The scandal of the S & Ls
Greider, William
The backbone of the nation's long-standing commitment to home ownership was the savings and loan industry, the principal mortgage lender for many years. The government protected it against...
...The deeper problems will not be truly mended until there is a general reform of the rules governing finance...
...Volcker mostly ignored this advice, but that doesn't mean it was wrong...
...The 1980 legislation, amid the rhetoric of free-market efficiency, This is an excerpt from The Trouble With Money, published by Whittle Direct Books...
...When Paul Volcker was steering his tough-minded monetary policy, he was warned repeatedly by colleagues and staff economists that whatever his goals for the overall economy might be, there would be expensive consequences if he did not moderate and allow interest rates to fall...
...The S&Ls were crippled by it, because as market interest rates rose, their balance sheets were turned upside down—they had lent long-term at fixed rates but were now borrowing short-term at higher rates...
...It was financial-sector politics combined with double-digit inflation...
...Furthermore, the once equitable social deal embedded in the preferential treatment for savings and loans now seemed badly skewed...
...Since neither Congress nor the president was prepared to take an honest look at the real damage wrought by the era of deregulation, they were naturally not prepared to consider real reforms...
...Yet Congress not only kept the same lenient rules for federal deposit insurance but also jacked up the coverage substantially, from $40,000 to $100,000 deposits...
...The S&L industry would now be "freed" to compete with commercial banks and others...
...Years later, it looks like a reasonably accurate, if not too conservative, forecast...
...The virtuous "small saver" —a widow or family of humble means whose savings were losing real value because of inflation, yet still collected artificially low interest rates because of Regulation Q—was invoked in the political debate...
...The driving political force for financial deregulation was not laissez-faire theories of economic efficiency or arguments about integrating with the global financial system...
...Instead of schooling the thrifts to live prudently in their harsh new environment, the Reagan administration encouraged the opposite, first by drastically cutting back regulatory supervision and then by advocating new lending powers for the embattled S&Ls, allowing them to try their luck in the tricky realms of commercial lending...
...Merrill Lynch and Company, Inc...
...The resulting wreckage is now fully visible...
...Many were insolvent, and the brokers knew it...
...Justice demanded market rates for everyone, or so it was said at the time...
...Perhaps, if even more spectacular failures lie ahead, the continuing shock and loss will eventually open their minds SUMMER • 1990 297...
...The government protected it against its larger competitors and provided a modest rate advantage to ensure that it would always have ample deposit funds for home lending...
...The creation of the Resolution Trust Corporation is a scandal waiting to happen...
...Housing and homelessness are not fixed either and won't be soon...
...The broken wheel has not been fixed...
...removed those privileges...
...The debate acknowledged as much...
...Reprinted by permission...
...Merrill Lynch and other big brokerages are now finding profit on the other end of the process too, as they prepare for a lively business buying and selling the governmentowned carcasses...
...The Federal Reserve also deserves more blame than it has been given for the S&L debacle...
...a higher capital base did not prevent the major commercial bankers from plunging into various swamps, such as Third World debt, from which the government had to extricate them...
...Each time the regulators gave in to the bankers, the remaining SUMMER • 1990 • 295 Comments and Opinions controls were weakened because there were more opportunities to evade them...
...Other firms picked up the game, and soon thrift managers were enjoying ample funding with which to make their disastrously bad loans...
...Having read nearly all of the congressional debate surrounding the financial deregulation of 1980, I was struck, first, by the fact that housing was barely mentioned...
...Albert Wojnilower of First Boston observed at the time: "Freeing the thrift and mortgage markets from government subsidy and guarantee is like freeing family pets by abandoning them in the jungle...
...But the result could well be the opposite...
...One former Fed economist told me that, early on, the staff predicted privately that given the level of interest rates the Federal Reserve was imposing on the economy, something like eight hundred savings and loans would eventually fail...
...To order, write to The Larger Agenda Series, Whittle Direct Books, 505 Market Street, Knoxville, Tennessee 37902, or call 1-800284-1956...
...The 1989 savings and loan bailout legislation did impose new restraints on the thrift industry, especially by setting more rigorous capital standards...
...Any apparent gain to the soundness of the financial structure as a whole is illusory...
...By putting more of the S&Ls' own money at risk, the higher capital requirements may make many S&L managers behave more prudently...
...inventively initiated "brokered deposits," in which vast billions from large-scale investors would be sliced up into $100,000 packages and parceled out by computer to S&Ls...
...Everyone, in both politics and finance, has dirty hands...
...When the Gray Panthers came out for financial deregulation, the long political argument was essentially settled...
...Several years earlier, when federal regulators were raising capital requirements for the banks, Albert Wojnilower observed: "The only way for most intermediaries to earn a competitive return on a higher capital base is by raising the average lending margin, 296 • DISSENT Comments and Opinions and that can be accomplished only by making riskier loans...
...It was as though the liberal Democrats who supported deregulation did not want to remind themselves that they were undoing one of the great achievements of the New Deal era...
...If they didn't borrow, they couldn't lend...
...These were jumbo deposits that were fully covered by federal insurance, regardless of whether the S&Ls were sound...
...Commercial banks had waged a fifteen-year campaign against the Federal Reserve's famous Regulation Q, which set interest-rate ceilings and differentials, and banks had succeeded in peeling off rate controls on one financial instrument after another...
...The earnest mom-and-pop depositors who kept modest savings accounts at their local thrifts had become victims of the system...
...Their depositors left for other places, especially the money-market mutual funds invented by Wall Street investment houses, where their savings would draw higher rates...
...The second fundamental point missing from the debate was the contradiction that has led to so much financial destruction...
...Homebuyers enjoyed a modest hidden subsidy and, except during episodes of tight money, most working people could obtain a mortgage...
...Larger and more savvy players enjoyed much greater returns in the money market...
...For more than forty years, the arrangement generally worked...
...The coup de grace that killed off Regulation Q, however, was inflation...
...Nor, beyond an embarrassed nod, did the bailout legislation acknowledge the housing crisis that is the social analogue of the financial crisis...
...Kenneth A. Guenther, executive vicepresident of the Independent Bankers Association of America, observed: "The combination of interestrate deregulation with 100 percent deposit insurance is like the invention of gunpowder—sooner or later it was bound to explode...
...Wall Street also played its part...
...The S&Ls would now be treated like grown-ups—freed to compete head-on with larger, more skillful financial adversaries—and surely that increased the likelihood that many would fail...
Vol. 37 • July 1990 • No. 3
