest rates soared as inflation

devalued what funds were available. Meanwhile unemployment peaked at 7.5% in 1973-1975 re-

161 Charles M. Torrance, Gross Flows of Funds Through Savings and Loan Associations, The Journal of Finance 15, no.2 (May, 1960): 157-160.

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cession .17 The S&Ls that held long-term assets from many years before the 1960s and 1970s inter-

est rate adjustments were the most susceptible to sudden insolvency. 18 No presidential administra-

tion wanted to adapt regulations of the S&L industry, perhaps because they focused on commercial

banks believing S&Ls to be safer because of their limited portfolios.

The John F. Kennedy, Lyndon B. Johnson, and Richard Nixon administrations received re-

ports of the effects the changing economy had on the thrift industry. In each successive report,

committees recommended permitting federal savings institutions to engage in broader investments.

The aim was to allow for a more flexible portfolio of individual S&Ls. President Nixons Com-

mission (known as the Hunt Commission) stated, Without additional investment powers, thrift in-

stitutions would not be able to survive. 19 So the administrations knew of the problems facing the

S&L industry as early as 1962. However, little more than commission recommendations came of

the committees who investigated the situation.

By the late 1970s, the gold standard was abandoned and inflation rates skyrocketed to 13%.

Typically, S&Ls never leant higher than 6% fixed-rate interest. S&Ls were more susceptible to the

these hikes in interest rates because depositors were receiving higher dividends than S&Ls were

collecting from interest payments. One must recognize that even Nixon and LBJs executive inter-

171 U.S. Department of the Treasury, Sources of Secular Increases in the Unemployment Rate,1969-82, Bureau of Labor Statistics, Available On-line, http://www.bls.gov/opub/mlr/1984/07/art4full.pdf; F. StebHipple, Fiscal Policy vs. Monetary Policy, College of Business and Technology East Tennessee State University,Available On-line, http://faculty.etsu.edu/hipples/fpvsmp.htm; David H. Papell, Monetary Policy in the UnitedStates Under Flexible Exchange Rates, The American Economic Review 79, no. 5 (December, 1989), 1106-1109; Michael D. Bordo and Barry Eichengreen, eds., A Retrospective on the Bretton Woods System:Lessons for International Monetary Reform, (Chicago: University of Chicago Press, 1993), v-xiii.181 Michael J. Boskin, Chairman, Presidents Council of Economic Advisers, The S&L Mess: WhatCaused it and How its being fixed, Presented before Citizens for a Sound Economy Washington, D.C., 9 Au-gust 1990, George H.W. Bush Presidential Library: White House Office of Cabinet Affairs, Case Studies File, Fold-er: S&L Strategy Group August 1990.191 U.S. Senate Republican Policy Committee, Dealing with the S&L Bailout, William L. Armstrong,Chairman, 101 st Congress. 16 July 1990.

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ventions could not stop the rising insolvency crisis. What made matters worse, was S&Ls that

were insolvent but masked their problems by way of poor accounting methods. These questionable

banking records were possible because of the lax enforcement protocols within the FHLBB. 20

Another remnant of the 1933 banking act was Regulation Q. This regulation limited the in-

terest rates that S&Ls were allowed to offer on savings accounts: 5.5%. However, treasury bills

were yielding over 8% in 1970 and 15% by 1980. To buy a treasury bill requires $10,000, thus

many depositors who could afford the price tag withdrew from their S&Ls. The richer depositors

who left the S&L industry during these years left individual S&Ls with less wealthy depositors and

less cash flow for new loans. The Federal Reserve realized how the interest yields in treasury bills

attracted only individuals who had the $10,000 to buy in, so the Reserve Fund created money mar-

ket mutual funds that allowed the less wealthy to pool their money. The process of moving low

yielding savings accounts to higher yielding money market funds is known as disintermediation.

However, the S&L industry could not compete with the rising interest yields; they were capped.

