Introduction
The Savings and Loan Industry
The savings and loan industry is established for the purpose of collecting and accumulating customer savings as well as lending money such as mortgages, personal, and business loans at an established market interest for both parties. Savings and loan institutions are usually shareholder owned in order to limit a single party of having one direct influence on the institution (Amadeo, 2018).
In the United States, the savings and loan industry has been established since the 19th century. After World War II, millions of service men returned to build their families, which erupted the need for real estate and subsequently increased mortgage and personal loans. This period of rapid growth was followed by a constant demand for savings and loan institutions to fuel even further loans and drive saving deposits (Robinson, 2013). This increase in the establishment of these institutions lead to a heated competition between these institutions and retail banks.
Due to the heated competition, the government intervened by imposing Regulation Q, which was imposed as an interest rate ceiling that limited the rate that each industry, both retail banking and savings and loan businesses could give their customers for their deposits (Robinson, 2013). This limited the competitive pressure within the market.
The Savings and Loan Crisis
Once the regulation was imposed and the competitive pressure cooled down, Saving and Loan institutions found it hard to compete efficiently against the retail bank industry. In 1979 , As a result of the inability to compete and the unattractive interest rates offered, their customers withdrew their deposits and invested in money market funds (Investopedia, 2018). instead in order to obtain a better return on their deposits and investments. As a result, a series of governmental regulations were proposed between 1980 and 1982 as a mean to help the institutions, which had a direct effect on who the savings and loan institutions could lend to, as well as as their risk practices and financial accounting (The WritePass Journal, 2011).
The crisis ignited under the volatile interest rate climate of the 1970s when the depositors withdrew their money from S&L institutions. When Regulation Q was imposed, it led to the dramatic increase of interest rates and inflation. As interest rates rose, these mortgages lost a considerable amount of value, which essentially wiped out the industry’s net worth. The government responded by passing the Depository Institutions Deregulation and Monetary Control Act of 1980. (The WritePass Journal, 2011)
To avoid dealing with the losses, federal regulators took steps to deregulate the industry in the hope that it could grow out of its problems. The industry’s problems, though, grew even more severe with the deregulation, and the burden was then shifted on taxpayers. By 1989, more than 1,000 of the nation's savings and loans had failed. The crisis cost approximately $160 billion. Taxpayers paid about $132 billion, and the savings and loan industry paid the rest. The Federal Savings and Loan Insurance Corporation paid $20 billion to depositors of failed institutions before it went bankrupt. More than 500 savings and loan institutions were insured by state-run funds. Their failures cost $185 million before they collapsed (Amadeo, 2018). The crisis ended what had once been a secure source of home mortgages. It also destroyed the idea of state-run bank insurance funds. (The WritePass Journal, 2011)
Economic and Financial Issues as a Result
The intervening regulations by the United States government played a major part in contributing towards the Savings and Loan Crisis, however, it remains that there are other micro and macro economic as well as financial factors that contributed to the falling and shutting down of the countless savings and loan institutions. The factors revolved around the economy of the United States in between the late 1970s and the 1980’s, the financial situations in the industry as the well as the continuously changing regulatory frameworks that were put in place at the time of the crisis. Over all it was an asset and liability mismatch that resulted in high margins of loss.(The WritePass Journal, 2011)
After the government deregulated the industry, the institutions were able to compete again and offer higher rates to attract deposits. In order to offer these unrealistic rates, they resorted to high risk activities to cover their previous losses, including real estate lending and junk bond investments(Amadeo, 2018). This led the business to grow as depositors continued to funnel money into these endeavors as their money was insured by the federal savings and loan insurance corporation (FSLIC)(The WritePass Journal, 2011).
Other legislations were passed that resulted in the reduction of the requirements that these institutions needed to remain solvent and continue running. The savings and loan institutions were allowed to appear solvent by issuing income capital certificates, as well as being allowed to invest 100% of customer deposits in any kind of venture that they felt was appropriate(The WritePass Journal, 2011). All deposits naturally increased as the depositors were assured by the government that all their deposits would be reimbursed in case of a loss.
This widespread corruption and continued deregulation lead to the insolvency of the FSLIC in which it could not aid the losses of the risky investments that the institutions carried out and hence, the burden was then shifted on tax payers and the government.
