Savings And Loan Crisis

The Savings and Loan Crisis

Savings and loans were created after the great depression as a government regulated way for people to have home mortgage loans. The creation of these savings and loans resulted from thousands of homes being foreclosed after the great depression. The idea of savings and loans were simple; first the government allowed savings and loans to pay slightly higher interest rates on deposits to attract investors. The government also offered insurance for these investments and agreed to give the savings and loans tax breaks. The result of these investments allowed savings and loans to issue mortgages in which they would make a profit off of the interest. In the years though prior to the 1970's and 1980's economic
conditions were changing. In this time period there were also a variety of different regulations in the savings and loan industry than exist today. As a result of these factors and with the addition of poor management, the savings and loan crisis of the 1970's and 80's occurred. As a result of this savings and loan crisis, tax payers lost over 150 billion dollars and drastic changes were made in the savings and loan industry.
One of the primary reasons for the occurrence of the savings and loan crisis was the unstable condition of the economy. The economy which had seen much growth particularly in the real estate area in the previous years was now beginning to fluctuate. Another example of a contributing factor was the doubling of gas prices in the late 1970's and the drastically increased inflation rates of the time. One way that the economy is controlled is through the process of altering interest rates on certain items. Market interest rates at this time were fluctuating rapidly and with an increased intensity. As these rates fluctuated, the savings and loans of the time experience much more difficulty in dealing with these interest rate increases. As a protective factor the federal government placed a ceiling on interest rates that would only allow a savings and loans to issue a loan at a maximum rate. Many of the assets that these savings and loans had were in long term mortgages that were set at a fixed rate. As previously mention inflation was rapidly occurring at this time and with inflation market rates were also increasing. This meant that due to the increased market rates, the mortgages that were written at lower fixed rates were now worth far less than their original face value. Now these savings and loans would have to lower the asking price that they had on their mortgages. The main factor here was that these mortgages were the primary assets of the saving and loan market at the time and these assets were being drastically depleted. With these assets being depleted the savings and loans were not making nearly enough profit on the interest of these mortgages. The issue of inflation and the rise of interest rates would then lead to other changes that would eventually create a snowball effect for the downfall of the savings and loan institutions. The interest rate situation in turn caused the government to institute new rules or change existing legislation in the savings and loan market. One of the big changes that occurred was the removal of the interest rate ceilings that had previously been in place on liabilities. The removal

