Who Killed the Savings and Loans?
BROCKWAY, GEORGE P.
The Dismal Science WHO KILLED THE SAVINGS AND LOANS? BY GEORGE ?. BROCKWAY The way we're going, we're not getting close to the truth about what happened to the savings and loans. It's much...
...How, then, do the two periods compare...
...In comparison, the cost of the S&L mess is small potatoes...
...If it wants to expand the money supply (a stratagem that rarely crosses its mind) it buys government bonds and builds up the banks' reserves...
...This will always be true because the outstanding nonfinancial debt in the nation is greater than the GNP...
...But what could the Federal Reserve do...
...Now we reach the root of the matter: What devastated the S&Ls was a tremendous rise in the interest rate...
...A low price for a bond (or any asset) yields a high rate of return...
...As it happens, 1951 is the midpoint between the founding of the Reserve in 1913 and 1989, the most recent full year for the Consumer Price Index...
...In the preceding decade the Federal Reserve Board and the Treasury worked together to maintain the price of government bonds, and the prime rate for most of those years —despite their including World War II and the first year of the Korean War— remained steady (believe it or not) at 1.50 per cent...
...In his Memoirs, President Harry S. Truman criticizes the Reserve for failing to live up to its part of the agreement...
...Given the size of the S&L disaster, I suggest that the Reserve ought to have a pretty convincing explanation of the necessity for its actions...
...Your price must be right...
...Yet some events are clearly more significant than others...
...He/she will borrow at the beginning and save toward the end...
...Obviously, something else caused the downfall...
...World Wars I and II and the start of the Korean War occurred in the first period, while the Korean War truce talks and the Vietnam War occurred in the second period...
...It's much easier to be bemused by the amount of money lost in the disaster, to be shocked by the skulduggery involved, to be flabbergasted by the bad judgment of rich men, to be titillated by political charge and countercharge...
...All of which brings us back to 1951...
...The first official action leading up to it was taken as early as March 1951, when the Federal Reserve Board got the Treasury to agree to a slight advance in interest rates...
...The recession of 1920 and the Great Depression occurred in the first period, while there have been five(or six, if you count what'sgoing on now) recessions in the second period...
...It's too bad—$500 billion too bad—that the S&Ls got caught in the crossfire of the Federal Reserve's war with inflation, but the war must go on, mustn't it...
...Several Presidents and Congresses have undoubtedly acted stupidly in regard to the S&Ls, but the S&Ls would still be operating and prospering to the benefit of us all if it were not for the stubbornly misguided behavior of the Federal Reserve Board...
...Thatis, they accepted deposits that could be withdrawn at will (30 days' notice was often reserved but seldom enforced), and they lent against mortgages running 30 years into the future...
...The only surprise is that the binge lasted for a full decade before the general collapse...
...From their point of view, there is much to be said for this balance...
...Its Federal Open Market Committee buys or sells government bonds (it could trade in other assets as well, but prefers not to...
...Not only are banks eager to buy high-interest Treasury bonds, they are also quick to adjust upward the rates they charge their customers, whose credit, after all, is less solid than that of theU.S...
...They were designed to perform two functions: First, they would offer a safe depository for the small savings of the middle class...
...They were also substantially responsible for a rebirth of personal savings following the Depression...
...Of course, the Reserve claims to control the money supply...
...The Reserve has, ever since, been undisturbed in following its gleam...
...When on October 6, 1979, the new chairman of the Federal Reserve Board, Paul A. Volcker, announced that thereafter the Reserve would concentrate on the money supply and let the interest rate go as it pleased (it pleased to go up), the S&Ls' fate was sealed...
...Doesn't inflation cause the interest rate to rise...
...To the best of my knowledge, his successor, Alan Greenspan, has not said him nay...
...In the later period, from 1951 through 1989, the index rose from 26 to 124, an increase of 377 per cent...
...If the price level is rising at a rate of 5 per cent a year, anyone lending $100 today will receive back only $95 in purchasing power a year from now...
...But it certainly does have determinate effects on the interest rate, and that certainly has definite effects on the cost of living...
...But look at the performance of the S&Ls over the long run—specifically, over the life of a mortgage...
...From 1913tol951,the Consumer Price Index (1982-84= 100) rose from 9.9 to 26, an increase of 163 per cent...
...The new S&Ls were successful for more than 30years...
...Taken by itself, inflation no more explains the S&L debacle than does the borrowing-short-lending-long story...
...By 1965 the average S&L was earning only 0.5 per cent on its capital...
...If it wants to contract the money supply, it sells government bonds until enough banks buy enough of them to reduce their cash reserves and hence their loan-issuing power...
