What Are Savings and Loans? History and Today

What's the Difference Between S&Ls and Other Banks?

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James Stewart and Donna Reed in a scene from the film 'It's A Wonderful Life', 1946. It depicts a depression-era bank run on the Savings and Loan. Photo by RKO Radio Picture/Getty Images

Definition: Savings and Loans (S&Ls) are specialized banks created to promote affordable homeownership. They use savings that are insured by the Federal Deposit Insurance Corporation (FDIC)  to fund mortgages. Depositors were willing to accept lower interest rates on their savings because they were insured. This allowed the banks to charge lower interest rates on the mortgages, and still be profitable.

 S&Ls make homeownership more affordable by extending the term of the loan to 30 years. This lowers monthly payments, eliminates the need to refinance, and allows families to afford larger homes. .

History

Before the Great Depression, mortgages were 5 - 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 (HOLC) bought one million defaulted mortgages from banks, changed them to the long-term, fixed-rate mortgage we know today, and reinstated them. 
  2. The Federal Housing Administration (FHA) provided mortgage insurance.
  3. The Federal National Mortgage Association (FNMA) created a secondary market for mortgages.

It 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.

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

Throughout the 60s and 70s, almost all mortgages were issued through S&Ls.

 Thanks to all these federal programs, homeownership rose from 43.6% in 1940 to 64% by 1980. 

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

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

The collapse of these investments led to the failure of half the nation's banks.  As banks went under, the state and Federal insurance began to run out of the money needed to refund depositors. (Source: Richard K. Green and Susan M. Wachter, "The American Mortgage in Historical and International Context," University of Pennsylvania, September 21, 2005)

In 1989, the first Bush Administration bailed out the industry with the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).

It provided $50 billion to close failed banks. It set up the Resolution Trust Corporation (RTC) to resell bank assets, using the proceeds to reimuburse depositors. FIRREA prohibited S&Ls from making more risky loans. For more, see Savings and Loan Crisis.

Savings and Loans and the Financial Crisis

Like other banks, Savings and Loans were 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. This allowed banks to use FDIC-insured deposits to invest in risky derivatives.

The most popular of these was the mortgage-backed security. Banks sold mortgages to Fannie Mae or Freddie Mac, who then bundled them and sold them to other investors on the secondary market.

Many hedge funds and large banks repackaged and resold them with subprime mortgages. They were insured against default by credit default swaps. The demand for these securities was so great that banks started selling mortgages to anyone and everyone. 

All went well until housing prices started falling in 2006. Just like in the Depression, homeowners began defaulting on their mortgages, and the entire derivatives market collapsed. For more, see 2008 Financial Crisis Timeline.

Savings and Loans Today

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 FIRREA.

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 secondary market, which had collapsed. When Lehman Brothers went bankrupt, WaMu depositors panicked. They withdrew $16.7 billion over the next 10 days. The FDIC took over WaMu, and sold it to JPMorgan Chase, for $1.9 billion.