How Politics & Money Destroyed America's Banking System: Savings & Loan Scandal (1989)

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• published: 09 Apr 2014
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The savings and loan crisis of the 1980s and 1990s (commonly dubbed the S&L; crisis) was the failure of about 747 out of the 3,234 savings and loan associations in the United States. A savings and loan or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members -- a cooperative venture known in the United Kingdom as a building society. In 1995, the RTC had closed 747 failed institutions, worth a book value of $402 billion, with an estimated cost of $160 billion. In 1996, the General Accounting Office estimated the total cost to be $370 billion, including $341 billion taken from taxpayers. William K. Black wrote that Paul Volcker as Chairman of the Federal Reserve helped create a criminogenic environment for the Savings and Loans in 1979 by doubling the interest rate (to reduce inflation): S&Ls; made long-term loans at fixed interest using short-term money. When the interest rate increased, the S&Ls; could not attract adequate capital and became insolvent. Rather than admit to insolvency, some CEOs of S&Ls; became "reactive" control frauds by inventing creative accounting strategies that turned their businesses into Ponzi schemes that looked highly profitable, thereby attracting more investors and growing rapidly, while actually losing money. This had two effects: it meant that the fraud continued longer and substantially increased the economic losses involved, and it attracted "opportunistic" control frauds who were looking for businesses they could subvert into Ponzi schemes. For example, Charles Keating paid $51 million from Michael Milken's junk bond operation for Lincoln Savings and Loan, which at the time had a negative net worth exceeding $100 million. The United States Congress granted all thrifts in 1980, including savings and loan associations, the power to make consumer and commercial loans and to issue transaction accounts. Designed to help the thrift industry retain its deposit base and to improve its profitability, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20 percent of their assets, issue credit cards, accept negotiable order of withdrawal accounts from individuals and nonprofit organizations, and invest up to 20 percent of their assets in commercial real estate loans. The damage to S&L; operations led Congress to act, passing the Economic Recovery Tax Act of 1981 (ERTA) in August 1981 and initiating the regulatory changes by the Federal Home Loan Bank Board allowing S&Ls; to sell their mortgage loans and use the cash generated to seek better returns soon after enactment;[17] the losses created by the sales were to be amortized over the life of the loan, and any losses could also be offset against taxes paid over the preceding 10 years.[18] This all made S&Ls; eager to sell their loans. The buyers -- major Wall Street firms -- were quick to take advantage of the S&Ls;' lack of expertise, buying at 60%--90% of value and then transforming the loans by bundling them as, effectively, government-backed bonds (by virtue of Ginnie Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls; were one group buying these bonds, holding $150 billion by 1986, and being charged substantial fees for the transactions. In 1982, the Garn-St Germain Depository Institutions Act was passed and increased the proportion of assets that thrifts could hold in consumer and commercial real estate loans and allowed thrifts to invest 5 percent of their assets in commercial loans until January 1, 1984, when this percentage increased to 10 percent.[19] A large number of S&L; customers' defaults and bankruptcies ensued, and the S&Ls; that had overextended themselves were forced into insolvency proceedings themselves. The Federal Savings and Loan Insurance Corporation (FSLIC), a federal government agency that insured S&L; accounts in the same way the Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency's resolution by mid-1995 of an additional 747 thrifts.[20] A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up being even larger than it would have been because moral hazard and adverse selection incentives that compounded the system's losses.[21] There also were state-chartered S&Ls; that failed. Some state insurance funds failed, requiring state taxpayer bailouts. http://en.wikipedia.org/wiki/Savings_and_loan_scandal