Individual S&Ls slowly moved to insolvency. 21

Even with the enormity of the escalating crisis. President Jimmy Carter and his cabinet

agreed deregulation of the thrift industry would best serve the situation. This was one of the great-

est blunders of the entire S&L crisis. The S&L industry had gone full circle. In Carters defense,

202 Michael J. Boskin, Chairman, Presidents Council of Economic Advisers, The S&L Mess: What

Caused it and How its being fixed, Presented before Citizens for a Sound Economy Washington, D.C., 9 Au-gust 1990, George H.W. Bush Presidential Library: White House Office of Cabinet Affairs, Case Studies File, Fold-er: S&L Strategy Group August 1990.212 Kirby R. Cundiff, Monetary Policy Disasters of the Twentieth Century, The Freeman Online 57, no.1(January, 2007). 6-8; U.S. Government Printing Office, Part 217: Prohibition against the Payment of In-terest on Demand Deposits (Regulation Q), Electronic Code of Federal Regulations, Available On-Line,http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&tpl=/ecfrbrowse/Title12/12cfr217_main_02.tpl; David H. Pyle,The Losses on Savings Deposits from Interest Rate Regulation, School of Business Administration Uni-versity of California, Berkeley, Available On-line,http://www.haas.berkeley.edu/groups/finance/WP/rpf018.pdf.

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deregulation did seem to be the only option aside from additional government monies that would

cause tax increases. From the early 20 th century loosely-watched thrifts developed their communi-

ties. The Great Depression forced early thrifts into insolvency fallout by the early 1930s. The fed-

eral government stepped in with Hoover and FDR establishing a possibly too firm grip on the S&L

industry. Then for three decades, nothing happened -- or at least on the surface.

The eventual bailout in 1989 could have been implemented with greater success sometime

in the 1960s. The evidential problems with the S&L industry during this decade were new, and a

greater awareness of the complications would have allowed for a remodeled S&L structure years

before individual S&Ls became desperate. From this angle, deregulation in 1980-1982 only exac-

erbated the core problem with the S&L industry: they could not compete with high interest yields

by only offering low-interest mortgages and savings accounts. However, such practices were all

the bankers in S&Ls knew.

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Risky Business

The 1980 deregulation of the S&L industry allowed corporate leaders to have free reign on

short-term, high-return, but high-risk endeavors. In addition to deregulation, federal insurance onS&Ls increased 150%. This was another poor decision. S&Ls fell to insolvency in historic num-

bers, and Congress increased the amount of savings insurance. A first attempt at aiding federal

bank regulators by expanding available aid was in 1981. The bill passed through the House, but

the Senate never voted. 22 Deregulation was a last effort to help the S&L industry fix itself. After

all, the majority of the debate at the time focused on S&Ls inability to compete. However, the

ability to compete ended up as a double-edged sword.

In the late 1970s, prime interest rates hit 21%. However, Regulation Q still limited deposit

interest and more prospective investors bypassed S&Ls in favor of Treasury bills and the growing

commercial real estate market. On a mark-to-mark basis, hundreds, if not thousands of individual

S&Ls were bankrupt. Thus, in 1979, President Carter formed a task force that concluded regula-

tion was the best course of action. The Depository Institutions Deregulation and Monetary Control

Act (DIDMCA) passed congress in 1980. DIDMCA provided for a phased elimination of Regula-

tion Q in hopes of attracting depositors back into S&Ls who could then offer higher yield returns.

Additionally, Carters act allowed federally-chartered thrifts to engage in commercial lending,

which was the largest growing market in 1980. Of most significance, was how DIDMCA in-

creased FSLIC insurance on deposits from $40,000 to $100,000. These drastic changes in regula-

tions forced the FHLBB to permit expansion of S&Ls beyond a certain comfort level. 23

222 Savings and Loan Chronology , White House Prep Copy. George H.W. Bush Presidential Library:White House Office of Cabinet Affairs, Case Studies File, Folder: S&L Strategy Group October 1990.232 Briefing Material: The Savings and Loan Crisis, George H.W. Bush Presidential Library: WhiteHouse Chief of Staff Collection, John Sununu Files, Box 86, Folder: Savings and Loan Industry (1990), 1-3.

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Despite the efforts by Carter and DIDMCA, interest rates continued to clim, and savings

institutions continued to lose money. Some estimated that up to two-thirds of the S&L industry

was insolvent by 1982. President Ronald Reagan responded in 1982 with the signing of the Garn-

St. Germain Act. This legislation furthered the deregulation motion started by DIDMCA two years

earlier. First, it gave regulators new emergency powers to deal with insolvent institutions. For

instance, allowing S&L regulators to arrange for interstate acquisitions of weaker S&Ls. Secondly,

Garn-St. Germain Act gave agencies new powers to provide financial assistance to failing thrifts.

