Understanding The S&L Mess

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It was a fateful congruence of interests. In truth, mutual savings banks had become obsolescent by the turn of the century, after commercial banks had begun offering services to ordinary citizens. The S&L industry would not have survived the upheavals of the 1930s and 1940s in anything like its traditional form had not the cartel fostered by the government protected it. When the cartel began to break down, as cartels always do, the realities of the marketplace brutalized the weakest members.

Had the integrity of the American banking system as a whole been Washington’s primary concern, banks too weak in capital and assets to survive on their own in the new financial marketplace would have been merged with stronger commercial banks. Other mutuals and S&Ls would have become commercial banks on their own, with the same capital and reserve requirements as all other commercial banks.

But because the banking lobby’s influence with politicians had always been extremely strong, it was the interest of bankers, not the banking system or even the Republic itself, that came first. The presidents of the 4,613 S&Ls in business in 1980 wanted to continue being bank presidents. The Chevy dealers and shoe-store owners on the boards of those S&Ls wanted to go on being bank directors. A series of quick fixes for the S&Ls ensued, rather than a basic restructuring of the industry.

The politicians and S&L regulators ignored three hundred years of history and the basic truth that banks are in the money business.
 

In 1790, when Alexander Hamilton submitted to Congress his “Report on a National Bank,” his plan for establishing the American banking system, he had cogently argued the folly of allowing politicians anywhere near the power to create money that is inherent in banking. The 1980s were to prove why Hamilton had been so very right.

In 1980 Congress removed the ceiling on the interest rates that bankers could pay and, while they were at it, raised the amount of the federal guarantee on deposits from forty thousand dollars to one hundred thousand. Had the federal guarantee simply tracked inflation since 1934, the guarantee would have amounted to slightly more than fifteen thousand dollars by 1980. Had it remained at the same multiple of average family income, it would have been slightly less than fifty thousand dollars. Raising it to one hundred thousand was not, therefore, done to protect widows and orphans. It was done to help out the bankers.

Here’s how. As early as the 1960s Wall Street had been making what are called brokered deposits in thrift institutions. These deposits were made in amounts that matched the limit on the federal guarantee and were designed to allow the rich to have as much of their savings under that guarantee as they wished. It was, in other words, a way around the limit that should never have been tolerated by the government in the first place. The FHLBB, realizing that these brokered deposits were what is known as hot money—that is, money likely to chase the highest interest rates—had limited thrifts to holding no more than 5 percent of their deposits in this form.

In 1980, with the S&Ls desperate for deposits—any deposits—the FHLBB discreetly dropped this regulation, and hot money flowed into the once-staid S&Ls, now able to offer every capitalist’s dream: a high-interest, zero-risk investment. In order to attract this money, the S&Ls had to offer higher and higher interest rates on deposits as they competed among themselves for the new source of funds.

But the S&Ls had no way to earn the money to pay the high interest rates they were promising. They were still stuck with their old loan portfolios of low-paying, fixed-interest singlefamily home mortgages. The result was not hard to predict: The S&L industry went broke. In 1980 the S&Ls had a collective net worth of $32.2 billion. By December 1982 it was $3.7 billion.

To remedy the consequences of the quick fixes of 1980, more quick fixes were now added. The FHLBB lowered the reserve requirements of S&Ls from 5 percent of assets to 3. “With the proverbial stroke of the pen,” wrote the journalist L. J. Davis, “sick thrifts were instantly returned to a state of ruddy health, while thrifts that only a moment before had been among the dead who walk were now reclassified as merely enfeebled.” The Bank Board also changed accounting requirements so that they, in effect, allowed S&Ls to show handsome profits when, in fact, they were fast becoming insolvent.