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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
These first banks had corporate charters from state governments, but soon private banks arose as well. These often performed exactly the same function as commercial banks, but holding no charters from the states, they were structured as partnerships. The potential liability of each partner was unlimited. This uncomfortable fact has always made private bankers notably cautious. Private banks never issued bank notes, as chartered banks could, but they were often large and powerful. The most influential bank in American history, J. P. Morgan and Company, was a private bank until the 1930s.
The first banks, chartered or private, were not interested in handling personal accounts or small accounts at all. Thus people of small or moderate means had no place to put their savings except under the mattress. In 1816, however, a new type of financial institution appeared in the United States, the mutual savings bank. The first one of all was the Philadelphia Saving Fund Society, which began operations on December 21 of that year. Unlike commercial banks, mutual banks are owned by the depositors. In the first mutuals, deposits were invested in government bonds, not loans, and all profits accrued to the depositors.
Obviously the mutual savings bank arrangement, in its initial form, was extremely safe, exactly suited to handling the savings of people of modest means who could not afford a loss. But actually it was not a bank at all. Because it did not issue bank notes or make loans, it created no money and thus in fact resembled a sort of government-bond mutual fund. Regardless, these operations soon evolved into banks. The chronic need for mortgages caused many state governments to give mutual savings institutions the power to make such loans.
By the end of the nineteenth century, there were nearly five hundred mutual savings banks, mostly in the Northeast, and they held nearly 50 percent of the money deposited in savings, or time, accounts. Savings accounts differed from regular accounts in that the bank could impose a waiting period, usually sixty days, before permitting withdrawal. By the end of the nineteenth century, commercial banks were also accepting savings deposits from individuals and making loans to them as well. The mutual savings bank industry ceased growing, though it didn’t wither away either.
In 1831 a second type of “bank” for people of modest means came into existence in the United States—the savings and loan association. The S&L has been known over the years by many names, such as building society and cooperative bank, but has always had the same purpose. Originally a set number of people would gather and agree to put up a sum of money every month until a certain total was achieved. When the total was reached, it was loaned to one of the members to build a house. When every member of the society had built a house, the society was dissolved.
Jefferson hated banks and transmitted his hatred to his political heirs. That legacy made it nearly impossible to regulate banks.
The first S&L in the country, the Oxford-Provident Association of Frankford, Pennsylvania, was this type of institution and dissolved after ten years, its mission accomplished. But before long S&Ls, too, evolved into permanent organizations, providing a place for small savers in the community to keep their money and helping finance the housing of these same people. In other words, they became banks. In fact, it has been a pronounced tendency of financial institutions, whether they be savings societies, building associations, insurance companies, trust companies, or brokerage houses, to evolve toward being full-service banks. Everyone, it seems, wants the power to create money.
The idea of the savings and loan institution, serving local savers and homeowners, caught on quickly. By the end of the 1920s there were more than eleven thousand throughout the country. As long as savings and loan institutions remained small and local, and the management, the depositors, and the borrowers all lived in the same community and knew one another, they worked well and helped fill a real need. But the banker’s nightmare was always a particular problem for S&Ls. Real estate loans in the form of singlefamily mortgages are, necessarily, long-term loans and can be difficult to convert into cash in times of financial stress. The assets of S&Ls, therefore, were illiquid. If the depositors panicked, there was no way even a basically sound S&L could pay them their money and avoid failure.
When the new Constitution came into force in 1789, Alexander Hamilton, the first Secretary of the Treasury, quickly established the first American banking system. Its apex was the federally chartered Bank of the United States, modeled on the Bank of England. The new bank was intended to act as the fiscal agent of the government and could thus discipline other banks by refusing to accept their bank notes in payment of taxes if it doubted the banks’ solvency. If the Bank of the United States didn’t accept a bank’s paper, no one else would either, and the bank would be out of business. This forced the early banks to be prudent, and indeed there was no bank failure for the first eighteen years, probably the longest failure-free period in American history.