Finally, the act authorized federally-chartered institutions to engage in several additional bank-

like powers, such as the authority to make a limited amount of commercial loans. The S&L in-dustry finally received fulfillment of its requests. It is important to recognize that Garn-St. Ger-

main only targeted federally-chartered thrifts, not state-Chartered institutions. However, a number

of State laws gave even broader powers to their S&Ls, Including the authority to make direct eq-

uity investments in speculative ventures, from wind mill farms, to hamburger franchises. Califor-

nia, Texas, and Florida deregulated their thrifts before Congress passed Garn-St. Germain even.

The mistakes were apparent by 1988 and 1989: over three-fourths of FSLIC losses were the result

of mismanaged State-chartered thrifts. 24

Merely two years after Garn-St. Germain, the FHLBB attempted to address ongoing abuses

by individual S&Ls. However, many in Congress felt the FHLBB was acting prematurely, over

half of the members of the House of Representatives co-sponsored the bill to delay the FHLBB in

1984. A year later, in 1985, the FHLBB requested $15-20 billion to aid the FSLIC fund. Congress

underestimated the amount of insolvent institutions, and deregulation as a cure was not working.

In 1987 the Senate and House Banking Committees recommended re-funding plans for the FSLIC

242 U.S. Senate Republican Policy Committee, Dealing with the S&L Bailout, William L. Armstrong,Chairman, 101 st Congress. 16 July 1990, 1-2.

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that totaled only $7.5 billion and $5 billion respectively. Congress aimed to prevent the FHLBB

from closing insolvent thrifts, even as late as 1987. Essentially, the end $10.8 billion funding

amount was a form of forbearance. The final legislation actually authorized S&Ls to use phony

accounting techniques to artificially bolster their capital, and specifically authorized the use of

goodwill in meeting capital requirements. Furthermore, the forbearance funding required the

FHLBB to allow tangibly insolvent institutions to remain open if their financial condition resulted

from loans in economically depressed regions. This was another example of how slow the gov-

ernment was with reacting to changing climates. Money was released to the FHLBB and FSLIC

eighteen months after requested on 29 July 1987. It was literally too little, too late. The late fund-ing bill was the target of criticism in 1989 when committee members tried to blame the S&L crisis

on members of the opposite parties. 25

Vice President George H.W. Bush led a commission on Regulations of Financial Services

in 1984. The commission produced its report, entitled Blueprint for Reform. Bushs task

group made recommendations for the Reagan administration along the same lines as former reports

had since Kennedys commission in 1962. Bush called for more effective regulation through the

elimination of overlapping regulatory structures, uniform capital and accounting standards aimed

at ending low capital levels and dubious accounting standards in the thrift industry. Further-

more, Bush recommended that the FDIC and FSLIC institute systems of risk-based insurance pre-

miums. Finally, the report requested that a portfolio test be taken in order to determine whether a

thrift industry is in fact essentially engaged in traditional specialized thrift activities. Those not

meeting the test would be required to be regulated as a bank and obtain deposit insurance from the

252 Ibid, 3-4.

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FDIC. 26 The mass insolvency issue was not cured in the 1980s. Not on Reagans watch, espe-

cially as the deficit had doubled from 1980-1988. The responsibility to resolve the S&L crisis fell

to the former vice president task group chair, George Bush.

262 Briefing Material: The Savings and Loan Crisis, George H.W. Bush Presidential Library: WhiteHouse Chief of Staff Collection, John Sununu Files, Box 86, Folder: Savings and Loan Industry (1990), 4.

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FIRREA & The Cost to Taxpayers

President Bush asserted his intention to permanently fix the S&L crisis in February 1987,

only eighteen days after his inauguration. The Financial Institution Reform Recovery and Enforce-ment Act (FIRREA) was the comprehensive solution. FIRREA was introduced more as a cleanup

rather than a bailout. However, it was a legitimate bailout because tax payers did front much of the

burden throughout the early 1990s. The near $200 billion bailout price tag was not only forced

onto Bush by decades of neglect, myopia, and mismanagement, but it also forced Bush to eat his

own words with his 1988 campaign slogan, Read my lips, no new taxes. In a period of large

deficits, Bush aimed to balance the budget and the S&L bailout did not allow him to keep his

promise.

