For a while, the system worked well. In the 1960s and 1970s, almost all Americans got S&L financing for buying their homes. Interest rates paid on deposits at S&Ls were kept low, but millions of Americans put their money in them because deposit insurance made them an extremely safe place to invest. Starting in the 1960s, however, general interest rate levels began rising with inflation. By the 1980s, many depositors started seeking higher returns by putting their savings into money market funds and other non-bank assets. This put banks and savings and loans in a dire financial squeeze, unable to attract new deposits to cover their large portfolios of long-term loans.
Responding to their problems, the government in the 1980s began a gradual phasing out of interest rate ceilings on bank and S&L deposits. But while this helped the institutions attract deposits again, it produced large and widespread losses on S&Ls’ mortgage portfolios, which were for the most part earning lower interest rates than S&Ls now were paying depositors. Again responding to complaints, Congress relaxed restrictions on lending so that S&Ls could make higher-earning investments. In particular, Congress allowed S&Ls to engage in consumer, business, and commercial real estate lending. They also liberalized some regulatory procedures governing how much capital S&Ls would have to hold.
Fearful of becoming obsolete, S&Ls expanded into highly risky activities such as speculative real estate ventures. In many cases, these ventures proved to be unprofitable, especially when economic conditions turned unfavorable. Indeed, some S&Ls were taken over by unsavory people who plundered them. Many S&Ls ran up huge losses. Government was slow to detect the unfolding crisis because budgetary stringency and political pressures combined to shrink regulators’ staffs.
The S&L crisis in a few years mushroomed into the biggest national financial scandal in American history. By the end of the decade, large numbers of S&Ls had tumbled into insolvency; about half of the S&Ls that had been in business in 1970 no longer existed in 1989. The Federal Savings and Loan Insurance Corporation, which insured depositors’ money, itself became insolvent. In 1989, Congress and the president agreed on a taxpayer-financed bailout measure known as the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). This act provided $50 billion to close failed S&Ls, totally changed the regulatory apparatus for savings institutions, and imposed new portfolio constraints. A new government agency called the Resolution Trust Corporation (RTC) was set up to liquidate insolvent institutions. In March 1990, another $78,000 million was pumped into the RTC. But estimates of the total cost of the S&L cleanup continued to mount, topping the $200,000 million mark.
Next Article: Lessons Learned From The Savings and Loan Crisis“