The Savings and Loan crisis of the 1980s was a wave of savings and loan failures in the USA, caused by mismanagement, rising interest rates, failed speculation and, in some cases, fraud. The US taxpayers took the brunt of the ultimate cost, which totalled around US$600 billion.

Many banks, but particularly savings and loan institutions were experiencing an outflow of low rate deposits, as depositors moved their money to the new high interest money market funds. At the same time, the institutions had much of their money tied up in long term mortgages which, with interest rates rising, were worth far less than face value.

Early in the Reagan administration, savings and loan institutions ("S&Ls") were deregulated (see the Garn - St Germain Depository Institutions Act of 1982), putting them on an equal footing with commercial banks. S&Ls (thrifts) could now pay higher market rates for deposits, borrow money from the Federal Reserve, make commercial loans, and issue credit cards.

Nature of the Deregulation

The deregulation of S & L's did not have the effect of casuing them to be under the same regulations as banks. Firstly, thrifts could choose to be either under a state or federal charter. Deregulation at the federal level however caused a race to the bottom at the state level (especially in California) because state regulators were paid by the thrifts the regulated, and they didn't want to lose that money.

In an effort to take advantage of the real estate boom and high interest rates of the early 1980s, many S&Ls lent far more money than was prudent, and in risky types of ventures in which many S&Ls were not competent. Whereas insolvent banks in the United States were typically detected and shut down quickly by bank regulators, the S&L regulators were apparently surprised by deregulation, and not sufficiently competent or staffed to perform the due diligence needed to regulate effectively.

The most important contributor to the problem was deposit brokerage. Deposit brokers, somewhat like stock brokers, are paid a commision by the customer to find the best CD rates and place their customers money in those CDs. These CDs however are usually short term 100,000.00 CDs. Previously banks and thrifts could only have 5 percent of their deposits be brokered deposits, the race to the bottom caused this limit to be lifted. A small one branch thrift could then attract a large amount of deposits simply by offering the highest rate. In order to make money off this expensive money, it had to lend at even higher rates, which means that it had to make more risky investments. This system was made even more damaging when certain deposit brokers (many of them mafia connected) instituted a scam known as "linked financing". In "linked financing" a deposit broker would approach a thrift and say that they would steer a large amount of deposits to that thrift if the thrift would loan certain people money (the people however were paid a fee to apply for the loans and told to give the loan proceeds to the deposit broker). This caused the thrifts to be tricked into taking on bad loans.

A large number of S&L customers' defaults and bankruptcies ensued, and the S&Ls that had overextended themselves were forced into bankruptcy themselves. The US government agency FSLIC, which at the time insured consumers' S&L accounts in the same way the FDIC insures consumers' bank accounts, then had to repay all the consumers whose money was lost.

The Federal Home Loan Bank Board reported in 1988 that fraud and insider abuse were the worst aggravating factors in the wave of S&L failures. The most notorious figure in the S&L crisis was probably Charles Keating, who headed Lincoln Savings of Irvine, California. Keating was convicted of fraud, racketeering, and conspiracy in 1993, and spent four and one-half years in prison before his convictions were overturned. In a subsequent plea agreement, Keating admitted committing bankruptcy fraud by extracting $1 million from the parent corporation of Lincoln Savings while he knew the corporation would collapse within weeks.

Keating's attempts to escape regulatory sanctions led to the Keating five political scandal, in which five U.S. senators were implicated in an influence-peddling scheme to assist Keating. Three of those senators -- Alan Cranston, Don Riegle, and Dennis DeConcini -- found their political careers cut short as a result. Two others -- John Glenn and John McCain -- escaped relatively unscathed.

External links

• FDIC: The S&L Crisis: A Chrono-Bibliography (http://www.fdic.gov/bank/historical/s&l/)

Refrences

Inside Job by Steven Pizzo Mary Fricker and Paul Muolo. ISBN 0-07-050230-7