To many financially savvy Americans, the savings and loan crisis is remembered as the largest financial crisis since the Great Depression. What caused this and why wasn’t the disaster averted, or at least minimized? Weren’t there strong warning signs of where this industry was headed? This article will highlight the key developments and factors in this economic crisis. It will explain how the situation got as bad as it did, and the rationale behind some of the choices that were made during the fallout.


Savings and LoanCredit: Wikimedia CommonsSavings and loans, or thrifts, were created by the government because of the massive number of home foreclosures following the Great Depression. Although these new thrifts could only offer home mortgage loans, customer deposits were still insured just like a regular bank. In addition, savings and loans were able to pay slightly more interest on savings accounts than banks. They also received government tax breaks. In theory, this sounded like an excellent idea, and the concept functioned very effectively for many years. Perhaps this is just what America needed to rebound from the tough economic times it was experiencing.

Congress also helped control the savings and loans’ competition by capping the amount of deposit interest a bank could pay its customers. Banks, which had held the financial power for so long, were obviously not pleased by these occurrences. Through these recent developments, savings and loans quickly realized they must “get in good” with Capitol Hill, to ensure they continued to receive favorable treatment. One of the most powerful lobby groups in the nation was the U.S. League of Savings Institutions. Ed Gray, director of the Domestic Policy Staff at the White House, stated, “When it came to thrift matters in the Congress, the U.S. League and many of its affiliates were the de facto government.” This group and its subsequent efforts remind us just how powerful political campaigning and lobbying can be in our nation. Simply put, if one doesn’t speak up, his voice won’t be heard. These lobby groups made sure they were heard loud and clear.


Warning Signs

The first struggle occurred in the late 1960s and 1970s. At times, rising inflation rates reached double digits, mainly due to rising oil prices. Each market interest rate increase impacted thrifts considerably; in fact at one point in 1979, interest rates were over twenty percent. The savings and loans’ income was still solely driven by low, fixed-rate 30-year loans so they did not have a lot of ways to generate additional revenue. Money market accounts and mutual funds, which could pay as much interest as they wanted, started getting customers and capital that were previously going to savings and loans. This is not surprising, since consumers are usually not very loyal during tough economic times. They are much more concerned with finding the best deal, so their dollar stretches as far as it possibly can. While only seven percent of these institutions were losing money in 1979, in 1980 an astounding eighty-five percent were in the red.

Savings and Loan Crisis 3Credit: Wikimedia CommonsSomething significant had to change to survive much longer. Thrifts pleaded with Congress for an effective, simple way to increase their income. Adjustable rate mortgages seemed to be the answer, since these would more closely match home loan rates with fluctuating market interest rates. Unfortunately, many powerful consumer groups begged to differ. Advocates including the Consumer’s Union, Gray Panthers, and Ralph Nader all made their voices known. These groups felt businesses should absorb costs for rising interest rates, not consumers. They also contended that adjustable rate mortgages were too confusing to the average American. The fact that these consumer groups succeeded is hard to imagine in today’s society.

March 1980 saw the enactment of the Depository Institutions Deregulation and Monetary Control Act. The Carter Administration’s goal here was to increase the similarity between different financial institutions. One of the results was the removal of an interest rate ceiling for deposit accounts. The deposit insurance limit was also raised from $40,000 to an astounding $100,000, at no extra cost to the consumer. Thrift lobbying groups claimed the increased insurance limit would lure more depositors, yet the only thrifts to probably benefit would be large branches in California, which were flooded with big savers from Latin America and Wall Street. Chairman of the House Banking Committee Fernand St Germain of Rhode Island was the man behind this dramatic increase in deposit insurance.

The Senate Bill called for a limit increase to $50,000; but St Germain proposed a “compromise” limit of $100,000; not realistically thinking he would get that much. Due to the strong powers of lobby groups and vested interests, the insurance limit of $100,000 did pass. Deputy Secretary of the Treasury Tim McNamar was quoted as saying, “We were lucky they didn’t get a million.” In my opinion, this demonstrates just how out of touch Congress can sometimes be with the average American citizen. The proportion of consumers who would actually benefit by this insurance limit increase was very minimal.

A Growing Problem

Paying increasingly high interest rates and maintaining low rate mortgages loans continued to make things worse. Net worth decreased by almost 90% in two years, from $32.2 billion in 1980 to a mere $3.7 billion in 1982. The early 1980s saw the initiation of many failed efforts meant to help the savings and loans.  In November 1980, the Federal Home Loan Bank decreased the net worth requirement at thrifts from five to four percent of total deposits. The Tax Reform Act of 1981 gave individuals powerful tax incentives for real estate investments. In September 1981, troubled branches were given the ability to issue “income capital certificates.” These purchased certificates were included as capital, in essence masking that a thrift was actually insolvent. 

