- Historic Sites
Understanding The S&L Mess
At its roots lie fundamental tensions that have bedeviled American banking since the nation began
February/March 1991 | Volume 42, Issue 1
Still worse, they changed the rules on who could own thrifts. Instead of only people living in the community, now anyone could own a thrift. Latter-day Willie Suttons moved in. To make it easier for them to do so, the regulators now allowed non-cash assets—land, for instance, the most illiquid of all assets—to be used in making these purchases. Since the days of the goldsmiths and their surplus gold, bank capital had always been in the form of money or very near money such as U.S. Treasury bills. The one essential ingredient in the magic formula that allows bankers to create money had always been the banker’s own money. Now the regulators decided that title to ten thousand acres of Arizona desert would do nicely as well. It did not.
Also in 1982 Congress passed the Garn-St. Germain Act, which allowed the S&Ls to make nonresidential real estate loans and consumer loans up to 70 percent of their loan portfolios. In effect they became very nearly full-service banks, but with only a small fraction of the capital and reserve requirements of commercial banks.
State regulators were forced to follow suit as state-chartered S&Ls pushed to join the federal system with its new freedoms. If they hadn’t, they soon would have found themselves with nothing left to regulate (and state politicians would have found themselves without the campaign contributions of the Chevy dealers and shoestore owners). California, which had the largest state S&L system by far, promptly upped the ante and allowed state-chartered thrifts to invest in whatever they pleased, from junk bonds to alternative energy schemes. California thrifts, in other words, became far more than full-service banks. They became venture capitalists. The only difference was that any losses were guaranteed by the government.
The S&L disaster was now unavoidable, for the politicians and the regulators they supervise had made three fundamental mistakes: (1) They had ignored all that three hundred years of history had taught about sound banking practices; (2) they had ignored the most intuitively obvious laws of economics; (3) they had forgotten what Willie Sutton and his ilk never forget—that banks are in the money business.
When they had done their work, they had created an economic oxymoron—the high-yield, no-risk investment called brokered deposits—that devoured the S&L industry, destroyed uncounted billions of American wealth, and wrecked an as-yet-uncounted number of political careers.
But at least the S&L crisis, a crisis that could have happened only in the American banking system, gives us the opportunity, once again, to make fundamental reforms. And that, in the last analysis, is why Churchill was a democrat for all of democracy’s foibles. Perhaps after two hundred years the American democratic process can at long last give the country a banking system that does not, in seeking to work the magic of creating money, periodically destroy wealth as well.