Savings and Loans Crisis Explained

How Congress Created the Greatest Bank Collapse Since the Depression

S&L bank customers
Baltimore: Depositors lined up for the fourth day to withdraw money from Old Court Savings and Loan downtown. Maryland officials obtained a court order that limits depositors' cash withdrawals until a purchaser can be found for the troubled savings and loan. Photo: Bettmann/Getty Images

Definition: The Savings and Loans Crisis was the greatest bank collapse since the Great Depression of 1929. By 1989, more than 1,000 of the nation's Savings and Loans had failed. Between 1986-1995, more than half of the nation's S&Ls had failed.

The crisis cost $160 billion. Taxpayers paid $132 billion and the S&L industry paid the rest. The Federal Savings and Loan Insurance Corporation paid $20 billion to depositors of failed S&Ls before it went bankrupted.

 More than 500 S&Ls were insured by state-run funds. Their failures cost $185 million before they collapsed.

The crisis ended what had once been a secure source of home mortgages. It also destroyed the idea of state-run bank insurance funds.  (Source: "The Savings and Loan Crisis and Its Relationship to Banking," FDIC.gov.)

Scandal

The Senate Ethics Committee investigated five U.S. Senators for improper conduct. The "Keating Five" included John McCain (R:AZ), Dennis DeConcini (D:AZ), John Glenn (D:OH), Alan Cranston (D:CA) and Donald Riegle (D:MI.)  

The Five were named after Charles Keating, head of the Lincoln Savings and Loan Association. He had given them $1.5 million in campaign contributions. In return, they put pressure on the Federal Home Loan Banking Board to overlook suspicious activities at Lincoln. The FHLBB was the agency responsible for investigating possible criminal activities.

Empire Savings and Loan of  Mesquite,Texas was involved in illegal land flips and other criminal activities. Empire's default cost taxpayers $300 million. Half of the failed S&Ls were from Texas. The crisis pushed that state into recession. When the banks' bad land investments were auctioned off, real estate prices collapsed.

That increased office vacancies to 30 percent, while crude oil prices fell 50 percent. (Source: "The S&L Crisis: A Chrono-Bibliography," FDIC.)

Causes

The Federal Home Loan Bank Act of 1932 created the S&L system to promote homeownership for the working class. The S&Ls paid lower-than-average interest rates on deposits in return for lower-than-average mortgage rates. S&Ls couldn't lend money for commercial real estate, business expansion or education. They didn't even offer checking accounts. 

In 1934, Congress created the FSLIC to insure the S&L deposits. It operated like the FDIC does for commercial banks. By 1980, the FSLIC insured 4,000 S&Ls with total assets of $604 billion. State-sponsored insurance programs insurance 590 S&Ls with assets of $12.2 billion. (Source: "The Savings and Loan Crisis and Its Relationship to Banking," FDIC.)

In the 1970s, stagflation combined low economic growth with high inflation. The Federal Reserve raised interest rates to end double-digit inflation. That caused a recession in 1980.

Stagflation and slow growth devastated S&Ls. Their enabling legislation set caps on the interest rates for deposits and loans. Depositors found higher returns in other banks.

At the same time, slow growth and the recession reduced the number of families applying for mortgages. The S&Ls were stuck with a dwindling portfolio of low-interest mortgages as their only income source. 

The situation worsened in the 1980s. Money market accounts became more popular by offering higher interest rates on savings without the insurance. When depositors switched, it depleted the banks' source of funds. S&L banks asked Congress to remove the low interest rate restrictions. The Carter Administration allowed S&Ls to raise interest rates on savings deposits. It also raised the insurance level from $40,000 to $100,000 per depositor.

But by 1982, S&Ls were losing $4 billion a year. That was down from a profit of $781 million in 1980.

In 1982, President Reagan signed the Garn-St. Germain Depository Institutions Act.

It solidified the elimination of the interest rate cap. It also permitted the banks to have 40 percent of their assets in commercial loans and 30 percent in consumer loans

Most important, the law removed restrictions on loan-to-value ratios. That gave the S&Ls permission to use federally-insured deposits to make risky loans. At the same time, budget cuts reduced the regulatory staff at the FHLNN, impairing its ability to investigate bad loans.

Between 1982 and 1985, S&L assets increased 56 percent. Legislatures in California, Texas and Florida passed laws allowing their S&Ls to invest in speculative real estate. In Texas, forty S&Ls tripled in size.

Despite these laws, 35 percent of the country's S&Ls still weren't profitable by 1983. Nine percent were technically bankrupt. As banks went under, the FSLIC started running out of funds. For that reason, the government allowed bad S&Ls to remain open. They continued to make bad loans and the losses kept mounting.

In 1987, the FSLIC fund declared itself insolvent by $3.8 billion.  Congress kicked the can down the road by recapitalizing it in May. But that just delayed the inevitable. 

In 1989, the newly-elected President George H.W. Bush unveiled his bailout plan. The Financial Institutions Reform, Recovery and Enforcement Act provided $50 billion to close failed banks and stop further losses. It set up a new government agency called the Resolution Trust Corporation to resell bank assets. It would use the proceeds to pay back depositors. FIRREA also changed S&L regulations to help prevent further poor investments and fraud.