Savings and Loan Crisis - Background

Background

The thrift industry has its origins in the British building society movement that emerged in the late 18th century. American thrifts (known then as "building and loans" or "B&Ls") shared many of the same basic goals: to help working-class men and women save for the future and purchase homes. Thrifts were not-for-profit cooperative organizations that were typically managed by the membership and local institutions that served well-defined groups of aspiring homeowners. While banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women. Thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals.

The first thrift was formed in 1831, and for 40 years there were few B&Ls, found in only a handful of Midwestern and Eastern states. This situation changed in the late 19th century as urban growth and the demand for housing related to the Second Industrial Revolution caused the number of thrifts to explode. The popularity of B&Ls led to the creation of a new type of thrift in the 1880s called the "national" B&L. The "nationals" were often for-profit businesses formed by bankers or industrialists that employed promoters to form local branches to sell shares to prospective members. The "nationals" promised to pay savings rates up to four times greater than any other financial institution.

The Depression of 1893 (the Panic of 1893) caused a decline in members, and so "nationals" experienced a sudden reversal of fortunes. Because a steady stream of new members was critical for a "national" to pay both the interest on savings and the hefty salaries for the organizers, the falloff in payments caused dozens of "nationals" to fail. By the end of the 19th century, nearly all the "nationals" were out of business (National Building and Loans Crisis). This led to the creation of the first state regulations governing B&Ls, to make thrift operations more uniform, and the formation of a national trade association to not only protect B&L interests, but also promote business growth. The trade association led efforts to create more uniform accounting, appraisal, and lending procedures. It also spearheaded the drive to have all thrifts refer to themselves as "savings and loans" not B&Ls, and to convince managers of the need to assume more professional roles as financiers.

In the 20th century, the two decades that followed the end of World War II were the most successful period in the history of the thrift industry. The return of millions of servicemen eager to take up their prewar lives led to a dramatic increase in new families, and this "baby boom" caused a surge in new mostly suburban home construction. By the 1940s S&Ls (the name change occurred in the late 1930s) provided most of the financing for this expansion. The result was strong industry expansion that lasted through the early 1960s.

An important trend involved raising rates paid on savings to lure deposits, a practice that resulted in periodic rate wars between thrifts and even commercial banks. These wars became so severe that in 1966 the United States Congress took the highly unusual move of setting limits on savings rates for both commercial banks and S&Ls. From 1966 to 1979, the enactment of rate controls presented thrifts with a number of unprecedented challenges, chief of which was finding ways to continue to expand in an economy characterized by slow growth, high interest rates and inflation. These conditions, which came to be known as stagflation, wreaked havoc with thrift finances for a variety of reasons. Because regulators controlled the rates thrifts could pay on savings, when interest rates rose depositors often withdrew their funds and placed them in accounts that earned market rates, a process known as disintermediation. At the same time, rising rates and a slow growth economy made it harder for people to qualify for mortgages that in turn limited the ability to generate income.

In response to these complex economic conditions, thrift managers came up with several innovations, such as alternative mortgage instruments and interest-bearing checking accounts, as a way to retain funds and generate lending business. Such actions allowed the industry to continue to record steady asset growth and profitability during the 1970s even though the actual number of thrifts was falling. Despite such growth, there were still clear signs that the industry was chafing under the constraints of regulation. This was especially true with the large S&Ls in the western U.S. that yearned for additional lending powers to ensure continued growth. Despite several efforts to modernize these laws in the 1970s, few substantive changes were enacted.

In 1979, the financial health of the thrift industry was again challenged by a return of high interest rates and inflation, sparked this time by a doubling of oil prices. Because the sudden nature of these changes threatened to cause hundreds of S&L failures, Congress finally acted on deregulating the thrift industry. It passed two laws, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St. Germain Depository Institutions Act of 1982. The deregulation not only allowed thrifts to offer a wider array of savings products (including adjustable rate mortgages, which fixed one important problem), but also significantly expanded their lending authority and reduced supervision, which invited fraud. These changes were intended to allow S&Ls to "grow" out of their problems, and as such represented the first time that the government explicitly sought to increase S&L profits as opposed to promoting housing and homeownership. Other changes in thrift oversight included authorizing the use of more lenient accounting rules to report their financial condition, and the elimination of restrictions on the minimum numbers of S&L stockholders. Such policies, combined with an overall decline in regulatory oversight (known as forbearance), would later be cited as factors in the collapse of the thrift industry.