Causes of the Savings and Loan Crisis

The savings and loan crisis happened in the 1980s and 90s, but the root cause goes back to the end of WWII, when millions of young Americans came home from the war eager to resume their interrupted lives.

A short history of S&Ls

They wanted to start families, buy houses and cars and achieve the American Dream. The situation was ready-made for an institution that had been introduced from England in the 19th century known as a "building and loan," or B&L, the first of which was formed in the United States in 1831.

Their business model of paying interest rates up to four times the prevailing rate and raking high profits were essentially an institutionalized early Ponzi scheme, depending on new depositors to pay the interest. They experienced several booms followed by spectacular losses, and by the late 1930s, they established themselves as their own regulators and underwent a name change.

They became "savings and loans," or S&Ls. These institutions encouraged their customers to bring in their savings and use those funds for mortgage loans, making a modest profit from the difference between the interest paid on savings and interest received from the mortgages.

It's all about interest rates

This business model worked fine until the mid-1960s, but its success was dependent on a stable economy with firm interest rates. This was when S&Ls became engaged in interest-rate wars with established banks in a conflict that became so intense that Congress stepped in to limit interest rates on banks' and S&Ls' savings deposits.

This was followed by stagflation, Federal Reserve Chairman Volker's tightening of the money supply and subsequent interest rates that reached into the mid-20 percent range.

The combination of events started to drive many S&Ls and banks out of business, giving opportunistic real estate developers a chance to pick up some of the institutions and loot them.

A pattern of abuse developed that should never have been tolerated in the industry. New "financial products" like adjustable-rate mortgages, featuring low initial payments with balloon payments that were added at back end that couldn't be refinanced, were introduced.

The industry was overrun by criminals intent on looting the system. There was Charles Keating as well as the Silverado Savings and Loan scandal, involving Neil Bush, the vice president's son, who, as a director of Silverado, made himself loans in the hundreds of millions of dollars that were never repaid. But these were not isolated incidents. Rather, they were part of a pattern of abuse practiced nationwide with the protection of politicians who, in turn, received millions in political donations from industry lobbyists.

The most notorious of those political influence-peddling cases was that of the Lincoln Savings and Loan scandal, wherein the S&L's chairman, Charles Keating, made the "Keating Five" infamous. They were all U.S. Senators: Alan Cranston, D-Calif., Don Riegle, D-Mich., and Dennis DeConcini, D-Ariz., who found their political careers cut short as a result. The two others, John Glenn, D-Ohio, and John McCain, R-Ariz., were scolded for their corruption, and McCain took advantage of the electorate's short-term memory to later run for the highest office in the land.

The regulators were blindsided by deregulation during the Reagan administration, along with a level of sophistication on behalf of the crooks that was unprecedented. They took advantage of every unregulated loophole they could, creating new ways to deceive the financial system and abscond with the loot. They caused the citizens of the United States to pay for over one sixth of a trillion dollars in losses and paved the way for the future fraud that would be committed by Angelo Mozilo, and many others, including Lehman Brothers and all those who bundled the subprime mortgages into AAA-rated securities, which eventually would lead to the meltdown of the U.S. economy in 2008.

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