Executive Summary

• Savings and Loans in the US began with a public service function and focused on providing home loans.
• Through corruption, the S&L’s were eventually allowed to shed their public service function and become a speculative entity, but with government insurance.

Introduction

Saving and loans quickly morphed in the 1980s to become entirely profit-motivated financial entities, eventually losing the plot as to why they exited in the first place.

This is explained in the following quotation.

In the early days of the Reagan administration, government regulations were changed so that the S&Ls were no longer restricted to the issuance of home mortgages, the sole reason for their creation in the first place. In fact, they no longer even were required to obtain a down payment on their loans. They could now finance 100% of a deal—or even more. Office buildings and shopping centers sprang up everywhere regardless of the need. Developers, builders, managers, and appraisers made millions. The field soon became overbuilt and riddled with fraud.

Source: Creature From Jekyll Island

https://www.scribd.com/doc/54912935/The-Creature-from-Jekyll-Island-G-Edward-Griffin

A Feature of the Reagan Administration

The Reagan Administration led to an enormous corruption of public institutions. The Savings and Loans were just one example of this. And yet the popular media describes Reagan as one of the best US presidents in history. He is often promoted as the “great communicator,” however what he was communicating was nothing but corporate corruption.

The quote continues.

Billions of dollars disappeared into defunct projects. In at least twenty-two of the failed S&Ls, there is evidence that the Mafia and CIA were involved. Fraud is not necessarily against the law. In fact, most of the fraud in the S&L saga was, not only legal, it was encouraged by the government. The Garn-St. Germain Act allowed the thrifts to lend an amount of money equal to the appraised value of real estate rather than the market value. It wasn’t long before appraisers were receiving handsome fees for appraisals that were, to say the least, unrealistic. But that was not fraud, it was the intent of the regulators. The amount by which the appraisal exceeded the market value was defined as “appraised equity” and was counted the same as capital. Since the S&Ls were required to have $1 in capital for every $33 held in deposits, an appraisal that exceeded market value by $1 million could be used to pyramid $33 million in deposits from Wall Street brokerage houses. And the anticipated profits from those funds was one of the ways in which the S&Ls were supposed to recoup their losses without the government having to cough up the money—which it didn’t have. In effect the government was saying: “We can’t make good on our protection scheme, so go get the money yourself by putting the investors at risk. Not only will we back you up if you fail, we’ll show you exactly how to do it.” 1. “How Safe Are Deposits in Ailing Banks, S&Ls?,” U.S. News & World Report, March 25,1985, p. 74.

Source: Creature From Jekyll Island

Reaganism and Deregulation Leads to the S&L Failure

Between 1980 and 1986, a total of 664 insured S&Ls failed. Government regulators had promised to protect the public in the event of losses, but the losses were already far beyond what they could handle. They could not afford to close down all the insolvent thrifts because they simply didn’t have enough money to cover the pay out. In March of 1986, the FSLIC had only 3 cents for every dollar of deposits. By the end of that year, the figure had dropped to two-tenths of a penny for each dollar “insured.” Obviously, they had to keep those thrifts in business, which meant they had to invent even more accounting gimmicks to conceal the reality. Postponement of the inevitable made matters even worse. Keeping the S&Ls in business was costing the FSLIC $6 million per day. By 1988, two years later, the thrift industry as a whole was losing $9.8 million per day, and the unprofitable ones—the corpses which were propped up by the FSLIC—were losing $35.6 million per day. And, still, the game continued. By 1989, the FSLIC no longer had even two-tenths of a penny for each dollar insured. Its reserves had vanished altogether. Like the thrifts it supposedly protected, it was, itself, insolvent and looking for loans. It had tried offering bond issues, but these fell far short of its needs. Congress had discussed the problem but had failed to provide new funding. The collapse of Lincoln Savings brought the crisis to a head. There was no money, period.

Source: Creature From Jekyll Island

The Fed Rides to the Rescue?