The primary focus of FIRREA was to protect depositor savings. Thousands of S&Ls were

insolvent by 1989, but FSLIC insured up to $100,000 on each deposit thanks to President Carter

ten years previously. The figures in November 1990 stated approximately 10 million deposit ac-

counts and $100 billion in deposits were protected by FIRREA. FIRREA instituted tougher capi-

tal standards that required thrift owners to increase capital at risk. Seventy-five percent of all

thrifts with $750 billion in deposits were operating on a solvent basis, however, by November

1990. Bush also had the Department of Justice pursue major thrift crimes along with the Federal

Bureau of Investigation. 27

Misinformation about the total cost worried many citizens in 1989 and 1990. Published es-

timates placed the cost between $100-$500 billion. The Resolution Trust Corporation (RTC), an

272 Oversight Board, Resolution Trust Corporation, Bush Administrations S&L Cleanup Goals and Results, Current as of 13 November 1990. George H.W. Bush Presidential Library: White House Office ofRecords Management, Folder: S&L Strategy Group, August 1990, OA/ID 03565 [1 of 4].

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agency created by Bush in 1989 to aid in closing insolvent thrifts, finished its work in 1995. By

then, 747 thrifts in addition to the 296 formerly closed by the FSLIC were gone. From 1 January

1986 through 1995, federally-insured S&Ls declined from 3,234 to 1,645, roughly by 50 percent.

How much did this cost the taxpayers? Estimates were based on varied information and statistics

perpetuating a public outcry. The Department of the Treasury initially reported a $50 billion ex-

pected cost to solidify the S&L industry. This rose to a range of $100 billion to $160 billion in

June 1991. The rising costs made it difficult to comprehend for Representatives and citizens. Ana-

lysts independent of the Treasury Department based their estimated on Thrift Financial Report data

that was inaccurate, or even outdated. It was also likely that no one expected a 50% failure of theentire industry in 1989. The Bush administration expected thrifts with assets of over $400 billion

to be turned over to the RTC. Misinformation abounded because such a large bailout had never

been executed in American history. Furthermore, some estimates included expected interest pay-

ments over a few years which compounded the number significantly. Ultimately, the final number

indicated that all direct and indirect losses totaled $152.9 billion. The thrift industry itself covered

19% of that figure, leaving the burden of $123.8 billion to the taxpayers .28 The S&L bailout of

1989-1995 was the largest fund of its kind to bailout an entire industry and its federal insurance

corporation until 2008.

282 Curry and Shibut, The Cost of the Savings and Loan Crisis: Truth and Consequences, 26-33.

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Conclusion

The Savings and Loan Crisis and subsequent bailout were the direct results of Federal,

State, and Corporate myopia, neglect, and mismanagement. The federal S&L industry as set up inthe early 1930s remained constant through a tumultuous five decades. The bailout in 1989 was not

popular for any politician in Washington and in part forced Bush to retract on his promise to avoid

new taxes. Why did the problem fall to Bushs administration? Because successive administra-

tions did not want to have their tenure tarnished with the inevitable cost and publicity of a failed

institution. Nevertheless, since no overhaul of the system took place, the federal S&L industry was

insolvent at its inception in 1932.

The thrift industry before 1932 was a community-based effort to develop real estate.

Though the industry was not hit as hard as commercial banks with the 1929 market crash, it still

succumbed to the will of its depositors and many individual thrifts closed. Presidents Hoover and

FDR established a pyramid structure to better protect and insure the industry with a key limitation:

that it largely deal with low interest, long term home mortgage loans. The early federal S&L sys-

tem worked throughout the remainder of the Great Depression but met increasingly competitive

markets and inflation in the postwar years. Administrations in the 1960s and 1970s were more

than aware of the problems with the S&L industry, but did not act until Carter in 1980 who deregu-

lated the industry and hiked up federal insurance amounts to bolster confidence in thrifts. All of

his efforts backfired. Deregulation was too loose and the already weak FHLBB had little enforce-

ment protocols to deal with surmounting troubles.

Though the S&L crisis was not an issue in the 1988 presidential election campaign, Bush

must have considered the problem significant enough to deal with early in his administration as

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shown by his announce eighteen days after his inauguration. Had Bush maintained the status quo

of neglect and ignorance as shown by earlier administrations, who know what may have come to

pass. Nonetheless, for acting on a national crisis thus forcing Bush to recall his no new taxes

pledge, he was denigrated. One can make the case that the S&L bailout was a major factor in his

failure to be reelected in 1992. From any vantage, the S&L crisis was a national tragedy on many

fronts. First, we see the inability of a federally-regulated institution to last. Secondly, utter disbe-

lief in the U.S. government that began with Vietnam fomented a revived sense of incredulity to-

wards Washington, State boards, and the S&L industry as a whole. Finally, one sees how an indus-

try-wide bailout became commonplace.

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savings & loan crisis historical perspective

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