3. Critical Analysis and Regulatory Reforms that Followed
Critical Analysis
If the industry was never deregulated, it may have led to an era in which the businesses and institutions would have bought themselves out.(Willoughby, 2009) However, others argue that the deregulation was needed, such as the interest rate ceilings and the ability to loan businesses since the state of the economy then in which prices and volatile interest rates needed the intervention. (Willoughby, 2009)
What can be deduced from this analysis is that there were many reasons behind the crisis, including interest rate volatility and inability to compete with money market funds, removal of interest rate ceilings, lending to organizations, and rise of brokered deposits. The deregulation of the industry was the a big culprit as well, which included one man ownership, real estate tax reforms, and depositary insurance. (The WritePass Journal, 2011)They fueled the organizations, enabling them to be owned by a sole person, not doing the same for banks, and thereby driving them to engage in risky activities as there was no other owners to hold back and give advice. The tax reform act was abolished to allow investors to deduct loss bearing assets from their tax payables as well as issue income certificates. This prompted a series of investments in property so investors could take up loss bearing assets that could be deducted from their annual earnings. Finally, the depository insurance was increased from around 40,000$ to 100,000$ to prompt depositors to invest in the institutions.
Reforms
In 1989, President Bush mentioned the scale of the savings and loan crisis, and the huge role taxpayers had to play in solving it. Measures were being put in place to tackle the crisis were not adequate enough to avoid the industry shutdown. The financial institutions reform, recovery and enforcement acts was therefore enacted in 1989, passed by congress, and the main aim behind it was the restructure of the United State’s financial regulations. The Office of Thrift Supervision would now be in charge of regulating the activities in the thrift industry, as well as the Resolution Trust Corporation responsible for liquidating assets of incumbent organizations. These actions came in late at time, and if they were enacted early, the number of losses witnessed in the crisis may have been dramatically reduced.(The WritePass Journal, 2011)
4. Lessons Learned
Many takeaways were learned from this crisis. The first lesson learned was that over-regulation and extreme intervention was the main cause behind the crisis. This served as a lesson to the United State’s government that the nature of the crisis was a direct outgrowth of federal regulation that defined the basic conditions under which all institutions operate (England, 2018). That prevented individual institutions from experimenting with different ways to adapt to changing market conditions, and had the government not intervened, it may have given the institutions space to try and salvage the situation on their own. Thereby, it could have resulted in a very different and a less catastrophic outcome.
The second lesson that was observed is that deregulation is only effective in increasing efficiency
if the reduction in government discipline is replaced by a compensating increase in market
discipline (Willoughby, 2009). In other words, giving the market something to lose without insuring all of their activities. For insolvent Savings and Loan institutions during the 1980s, there was no market discipline. Neither owners nor depositors had something to lose, and both groups resorted to risk-taking activities as a result.
The de-regulations provided a demonstration of how federal guarantees and deposit insurances can give the institutions as well as the depositors extra confidence.(England, 2018) Money will flow to the riskiest firms in the industry as individuals seek out the highest returns. In normally functioning capital markets, private capital and individual firm's' risk-taking is followed closely . In federally insured markets they do not. Although the S&L industry of the past decade provided a worst-case scenario, the introduction of federal financial guarantees encourages insured institutions to economize on capital from the beginning. That itself is a risk-enhancing move. (Willoughby, 2009)
The final takeaway was that the crisis was a mishandled industry restructure (England, 2018). When the government becomes committed to protecting just ONE particular industry for the “ social good”, policy makers are often tempted to override market signals about the continued utility of the industry. The takeaway here is that policymakers cannot focus on protecting one industry without affecting the other as the entire economy is interrelated. Hence, singling out one industry was a mistake as such efforts are rarely successful(Willoughby, 2009). Their efforts at the time was explained by the disruption of closing hundreds of savings and loan institutions. However, in the end they were closed anyway.
5. Conclusion
It is not clear, however, whether American decision makers have completely absorbed these lessons from the crisis. Regulatory flexibility remains a problem particularly in the banking industry. Congress placed new restrictions on both the FDIC and the Federal Reserve that were designed to increase the risk of loss for account holders with deposits exceeding a $100,000 face.(England, 2018) However, tougher capital standards will only be as effective as the processes of actually enforcing them. (The WritePass Journal, 2011)
As far as the insurance industry is concerned, the crisis should give regulators a pause when they consider a narrow list of appropriate or safe assets. Similarly, proposals to introduce federal insurance guarantees should raise alarms for both taxpayers and well-capitalized, insurance companies. The cost of the crisis affected the United States greatly. It is difficult to imagine how many jobs could have been created or businesses funded with the funds lost from the institutions desperate bids for survival. The United State’s government, however, should take this crisis and turn it into a lesson that will help them avoid similar problems in the future.(England, 2018)