Savings and Loan Crisis - Failures

Failures

The United States Congress granted all thrifts in 1980, including savings and loan associations, the power to make consumer and commercial loans and to issue transaction accounts. Designed to help the thrift industry retain its deposit base and to improve its profitability, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20 percent of their assets, issue credit cards, accept negotiable order of withdrawal accounts from individuals and nonprofit organizations, and invest up to 20 percent of their assets in commercial real estate loans.

The damage to S&L operations led Congress to act, passing the Economic Recovery Tax Act of 1981 (ERTA) in August 1981 and initiating the regulatory changes by the Federal Home Loan Bank Board allowing S&Ls to sell their mortgage loans and use the cash generated to seek better returns soon after enactment; the losses created by the sales were to be amortized over the life of the loan, and any losses could also be offset against taxes paid over the preceding 10 years. This all made S&Ls eager to sell their loans. The buyers—major Wall Street firms—were quick to take advantage of the S&Ls' lack of expertise, buying at 60%-90% of value and then transforming the loans by bundling them as, effectively, government-backed bonds (by virtue of Ginnie Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls were one group buying these bonds, holding $150 billion by 1986, and being charged substantial fees for the transactions.

In 1982, the Garn-St Germain Depository Institutions Act was passed and increased the proportion of assets that thrifts could hold in consumer and commercial real estate loans and allowed thrifts to invest 5 percent of their assets in commercial loans until January 1, 1984, when this percentage increased to 10 percent.

A large number of S&L customers' defaults and bankruptcies ensued, and the S&Ls that had overextended themselves were forced into insolvency proceedings themselves.

The Federal Savings and Loan Insurance Corporation (FSLIC), a federal government agency that insured S&L accounts in the same way the Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency’s resolution by mid-1995 of an additional 747 thrifts.

A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up being even larger than it would have been because moral hazard and adverse selection incentives that compounded the system’s losses.

There also were state-chartered S&Ls that failed. Some state insurance funds failed, requiring state taxpayer bailouts.