In the 1980’s, the savings and loan (S&L) industry was in turmoil with the watershed event of this being the implementation of price fixing legislation in favour of home ownership in the 1930’s. Even though it was the basis of the crisis, the trigger lies in more fundamental concepts, including fiscal policy, mismanagement of assets and liabilities, pure imprudence by S&L institutions, brokered deposits and the cyclicality of the regulation/deregulation process and this was fuelled by economic reactions such as inflation. It would be ‘unfair’ to attribute it to only one factor. Therefore, to properly investigate the crisis and with a view of having all round perspective of the crisis, this report will discuss this financial disaster’s main causes. The impact of the crisis was borne mostly by the S&L industry, the savings and commercial banks in the US and more generally, the US economy. This report will further cover the corrective measures undertaken by regulators and the government with the aim of saving the S&L sector as the number of institutions with worsening financial conditions steeply increased. The consequences of this crisis persisted until the early 1990’s and this long term effect is understood by analysing the regulations enacted in the aftermath of the crisis. The main turning point has been the enactment of the Financial Institutions Reform, Recovery and Enforcement Act in 1989. Finally, there are essential lessons to be learned from the S&L crisis, not only for the S&L institutions, but also the banking industry, regulators and the government.
In the 1930s the S&L industry was a conservative residential mortgage sector surrounded by legislation put in place during that period to promote home ownership. At the same time it has its own regulator which is the federal savings and home loan banking loan, and its own insurance firm to insure deposits at S&L institutions. However the regulatory and interest rate environment started to change dramatically as from the 1960s when congress applied the Regulation Q to the S&L industry by putting a ceiling on the interest rate that S&Ls can pay to depositors. The purpose was to help thrift institutions to extend interest rate ceiling to them in order to reduce their cost of liabilities and protect them from deposit rate wars since there were inflationary pressures in the middle till late 1960s. Regulation Q was price fixing, and in trying to fix the prices, Regulation Q caused distortion where the costs outweigh any benefits it may have offered. Regulation Q created a cross subsidy, passed from saver to home buyer, that allowed S&Ls to hold down their interest costs and thereby continue to earn, for a few more years, an apparently adequate interest margin on the fixed-rate mortgages they had at that recent past years. The problem was that the S&L industry was not competing effectively for funds with commercial banks and securities market leading to large things in the amount of money available for mortgage lending. The ceiling on interest rate that S&L could offer to depositors as per the Regulation Q led dampening of competition for depositors funds between bank and S&L. But as new money market funds began to compete fiercely during the 1970s for depositors’ money by offering interest rates set by the market, S&Ls suffered significantly withdrawal of deposits during periods of high interest rates. This caused outflows from financial institution into higher yielding investment such as capital market instrument, government securities and money market funds. This process is known as disintermediation. Disintermediation has several undesirable consequences. Most important, it both restricted the availability of credit to consumers and increased its cost, particularly for home mortgages, the same consequences affected small and medium sized businesses that did not have access...
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