of the interest rate ceiling also coincided with the increase in loan insurance which was previously at 40,000 dollars to the new mark of 100,000 dollars.
This meant that investors would be protected on their investments up to but not over the 100,000 dollar mark. The protection meant that they would be 100 percent protected which was also an increase from the 70 percent protection that was previously in place. With the removal of rate ceilings and increased insurance, these savings and loans became more appealing to potential investors and also created the opportunity for the issuing of more loans (particularly in the real estate area) to more
customers. Economic factors that contributed to this crisis also came in the form of previous regulations that were being changed in order to try to minimize the damage that was already being done. In 1980 as well as 1982 congress lifted the restrictions that imposed savings and loans from investing in certain types of markets. The main change that congress made allowed these savings and loans to be able to directly invest in service corporations. Service corporations in previous years had the reputation of being very profitable while at the same time being very risky investments. Congress also allowed savings and loans to make real estate loans regardless of the geographical location of the loan. This meant that a savings and loan located in California could make a loan to a person located in Pennsylvania. In the time period, without the use of the internet and the technology of today, loan enforcement and communication were much more difficult. One of the last changes that were made was the allowing of a savings and loan to lend up to 40 percent of their total assets in commercial real estate. The government at the time justified these changes by explaining that if they allowed savings and loans to make higher-yielding but riskier investments that they would also then have an increased return on these investments. Basically this would allow them to generate more money to help offset the damage that was created by the fixed rate mortgages and interest rates that were previously mentioned. All of these economic conditions were accompanied by one issue that eventually led to the demise of thousands of savings and loans: Bad Management. Many managers throughout the savings and loan period continued to make high risk loans that that often defaulted. One interesting factor is that a majority of these savings and loans were mom and pop organizations that were settled in small towns. A majority of the fraud that took place started in large savings and loans which willingly and adamantly went out to find new investors. These large savings and loans are the ones that pushed for the new regulations that allowed them to compete in the market and primarily with their long time competitors, banks. Fraud, scandal, and bad management can often be directly associated with Charles Keating in relation to the savings and loan crisis. Charles Keating began working for American Financial Corporation in 1972 and then proceeded to move to Arizona to take over American Continental Corporation. In 1984 American Continental Corporation bought the Lincoln Savings and Loan in the city of Phoenix Arizona.
Keating took full advantage of the opportunity to make very risky investments as a result of the new deregulations that were pushed for by large volume savings and loans. Keating was a very influential man and in many cases money is a very powerful motivator. Keating was a very big supporter of government officials and made numerous campaign donations that would help assure their support of the savings and loan regulations. Keating directly supported five United States senators which are today known as the Keating five. These senators were Dennis DeConcini, Alan Cranston, John Glenn, Don Riegle, and today presidential hopeful John McCain. These U.S. Senators had a large impact on the savings and loan market. One of the possible solutions that would have saved the United States a larger amount of money was for the government to step in and close what are called insolvent or failing savings and loan institutions. As a result of the contributions (which exceeded 300,000 dollars) to these influential senators continued to allow the Lincoln Savings and Loan as well as many other large savings and loans to operate. Another government official that backed Keating at the time was Alan Greenspan. Greenspan was an important economic analyst who defended the financial situation of the Lincoln savings and loan as well as others. Greenspan wrote formal reports that stated that these savings and loans were in a suitable economic condition and should be
allowed to maintain their right to invest. Keating was not the only manager of the time that mismanaged his business in order to obtain personal gains. He is widely used as a poster child for bad management and fraud because of his dealings with United States senators. Afterward Keating was charged with fraud, racketeering, and conspiracy that resulted in a ten year prison sentence which of these ten years Keating served a mild four and a half. One of the reasons that Keating was charged with fraud was that he convinced investors to invest their money in junk bonds through the American Continental Corporation which was the father corporation of the Lincoln Savings and Loan. This allowed Keating to invest these peoples money in whatever investment he deemed appropriate while at the same time not informing his investors that their money was not protected by government regulation. Keating tricked his investors into believing that their investments in the father company were under the same federal regulation as that of the investments in the savings and loan. These investments however were not under that protection and these investors lost an upward of 285 million as a result of this. In later interviews Keating blamed the United States government by expressing that they should have been responsible for the closure of the insolvent savings and loans in earlier years. With the political influence that Keating and others were able to buy, they managed to keep these savings and loans running from the time they should have been shut down in 1983 to after the presidential election of 1988. In those five years the debt that was incurred cost U.S. tax payers billions upon billions of dollars that will still be paid out in years to come. The aftermath of the Savings and Loan crisis cost United States tax payers an estimated 150 billion dollars. Some estimates say that the United States government will be paying the debt that they incurred as a result of this until the year 2030. In hindsight it is easy for people to see that this financial disaster could have been easily minimized if not avoided. This scandal shows the public that money and governmental influence can be very powerful tools that if used incorrectly can cost unsuspecting victims great financial losses.

Sources http://en.wikipedia.org/wiki/Savings_and_Loan_crisis http://www.fdic.gov/bank/historical/s&l/ http://www.econlib.org/library/Enc/SavingsandLoanCrisis.html http://findarticles.com/p/articles/mi_m1316/is_n5_v27/ai_16947718 http://web.ebscohost.com/ehost/detail?vid=8&hid=21&sid=3b4020b4-9436-4ed0-b791-8ab4961fdfbf%40sessionmgr8 www.erisk.com
http://www.charliekeating.com/