In February, an agreement was reached between Alan Greenspan, Chairman of the Federal Reserve Board, and M. Danny Wall, Chairman of the Federal Home Loan Bank Board, to have $70 million of bailout funding for Lincoln Savings come directly from the Federal Reserve. This was a major break in precedent. Historically, the Fed has served to create money only for the government or for banks. If it were the will of the people to bail out a savings institution, then it is up to Congress to approve the funding. If Congress does not have the money or cannot borrow it from the public, then the Fed can create it (out of nothing, of course) and give it to the government. But, in this instance, the Fed was usurping the role of Congress and making political decisions entirely on its own. There is no basis in the Federal Reserve Act for this action. Yet, Congress remained silent, apparently out of collective guilt for its own paralysis.

Source: Creature From Jekyll Island

This again points to the outsized role of the Fed. Because the FDIC and FSLIC are not funded anywhere near what their mandate would entail, it places the Fed as the true bail-out entity in the US. However, the Fed is a private corporation that is only responsive to private banking interests and seeks to eliminate responsibility on the part of bank management. For example, the Fed would never require the management of banks to step down, and would never recommend that a troubled bank be taken over by the government.

What Were S&Ls Originally?

The S&Ls were distinctively not profit-making entities—they were self-help institutions for the poor, made possible by government subsidies and regulation. Even after the New Deal changes, the thrift industry’s model remained “neighbors helping neighbors” and emphasized mutual ownership; it focused on building homes for neighbors, not making profits. Members also participated heavily in governance and elected the institution’s officers, who were often community leaders. The post–WWII housing boom not only made thrifts the predominant mortgage lenders in the country but also led to unprecedented industry growth. Their mission focused on residential housing, and their business plan was simple: collect deposits, make mortgage loans. Because of high demand, it was easy to lend and become profitable, illustrated by the famous “3-6-3 Rule”—pay 3 percent on deposits, charge 6 percent on loans, and be on the golf course by 3:00 p.m. The thrift industry just sat back and watched its loan volume grow. It had a significant advantage against banks in collecting deposits—that first “3” in interest, though modest, was more than commercial banks could pay for consumer savings.142As we saw with credit unions, these large profits changed the industry. By the 1960s, the industry bore little resemblance to the charitable and mission-oriented industry of the 1800s or even the 1930s. S&Ls possessed over $100 billion in assets and competed vigorously with banks for consumer deposits. Having graduated their customers into the middle class through affordable homeownership, they had abandoned their mutual ownership and no longer rejected profits. They looked nothing like the Bailey’s Building and Loan, and soon the industry’s growth naturally led to increased political influence.Not only had the industry stopped pursuing its mission, it appeared to be actively fighting it. The industry forcefully opposed the first federal legislative attempt, the Housing Act of 1949, to provide public housing for the low-income. It labeled the attempt “Socialism” and a threat to private business. Apparently, the S&Ls had already forgotten that they owed their very existence to heavy federal government support. They believed that if the government started building housing for the poor, they would lose their prime spot atop the mortgage-finance industry. Senator John Bricker, cozy with the S&L industry, revealed this fear to Congress: “Where do we stop?… With government threatening to encompass between one-third to one-half of the home-financial field, [the thrift industry’s] very existence is at stake.” By the 1970s, market competition hampered the 3-6-3 gravy train, and thrifts joined banks in pushing for deregulation so that they could remain profitable. Congress and the thrift regulators famously responded with several deregulatory actions that would allow the weakened thrift industry to survive in a hypercompetitive financial sector.145 The “reforms” removed their interest rate caps, broadened their permissive activities beyond home mortgages, and removed geographic restrictions. S&Ls could now offer credit cards and traditional interest-bearing checking accounts as well as engage in commercial and general consumer lending. They could also invest in commercial paper and corporate bonds before commercial banks were able to invest in any type