...When the media go beyond personalities, they explain that the S&Ls failed because they borrowed short and lent long...
...Because the functions were restricted, it was understood that expenses would likewise be restricted...
...Nevertheless, it must be added to the other costs the Federal Reserve Board is responsible for...
...High T-bill rates and the new money-market mutual funds drained the S&Ls of deposits...
...So we may say with some justice that the control of inflation should have been no harder in the more recent period— particularly since the Federal Reserve Board had now proclaimed this to be its primary objective—than in the earlier one...
...The curious fact, however, is that the S&Ls were deliberately set up to act in this way from their beginnings in the Great Depression...
...They were substantially responsible for the United States' achieving the highest rate of home ownership in the world (a rate considerably higher than the present one...
...For all those years that they were contributing to the wealth and happiness of the American people, the S&Ls were borrowing short and lending long...
...If you want to sell, your price must be enticingly low...
...When all is said and done, isn't the culprit the usual suspect—inflation...
...They will gain from inflation (if any) when they are young and lose to inflation as they approach middle age...
...Crises followed in 1966, '69, '74,and'78...
...From the point of view of the lending bank, inflation is not without its compensations...
...At the present time, the former stands at about $9.75 trillion, and the latter is about $5.4 trillion...
...Inflation is always bad for lenders...
...In 1951 the Reserve, worried about inflation, managed to break free of the agreement with the Treasury and thereafter devoted itself to controlling inflation by managing the money supply...
...The $500 billion fiasco has been a long time in preparation...
...Several fat volumes would be required for an exhaustive economic history of each period, and a thorough analysis of the impact of those histories on the CPI would be beyond reasonable achievement...
...S&Ls, it was reasoned, could therefore offer a little bit more than the going rate on the deposits and charge a little bit less than the going rate on the mortgages...
...My wife and I were able to buy a home and start saving at a far younger age than either our parents or our children...
...In March 1980, the grandiloquently styled Depository Institutions Deregulatory and Money Control Act confirmed the seal...
...The first noticeable sign of things to come was a period of tight money in 1955-57, but no one expected the trouble we've seen...
...In other words, during the 38 years that the Federal Reserve Board has been deliberately and ostentatiously fighting inflation, theinflation rate has gone up more than twice as fast as it did in the previous 38 years...
...For obvious reasons, wars are held to be especially inflationary, while depressions are deflationary...
...With interest rates currently running about six points above normal, this year's net cost of the Federal Reserve Board's inflationary policies will be $261 billion—or considerably more than the budget deficit everyone moans about...
...As I have argued previously ("Bankers Have the Classic COLA, " NL, January9,1989), ahigh interest rate causes rather than cures inflation...
...And so it was...
...Practically unrestricted competition, coupled with $100,000 deposit insurance, guaranteed that the Savings and Loans, trying to escape the consequences of high interest, would engage in a binge of blue-sky financing and outright thievery...
...Plenty of people are ready to tell you the problem was inflation...
...Foreclosures will be fewer, and losses in each foreclosure will be lower...
...The Federal Funds rate in those years jumped from 1.78 percent to 3.11 per cent, and continued to rise...
...There's more to buying and selling than stamping your foot and saying that's what you want to do...
...On the record, the burden of proof is on the Federal Reserve Board to show that its policies, which have resulted in the destruction of the S&Ls, have been effective by any standard whatever...
...Well, if the Federal Reserve does not control the interest rate, I don't know what it does do—unless, as W.S...
...but as William Greider points out in Secrets of the Temple, the issue became moot with President Dwight D. Eisenhower's election...
...Gilbert sang of the House of Lords, it does nothing in particular and does it very well...
...second, they would aggregate those savings and lend them to finance middleclass home ownership...
...Thus each percentage point in the interest rate is paid for by an increase of $97.5 billion in the general price level, while a one point increase in inflation costs only $54 billion...
...Inflation of real estate prices has the advantage of improving the quality of the bank's portfolio...
...In that run of 20 or 30 years a go-getting middleclass American will both a borrower and a lender be...
...Government...
...Because the money supply is not a precise figure (the Reserve publishes four different major and two minor ways of measuring it), the effects of this activity on the money supply are not precise...
...Wall Street won out over Washington...
...Chairman Volcker used to tell us that the interest rate was none of his doing but was the doing of the impersonal market...
...At the same time, naturally, inflation is good for borrowers, who borrow $100 today and pay back $95 in purchasing power next year...
...In the same way, when the Open Market Committee buys bonds at a high price, it drives the interest rate down...
Vol. 73 • September 1990 • No. 11
