The Savings and Loan Debacle: Twenty-Five Years Later
August 9, 2014 marks twenty-five years since the signing into law of the US savings and loan (S&L) industry bailout, the Financial Institutions Reform,
Recovery, and Enforcement Act (FIRREA) of 1989. After FIRREA was signed into law by President George H.W. Bush, the federal government took control of 327
failed S&Ls with $147 billion in assets.
“Deregulation” Did It?
By now the S&L scandal lies deep in the Memory Hole, but at the time, the mainstream media had the greatest effect on how most Americans viewed the debacle. A quarter of a century ago the mainstream press and television media — as with the 2008 financial crisis — portrayed the debacle as the inevitable result of unfettered free markets run amok. In particular, they focused on an alleged spurt of deregulation that supposedly occurred during the “laissez-faire” Reagan administration (January 1981-January 1989). A current expositor of this view is of course Paul Krugman.
This favorite go-to of progressives is not only completely unsupported by facts but further investigation also reveals what a sham the supposedly free-market Reagan really was.
As a chart from Business Economics reveals, the 1970s to 1980s wave of “deregulation” actually began in 1976 with the railroad industry under President Gerald Ford. From 1978 to 1980, President Carter signed four laws relaxing regulatory controls over the airline, railroad, trucking, and banking industries. The vaunted “free market” Reagan only signed two relaxations of controls over the busing and thrift industries.
It should go without saying that the “deregulations” signed into law by Carter, Reagan, and Clinton — FSMA 1999 and CFMA 2000 — hardly ushered in industry structures resembling anything close to free markets. DIDMCA in 1980 raised the federal deposit insurance ceiling from $40,000 to $100,000 per account and thus increased the moral hazard of the industry. Garn-St. Germain in 1982, with its new “capital assistance” programs was another round of corporate welfare masquerading as genuine deregulation.
What Really Happened to the Industry
Since the formation of the Oxford Provident Building Association in Frankford, Pennsylvania in 1831, S&Ls, except during a recession in the 1890s, were economically sound enterprises for the next one hundred years. Mayer, Duesenberry, and Aliber place a turning point at the Great Depression and New Deal.
Before the New Deal, mortgages typically were five years in length and paid off in full lump sum (total interest plus principal) at maturity. The National Housing Act (NHA) of 1934 was the legislation that established the Federal Housing Administration (FHA), which encouraged S&Ls to abandon short-term, balloon-payment mortgages in favor of the “more affordable” long-term, fixed-rate mortgage (LTFRM) that is prevalent today.
While progressives in Congress and the Roosevelt administration certainly thought that the FHA would make houses more affordable, they were also motivated to create jobs in a depressed economy. By themselves, though, they could not pass the housing bill. What came to their rescue was a broad coalition of conservative business interests including not only S&Ls, but real-estate firms, construction firms, lumber dealers, brick manufacturers, and architects.
The Keystone in Place
While the first component of the unstable structure of the S&L industry was the long-term, fixed-rate mortgage, the second was its dangerously undiversified asset portfolios. S&Ls had been given incentives to hold usually not much more than long-term, fixed-rate mortgages.
Mayer and Hadley both faulted the Internal Revenue code for encouraging a reckless lack of asset diversification. Hadley also faulted the Interest Rate Control Act (IRCA) of 1966. In return for a deposit interest-rate ceiling advantage over commercial banks, IRCA required S&Ls to invest a large portion of their assets in mortgages. About how large? Hadley reported that before “deregulation,” mortgages on average comprised about a whopping 82 percent of S&L asset portfolios.
The Postwar Industry 1945–1960
From the perspective of its executives, the golden years of the industry in the twentieth century were undoubtedly after World War II, when the economy reverted to peacetime production. Suburbanization followed and S&Ls, with their protected turf in home lending, assumed a prominent position in many communities throughout the nation.
All was more or less well until about the mid-1960s.The slight rise in interest rates in the two decades after World War II did not pose much of a problem for S&Ls. The interest rate on ten-year T-bonds was 2.8 percent in 1953 and 4 percent by 1963. The term structure of interest rates did not change at all during this time period.
The years between 1965 and 1982, however, were a different story. In 1982 the rate on T-bills was 14 percent and the rate on ten-year T-bonds was 13.9 percent. Not only had rates risen dramatically, but the yield curve had inverted as well. S&Ls were paying higher interest rates to their depositors than they were earning on their mortgage loans, with no quick exit in sight.
The Turbulent 1970s
While IRCA (1966), in conjunction with Regulation Q, helped slow the flow of funds out of S&Ls to higher rates of return elsewhere, the flow did not stop. Wealthy depositors earned higher rates of return by withdrawing their funds from banks and S&Ls and purchasing Treasury securities. S&Ls had to reduce their lending, which defeated the purpose of IRCA 1966.
Barred from competing on the basis of interest rates, banks and thrifts offered depositors flashlights, toasters, and clock radios for opening new accounts. Besides this non-price competition, a convenience arms race arose where superfluous bank and thrift branches were built in a multitude of locations in cities to supposedly satisfy customer demands for convenience.
The Runaway 1980s
After about fourteen futile years fighting market forces, Regulation Q (interest-rate control) was fully repealed by March 1986. Although Regulation Q and interest-rate controls kept S&Ls on life support for over a decade, they clearly wasted an incalculable amount of resources attempting to circumvent the problem of the industry’s maturity mismatch.
At the end of 1980, by one estimate, the market value of the entire S&L industry was -$120 billion.  It was this condition of the industry that in part motivated the passage of the DIDMCA and Garn-St. Germain. These faux deregulations encouraged S&L managers to hide the poor financial condition of the industry behind deceptive accounting practices.
Only a skeleton of the private-interest coalition that had successfully pushed for the passage of the National Housing Act in 1934 attempted to save the S&L industry in 1989: construction companies, unions, and real-estate firms.  However, the negative press and television media stories took their toll. Instead of the lavish bailout that some industry executives expected, what the industry received instead was a legislative restructuring from FIRREA that almost completely erased it from the financial-services industry landscape.
 Leonard Silk, “Reagan’s High Risk Growth Game,” The New York Times (10 Feb. 1985): sec. A: 1ff.
 James R. Barth, The Great Savings and Loan Debacle (Washington, D.C.: American Enterprise Institute, 1991), pp. 9, 12.
 Thomas Mayer, James S. Duesenberry, and Robert Z. Aliber, Money, Banking, and the Economy, 4th ed. (New York: Norton, 1990).
 Ibid., p. 94.
 Barry G. Jacobs et al. Guide to Federal Housing Programs, 2nd. ed. (BNA, 1986), p. 7.
 Mayer et al., p. 33.
 Linda U. Hadley, “Agency Implications of Inside Ownership and the Thrift Crisis: An Empirical Analysis.” Dissertation. Auburn University, 1993.
 Ibid., citing Kaufman, 1992.
 Mayer et al., p. 94.
 Ibid., p. 95.
 Mayer et al., pp. 96–97.
 William Niskanen, “Heads I Win, Tails You Lose,” National Review (31 August 1992): 45–48.
 Martin Mayer, The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry (New York: Scribners, 1990), p. 51.