of securities. Mutual ownership was also abandoned. Previously, an S&L was required to have at least four hundred shareholders, with no one shareholder owning more than 25 percent of the stock. Now, a single shareholder could own an S&L. At the same time, Congress increased their insurance from $40,000 per account to $100,000 per account and placed the full faith and credit of the United States behind the FSLIC insurance fund.148The moral hazard introduced by increased FSLIC insurance, combined with deregulation and increasing competition, led to a toxic mix. Thrift owners could deal fast and loose with deposits that were fully insured and backed by the government. The industry immediately became an attractive target for many unscrupulous investors and organizations. The loosened regulations attracted the interest of anyone, including people with ties to the Mafia and other organized crime, who wanted access to millions of FSLIC-insured dollars without much fear of close scrutiny from regulators. In reference to the S&L industry in the 1980s, Representative Jim Leach said, “What has developed … is a giveaway system where the potential profit has been privatized while the potential loss has been socialized.” One of the ironies of deregulation is that it bred problems that could only be remedied through more deregulation. Without an orienting mission, the thrift was just like any other bank—but with a more compliant regulator. For example, the repeal of the interest rate cap posed a problem for S&Ls, whose assets were primarily composed of long-term home loans that continued to pay interest at low rates. S&Ls had to pay a sudden jump in rates to attract deposits, but their existing long-term borrowers were not paying the corresponding jump in rates, meaning that much more money flowed out than in. S&Ls were caught in an interest rate squeeze. The Garn-St. Germain Act addressed this by allowing S&Ls to lend to short-term and higher profit products like securities or commercial paper—products that had nothing to do with the S&Ls’ core mission. The act, in an attempt to allow the industry to bring in more loans, dropped the down payment requirement for home loans and allowed S&Ls to offer variable-rate mortgages to shift some of the interest rate risk onto their customers. These products included the exotic Adjustable Rate Mortgages that were among the highest defaulting loans during the 2008 financial crisis. The point of deregulation was to help the S&L help itself in an unregulated free market. The strategy, called “gambling for resurrection,” indicated the general banking philosophy of the time. Many blamed the industry’s lack of profitability on onerous regulation and advocated deregulation so that S&Ls could compete with other market entities on an even playing field. But these institutions had been playing a different game; they were distinctly not pure profit organizations. All of their restrictions, such as mutual ownership, a singular focus on home loans, and interest rate caps, served a purpose. But once they became profit-oriented banks with any public purpose set aside, they suffered not only an interest rate squeeze, but a mission squeeze. Trying to serve two masters—profits and the public good—proved impossible, so they chose to chase profits, rather unsuccessfully. Disaster eventually struck, and the thrift industry famously imploded. The federal government bailout cost somewhere between $87 billion and $130 billion. Some claim that deregulation caused the collapse by allowing risks to enter the previously sound industry. One expert notes that the thrift industry “captured its regulatory process more thoroughly than any other regulated industry in the country.” Responding to this charge, the thrift regulator was changed from the FHLBB to the Office of Thrift Supervision (OTS), a slap on the wrist to a defunct agency. In reality, in 1989 President George H. W. Bush gave a speech promising regulatory reforms and said that “never again will America allow any insured institution [to] operate without enough money.” Meanwhile, the FHLBB employees walked outside their agency to a hotel to watch the speech and walked right back to work—the sign on the door was soon changed to reflect the name of the new agency. Predictably, the OTS would be in trouble again in 2008, regarded as the most irresponsible of federal regulators for failing to meaningfully oversee the large and powerful thrifts, like WaMu, AIG, and IndyMac, under its charge. Dodd-Frank finally abolished the OTS in October 2011.

Source: How the Other Half Banks

https://www.amazon.com/How-Other-Half-Banks-Exploitation/dp/0674286065

One way of describing this is that the later S&Ls were a disaster, and it demonstrates the problems in migrating an entity with public support and a public service function so far from its original roots.