What Was the Savings and Loan (S&L) Crisis?

What Was the Savings and Loan (S&L) Crisis?

Let me tell you about the Savings and Loan Crisis from the late 20th century—it was a time of speculative lending and financial meltdown that hit over 1,000 institutions across the U.S. This stemmed from regulatory issues, moral hazards tied to deregulation, fraud, and dangerous lending habits, which ended up requiring a huge bailout funded by taxpayers and sparking major financial reforms. In this piece, I'll walk you through the causes, how the government stepped in, and what it all meant for banking in the long run.

Key Takeaways

You should know that the Savings and Loan Crisis resulted in more than 1,000 S&Ls failing during the 1980s and 1990s, with a taxpayer cost of $132 billion. Deregulation paired with speculative lending created a moral hazard, backed by guarantees that put the public on the hook. The government responded with the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 to fix and reform the S&L sector. This crisis hit Texas hard, fueling a recession through wild real estate bets and fraud. You'll see similarities to the 2007-2008 financial crisis, both driven by speculation, bad risk handling, and bailouts paid by taxpayers.

Key Events and Factors Behind the S&L Crisis

When S&Ls were set up under the Federal Home Loan Bank Act of 1932, they faced restrictions like caps on interest rates for deposits and loans, which made it tough for them to compete as the economy slowed and inflation rose. For example, in the early 1980s, people shifted money to money market funds, and S&Ls couldn't keep up with banks because of their lending limits.

Then came a recession driven by the Fed's high interest rates to fight double-digit inflation, leaving S&Ls stuck with low-interest mortgage loans and shrinking revenues. By 1982, their luck had reversed—they were losing up to $4.1 billion a year after profits in 1980.

Unfolding of the S&L Crisis: A Timeline

In 1982, President Ronald Reagan signed the Garn-St. Germain Depository Institutions Act to address the S&Ls' woes, removing loan-to-value ratios and interest rate caps, and letting them put 30% of assets in consumer loans and 40% in commercial ones. They were freed from Regulation Q, which had squeezed the gap between money costs and asset returns.

With risks detached from rewards, failing 'zombie' thrifts offered higher rates to draw funds and dove into risky commercial real estate and junk bonds, betting on big payoffs. If it failed, taxpayers via the Federal Savings and Loan Insurance Corporation (FSLIC) would pay, not the officials—and that's what occurred.

This mix of loose lending rules, low capital needs, and taxpayer backups bred massive moral hazard, pushing S&Ls to take wild risks and grow fast with speculation. At first, it looked good—by 1985, S&L assets grew nearly 50%, outpacing banks, especially in Texas where state laws allowed even more real estate gambles. But over one in five S&Ls weren't profitable that year.

Meanwhile, the FSLIC's funds were strained, yet failing S&Ls kept lending. By 1987, the FSLIC was broke, but the government recapitalized it instead of letting failures happen, increasing taxpayer exposure and letting the risk buildup continue.

Fraud and Misconduct in the S&L Sector

A 'Wild West' mindset in some S&Ls led to straight-up fraud by insiders. A typical scam involved two partners and an appraiser buying land with S&L loans, inflating its value through fake appraisals, flipping it, and defaulting to split profits—sometimes with the S&L's knowledge.

Law enforcement was slow to act due to understaffing, heavy workloads, and case complexity, even when fraud was obvious.

Resolving the S&L Crisis: Legislative and Regulatory Actions

Congress responded with the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), overhauling S&L regulations. It created the Resolution Trust Corporation to handle and wind down seized failed S&Ls. Passed under George H.W. Bush, it provided $50 billion for costs and losses.

FIRREA set minimum capital rules, hiked insurance premiums, capped non-mortgage holdings at 30%, and forced junk bond sales. In the end, the Resolution Trust Corp. liquidated over 700 S&Ls.

Aftermath of the S&L Crisis: Economic and Industry Impact

This was probably the worst banking collapse since the Great Depression, with over 1,000 S&Ls failing by 1989, wiping out a key source of home mortgages. Their market share for residential loans dropped from 45% in 1980 to 27% in 1990.

It hammered finance and real estate, likely causing the 1990-1991 recession as new home building hit WWII lows. Some experts note that the moral hazards and incentives here mirrored those in the 2007 subprime crisis.

Texas: The Epicenter of the S&L Crisis Impact

Texas felt it worst, with half the failed S&Ls there, plunging the state into recession. Bad land deals were sold off, crashing real estate prices; office vacancies soared, and oil prices halved. Institutions like Empire Savings and Loan engaged in crimes, costing taxpayers $300 million for its default.

State Insurance Challenges Amid the S&L Crisis

The FSLIC insured S&L deposits but ended up $20 billion in debt when failures mounted, bankrupting it as premiums couldn't cover losses. After its 1989 dissolution, duties went to the FDIC. During the crisis, state funds backed about 500 institutions' deposits, costing $185 million and killing off state-run insurance.

The Keating Five: A Political Scandal in the S&L Crisis

Five senators, the Keating Five, faced investigation for taking $1.5 million from Charles Keating of Lincoln Savings and Loan and pressuring regulators to ignore his shady dealings. They were John McCain (R-Ariz.), Alan Cranston (D-Calif.), Dennis DeConcini (D-Ariz.), John Glenn (D-Ohio), and Donald W. Riegle, Jr. (D-Mich.).

In 1992, the Senate found Cranston, Riegle, and DeConcini interfered improperly; Cranston got reprimanded. Lincoln's 1989 failure cost $3 billion in bailout and left depositors with junk bonds. Keating was convicted but later had it overturned, pleading guilty to lesser charges in 1999 for time served.

Do Savings and Loans Still Exist?

Yes, they do—as of 2023, there are about 563 S&Ls in the U.S., down from 3,371 in 1989.

How Many People Were Prosecuted for the Savings and Loan Crisis?

The Justice Department convicted over 1,000 bankers following the crisis.

How Was the S&L Crisis Different or Similar to the Credit Crisis of 2007–2008?

Both arose from boom-bust cycles, with banks and thrifts funding booms then suffering in busts. Speculation, especially in real estate, and poor risk management marked both, along with loosened commercial lending standards in the 1980s. Small banks failed mostly, but big ones needed government help, using taxpayer funds.

The S&L Crisis spanned three recessions and lasted longer, with gradual failures, while 2007-2008 was one shorter recession with quick failures.

What Could Regulators Have Done Better to Solve the Savings and Loan Crisis?

Regulators didn't stop S&Ls from using insured deposits for risky loans. Reagan cut FHLBB staff budgets, hindering investigations. States allowed speculative real estate investments, and without mark-to-market accounting, assets weren't devalued properly, hiding true losses.

How Were Commercial Banks Affected by the Savings and Loan Crisis?

Both S&Ls and commercial banks faced heavy taxes to fund the crisis. By the late 1980s, Congress dismantled barriers between them, folding much of the S&L industry into regular banking.

The Bottom Line

The Savings and Loan Crisis of the 1980s and 1990s devastated over 1,000 U.S. S&Ls through speculation, deregulation, and moral hazards, leading to big bailouts and FSLIC insolvency. It prompted FIRREA reforms in 1989, but exposed weaknesses that echoed in the 2007-2008 crisis. As you consider this, remember the dangers of speculative lending and why strong regulation matters to avoid future disasters.