Savings and Loans, S&L History and Operations

How They Differ From Other Banks

Depositors form a line to make withdrawals from a troubled S&L bank in Baltimore.
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Savings and Loans (S&Ls) are specialized banks created to promote affordable homeownership. They get their name by funding mortgages with savings that are insured by the Federal Deposit Insurance Corporation. Historically, they have offered higher rates on savings accounts to attract more deposits, which increases their ability to offer mortgages.

Early Supplier of Home Mortgages

Before the Federal Home Loan Bank Act of 1932, most home mortgages were short-term and provided by insurance companies, not banks. S&Ls then gained the ability to offer 30-year mortgages that offered lower monthly payments than previously available. It helped make homeownership more affordable.

S&Ls have changed significantly in recent decades. Those that still exist today operate like most commercial banks by offering checking accounts and other common features. The key difference is that they must have nearly two-thirds of their assets invested in residential mortgages.

Creation of the Savings and Loan Banks

Before the Great Depression, mortgages were 5 to 10-year loans that had to be refinanced or paid off with a large balloon payment. By 1935, 10% of all U.S. homes were in foreclosure, thanks to these harsh terms and falling housing prices. To stop the carnage, the New Deal did these three things: 

  1. The Home Owner’s Loan Corporation bought 1 million defaulted mortgages from banks. The HOLC changed them to the long-term, fixed-rate mortgage we know today and reinstated them. 
  2. The Federal Housing Administration provided mortgage insurance.
  3. The Federal National Mortgage Association created a secondary market for mortgages.

The FNMA also created Savings and Loans to issue these mortgages. These changes were in response to an economic catastrophe. But they significantly boosted homeownership in the United States.

The Growth of the Home Loan Market

In 1944, the Veterans Administration created a mortgage insurance program that lowered payments. That encouraged returning war veterans to buy homes in the suburbs. The program spurred economic activity in the home construction industry.

Throughout the 1960s and 1970s, almost all mortgages were issued through S&Ls. Thanks to all these federal programs, homeownership rose from 43.6 percent in 1940 to 64 percent by 1980.

Trouble for the S&Ls

In 1973, President Richard Nixon created rampant inflation by removing the U.S. dollar from the gold standard. S&Ls couldn't raise interest rates to keep up with rising inflation, so they lost their deposits to money market accounts. That eroded the capital S&Ls needed to create low-cost mortgages. The industry asked Congress to remove certain restrictions on its operations.

In 1982, President Ronald Reagan signed the Garn-St. Germain Depository Institutions Act. It allowed banks to raise interest rates on savings deposits, make commercial and consumer loans, and reduce loan-to-value ratios. S&Ls invested in speculative real estate and commercial loans. Between 1982 and 1985, these assets increased by 56%.

Collapse and Bailout

The collapse of these investments led to the failure of half the nation's banks. As banks went under, state and federal insurance funds began to run out of the money needed to refund depositors. 

In 1989, the George H.W. Bush administration bailed out the industry with the Financial Institutions Reform, Recovery, and Enforcement Act. FIRREA provided $50 billion to close failed banks, set up the Resolution Trust Corporation to resell bank assets, and used the proceeds to reimburse depositors. FIRREA prohibited S&Ls from making more risky loans. 

Unfortunately, the savings and loan crisis destroyed confidence in institutions that once had been thought to be secure sources of home mortgages because state-run funds backed them.

Repeating Past Mistakes

Like other banks, S&Ls had been prohibited by the Glass-Steagall Act from investing depositors' funds in the stock market and high-risk ventures to gain higher rates of return. The Clinton administration repealed Glass-Steagall to allow U.S. banks to compete with more loosely regulated international banks. It allowed banks to use FDIC-insured deposits to invest in risky derivatives.

The most popular of these risky investment instruments were the mortgage-backed security (MBS). Banks sold mortgages to Fannie Mae or the Federal Home Loan Mortgage Corporation. They then bundled the mortgages and sold them as MBS to other investors on the secondary market.

Many hedge funds and large banks would buy the loans and, in turn, repackaged and resell them with subprime mortgages included in the package. These institutional and large buyers were insured against default by holding credit default swaps (CDS). The demand for the packaged and high-yielding MBS was so great that banks started selling mortgages to anyone and everyone. The housing bubble expanded.

2006 Financial Crisis

All went well until housing prices started falling in 2006. Just like during the Great Depression, homeowners began defaulting on their mortgages, and the entire derivatives market selling the packaged and repackaged securities collapsed. The 2008 financial crisis timeline recounts the critical events that happened in the worst U.S. financial crisis since the Great Depression.

Washington Mutual was the largest savings and loan bank in 2008. It ran out of cash during the financial crisis when it couldn't resell its mortgages on the collapsed secondary market. When Lehman Brothers went bankrupt, WaMu depositors panicked. They withdrew $16.7 billion over the next ten days. The FDIC took over WaMu and sold it to JPMorgan Chase for $1.9 billion. 

Post-Crisis S&Ls

The difference between commercial banks and S&Ls has narrowed significantly. In 2013, there were only 936 Savings and Loans, according to the FDIC. The agency supervised almost half of them. Today, S&Ls are like any other bank, thanks to the FIRREA bailout of the 1980s.

Most S&Ls that remain can offer banking services similar to other commercial banks, including checking and savings accounts. The key difference is that 65% of an S&L's assets must be invested in residential mortgages.

Another key difference is the local focus of most S&Ls. Compared to banks that often are large, multinational corporations, S&Ls more often are locally owned and controlled, more similar in fashion to credit unions. For this reason, they often can be a good place to get the best rates on mortgages.