The Savings & Loan Crisis

The savings and loan industry existed to do one thing: take short-term deposits and make thirty-year fixed-rate mortgages. When Paul Volcker pushed interest rates into the high teens to break inflation, that business model died instantly. Thrifts were paying more for deposits than their old mortgages earned, and marked honestly the industry’s net worth was gone by 1982.

Rather than close hundreds of institutions, Washington chose forbearance and deregulation: relax the accounting, let thrifts hold whatever assets they liked, and raise deposit insurance to $100,000 per account. The combination was combustible. An insolvent thrift has nothing left to lose, its owners capture the upside of any gamble, and federal insurance means depositors will fund it regardless — brokers assembled deposits nationwide for whoever paid the highest rate.

The money went into Texas office towers, Arizona land, casinos and junk bonds, often lent to the owners’ own ventures on appraisals the lending itself had inflated. When Sun Belt property turned in the late 1980s, the losses were catastrophic and the fraud extensive — Charles Keating’s Lincoln Savings became the emblem, along with the five senators who intervened on his behalf.

The cleanup took the Resolution Trust Corporation, 1,043 closures, and $124 billion of public money. The book uses the episode as its clearest case of moral hazard operating in the open: the crisis was not caused by a mania in the usual sense but by a guarantee that removed the depositor’s reason to care, applied to institutions with nothing left to protect.

What it cost

The insurance worked exactly as designed: insured depositors at the thrifts that failed lost nothing, and the bill went to the Treasury instead. The people who lost money directly were the ones who had been sold something that only looked like a deposit. Everyone else paid through the Treasury, and paid mostly for the delay.

• $25bn what the National Commission on Financial Institution Reform, Recovery and Enforcement estimated in 1993 it would have cost the FSLIC to close, in early 1983, the 415 thrifts already insolvent on tangible net worth at the end of 1982 FDIC, History of the Eighties — Lessons for the Future, Volume I, chapter 4, The Savings and Loan Crisis and Its Relationship to Banking
• $152.9bn the estimated total cost of the cleanup to the end of 1999: $123.8bn of it borne by US taxpayers, 81% of the whole, and $29.1bn by the thrift industry Curry and Shibut, The Cost of the Savings and Loan Crisis: Truth and Consequences, FDIC Banking Review, 2000, Table 1
• 23,000 members of the class who had bought American Continental Corporation stock or debentures between January 1986 and April 1989 — most of them unsecured subordinated debentures bought over the counter at Lincoln Savings branches. American Continental filed for bankruptcy in 1989 and most of the bond purchasers lost the money they had invested Aetna Casualty & Surety Co. v. Dannenfeldt, 778 F.Supp. 484 (D. Ariz. 1991), Bilby J.; In re American Continental Corporation/Lincoln Savings & Loan Securities Litigation, 794 F.Supp. 1424 (D. Ariz. 1992); Keating v. Hood, 191 F.3d 1053 (9th Cir. 1999)

Judge Bilby set out what the complaints alleged. The debentures were sold by bait-and-switch at Lincoln’s 29 branch offices, by staff who appeared to be Lincoln employees and were not licensed to sell securities. Many of the buyers were elderly people who had come in to make a federally insured deposit or buy a federally insured certificate, often after a letter or a telephone call, and were given a canned presentation: the debentures were as safe as an insured certificate, paid a little more interest, and Lincoln stood behind them.

What followed

Congress enacted FIRREA on 9 August 1989, abolishing the FSLIC, creating the Resolution Trust Corporation and beginning the taxpayers’ involvement. A Los Angeles jury convicted Charles Keating in December 1991 of aiding and abetting the fraudulent sale of the bonds, and a federal jury convicted him in January 1993 of racketeering, conspiracy, bank fraud, securities fraud and wire fraud. Both trials were found to have been flawed and both convictions fell. He pleaded guilty to federal charges in 1999 and was sentenced to time served, having spent five years in prison.

Curry and Shibut, FDIC Banking Review, 2000, for FIRREA; United States v. Keating, 147 F.3d 895 (9th Cir. 1998); Keating v. Hood, 191 F.3d 1053 (9th Cir. 1999)

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