What was the Savings and Loans crisis? What caused it? Could the crisis have been prevented? How?

The savings and loan crisis was the greatest banking collapse since the great depression. Emerging in the 1970’s and escalating during the 1980’s, by 1989 over half of the United States savings and loan associations along with the Federal Savings and Loan Insurance Corporation fund that was created to insure their deposits had collapsed. The overwhelming cost of the savings and loan crisis still astounds many taxpayers, depositors, and policymakers today. This savings and loan experience produced three valuable lessons: excessive regulation was the initial cause of the industry's problems; federal deposit insurance was ultimately responsible for the high costs of this crisis; government sponsored efforts to protect the industry only invited abuses and increased the ultimate cost of restructuring (England).
The foremost cause of the saving and loan crisis was the high inflation levels that occurred during the 1970’s. Savings and loan institutions depended on residential mortgages for income. During the 1970’s these institutions began losing money on fixed rate loans because the interest rates set were created in previous years when interest rates were well under the rate of inflation. Congress subsequently decided to allow the savings and loans to diversify into riskier and more profitable commercial real estate and relaxed lending requirements to prevent the savings and loans from collapsing. This change in the law relaxed restrictions and accounts for about 50 billion of the savings and loan bill (Ely).
The following are policy decisions which greatly affected the savings and loan crisis:
• Lending requirements were relaxed.
• Deposit Insurance rose from 40,000 to 100,000.
• Enforcement of the law by banking regulators decreased.
• Interferences in investigations by politicians of failing thrifts on behalf of specific savings and loan owners.
• Putting the solution into effect was delayed until the industry itself could not afford to pay for it; taxpayers in turn were stuck with the bill.
Referring to the policy decisions listed above, the relaxation of lending requirements, although a questionable decision was made for good reasons. The following four decisions were made at the request of saving and loan lobbyists which was paid for with campaign contributions and loans to elected officials. Thus, a $50 billion economic problem was turned into a $400 billion corruption problem (Ely).
The following chart demonstrates the increase of bank and thrift failures which peaked especially between 1986 and 1989 (Savings and Loan Crisis):

Federal guarantees allow political decision makers to protect favored firms and industries. If there had not been federal deposit insurance, then there is a possibility that there would not have been a savings and loan crisis during the 1980’s; savings and loans with fixed rate mortgages and short term deposits would have adapted or failed prior or during the 1970’s as their depositors demanded safe havens for their funds. Even though a large number of closures may have occurred, the cost would have been substantially lower than the $200 billion taxpayers are currently left facing.
The Savings and Loan Crisis may have been prevented…

• If there had been greater depositor discipline. If the U.S. government would have abandoned its “to big to fail” policy which in effect assured that all deposits in failed institutions, whether or not they are insured, were protected against loss. Imposing losses on large depositors only further depresses economies (Ely).

• If there were stronger regulation of banks and savings and loans. The federal home loan banks failed to act on what its examiners had uncovered during the 1980’s. Higher uniform capital standards, whether risk adjusted or not, were self defeating. These standards ignored the fact that not all banks require the same amount of capital. Banks that were unable to meet higher capital requirements began to acquire riskier assets, driving the risk adjusted spread of riskier assets below the level of safe assets (Ely).

• If there had been better information systems, better monitoring systems, and better recapitalization systems available for the insurer. The insurer could have been more effective in substituting capital requirements for detailed restrictions on the activities of clients.

• If delays and inaction by congressional and administration did not allow federal savings and loan insurance corporation’s losses to escalate. The incentive system for politicians needed to be improved as well. This could have been done with accounting reforms and oversight reforms. Stricter failure resolution processes needed to be in place. The incentive system for the insured thrift institutions needed to be improved since they were the most directly involved with the problems that were incurred. Improvement of the incentives system for the insured thrift institutions could have been done essentially through reinforcing market discipline or by increasing regulatory discipline.

• If the federal savings and loan insurance corporation insurance would have been decreased back to its original amount or possibly dropped entirely. This would have caused everyone to be more cautious. The thrift managers in turn would have needed to be more careful simply because if they made too many bad decisions people would no longer make deposits with them.

• If the incentive system for deposit insurers had been strengthened by placing greater obligations on managers. This could have included an accounting reform, capital enforcement, or market structure reform. Market structure reform would have been the most important in that it would check the adequacy and credibility of the accounting and capital policies (Ely).
The savings and loan crisis of the 1980’s and early 1990’s produced the greatest collapse of U.S. financial institutions since the Great Depression. Between 1986 and 1995, 1,043 thrifts with total assets of over $500 billion failed (Savings and Loan Crisis). The large number of failures distressed the resources of the Federal Savings and Loan Insurance Corporation, so U.S. taxpayers were forced to back up the obligations extended to insured depositors of these failed institutions. “As of December 31, 1999, the thrift crisis had cost taxpayers approximately 124 billion and the thrift industry another 29 billion, for an estimated total loss of approximately 153 billion” (Savings and Loan Crisis).

Works Cited

Ely, Bert. "Savings and Loan Crisis." The Concise Encyclopedia of Economics. 2nd. Web. http://www.econlib.org/library/Enc/SavingsandLoanCrisis.html.

England, Catherine. "Lessons from the Savings and Loan Debacle The Case for Further Financial Deregulation." Regulation - The Cato Review of Business & Government. 7 Feb 2011. http://www.cato.org/pubs/regulation/regv15n3/reg15n3-england.html.

"Savings and Loan Crisis." Mutual Funds, Investing, Retirement, Economy, Personal Finance. Web. 6 Feb 2011. http://www.fundmasteryblog.com/2008/07/14/bank-failures-today-vs-sl-crisis-chart-of-the-day/.