Savings and Loan Crisis 2Credit: MorguefileIn January 1982, the net worth requirement saw another decrease—from four to three percent of total deposits—and savings and loans were allowed to use more liberal regulatory accounting principles instead of generally accepted accounting principles. This laundry list of questionable changes over the span of only two years should have raised numerous red flags. It is said that hindsight is always 20/20, but it seems obvious the envelope was really being pushed here. One may wonder if the government was stubborn or afraid to give up on this banking concept, so it kept treading water in hopes that its problems would somehow solve themselves.

The straw that probably broke the camel’s back was the Garn – St Germain Act of 1982. The goal of this act was to help savings and loans rebuild capital. The bill greatly increased the types of investments these institutions could make, hoping investing with aggressive risk-takers would allow thrifts to earn their way out of their hole. This questionable act passed due to heavy pressure from large savings and loans in California. The Golden State had a reputation for being a trendsetter and making sound business decisions, so California was able to heavily influence this decision with little resistance. It is amazing how one state could have so much influence, however this is still a reality today, where one or a few swing states often decide who wins the presidency. Since it only made sense, many California locations chose to be federally chartered so they could take advantage of this new act. As an incentive to keep California thrifts state chartered instead, the Nolan Bill was passed in December 1982. This allowed all California state-chartered thrifts to invest a full 100% of their deposits in any kind of business venture. Similar plans also were rolled out in Texas and Florida.

All of this was not occurring without some warning. Earlier in 1982, before the Garn – St Germain Act was passed, respected economist Dennis Jacobe explained some studies the U.S. League of Savings of Institutions had been conducting. He concluded the potential for success in just about every field beyond home loans was largely negative. Cost/benefit analysis, a sound staple of economic theory, simply didn’t look favorable here. Richard Pratt, Chairman of the Federal Home Loan Bank Board, responded by saying, “You can grow out of your problems.” It seems completely unfathomable that so many people could not see this downward spiral towards economic crisis as things got progressively worse. Is there any possible way it made more sense at this point to press ahead instead of taking a step back? 

Within the next few years, corporate criminals including Don Dixon and Ranbir Sahni began to surface. Dixon’s Dallas Vernon Savings and Loan was found to have an astounding 96 percent of its portfolio in default. One $24 million loan was for 99 acres of land: one third of which was actually underwater. Vernon had also purchased a $2 million beach mansion in California, where Dixon and his wife had lived for eighteen months. In addition, $6 million went to a Vernon fleet of corporate airplanes, and another $5.5 million went towards rare artwork to decorate executive offices. Amazingly, Ranbir Sahni’s American Diversified Savings & Loan never even wrote a single home-mortgage loan. In 1983, American Diversified was paying the highest interest in the country. Over the next two and a half years, its capital grew from $11.7 million to $1.1 billion. Sahni used this money to invest in ventures including windmill farms, chicken farms, shopping centers, and junk bonds. One analyst commented that American Diversified was a company with only $500,000 in equity that lost $800 million in insured deposits. A news report equated this to one drunken motorist wiping out the entire city of Pittsburgh.

Many states were already getting hit hard from insolvencies. The failure of the Empire Savings and Loan in Texas eventually cost taxpayers $300 million. Failed thrifts in Maryland killed state deposit insurance funds and coast Maryland residents $185 million. In 1986, estimates already assessed losses to state insurance funds at $20 billion. By this point, there really wasn’t anything that would solve the out of control problem.

Cleaning Up The Mess

Finally, in 1989, newly elected President Bush took the necessary steps to end the savings and loan crisis. Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act. This bill finally closed all insolvent savings and loans, repaid depositors, and significantly reordered the entire financial industry’s regulatory structure. Unfortunately, it also confirmed that taxpayers would foot the bill for much of these losses. In front of the television nation and numerous reporters, Bush admitted that a huge, multibillion dollar problem existed in the savings and loan industry. The president’s plan was unveiled: a highly detailed financial arrangement using thirty-year notes to pay down the portion not paid by taxpayers.

In closing, there really wasn’t one simple factor that caused the savings and loan crisis. Instead, it was a snowball effect from the culmination of many occurrences over a few decades. Looking back, we can only study these financial mistakes in hopes that history does not repeat itself. Still, since the government guarantees $100,000 of federal deposit insurance to every single person, there is always the chance that something similar could happen again.