David Mason, Young Harris College
The savings and loan industry is the leading source of institutional finance for residential home mortgages in America. From the appearance of the first thrift in Philadelphia in 1831, savings and loans (S&Ls) have been primarily local lenders focused on helping people of modest means to acquire homes. This mission was severely compromised by the financial scandals that enveloped the industry in the 1980s, and although the industry was severely tarnished by these events S&Ls continue to thrive.
Origins of the Thrift Industry
The thrift industry traces its origins to the British building society movement that emerged in the late eighteenth century. American thrifts (known then as “building and loans” or “B&Ls”) shared many of the same basic goals of their foreign counterparts — to help working-class men and women save for the future and purchase homes. A person became a thrift member by subscribing to shares in the organization, which were paid for over time in regular monthly installments. When enough monthly payments had accumulated, the members were allowed to borrow funds to buy homes. Because the amount each member could borrow was equal to the face value of the subscribed shares, these loans were actually advances on the unpaid shares. The member repaid the loan by continuing to make the regular monthly share payments as well as loan interest. This interest plus any other fees minus operating expenses (which typically accounted for only one to two percent of revenues) determined the profit of the thrift, which the members received as dividends.
For the first forty years following the formation of the first thrift in 1831, B&Ls were few in number and found in only a handful of Midwestern and Eastern states. This situation changed in the late nineteenth century as urban growth (and the demand for housing) related to the Second Industrial Revolution caused the number of thrifts to explode. By 1890, cities like Philadelphia, Chicago, and New York each had over three hundred thrifts, and B&Ls could be found in every state of the union, as well as the territory of Hawaii.
Differences between Thrifts and Commercial Banks
While industrialization gave a major boost to the growth of the thrift industry, there were other reasons why these associations could thrive along side larger commercial banks in the 19th and early 20th centuries. First, thrifts were not-for-profit cooperative organizations that were typically managed by the membership. Second, thrifts in the nineteenth century were very small; the average B&L held less than $90,000 in assets and had fewer than 200 members, which reflected the fact that these were local institutions that served well-defined groups of aspiring homeowners.
Another major difference was in the assets of these two institutions. Bank mortgages were short term (three to five years) and were repaid interest only with the entire principle due at maturity. In contrast, thrift mortgages were longer term (eight to twelve years) in which the borrower repaid both the principle and interest over time. This type of loan, known as the amortizing mortgage, was commonplace by the late nineteenth century, and was especially beneficial to borrowers with limited resources. Also, while banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women.
There was also a significant difference in the liabilities of banks and thrifts. Banks held primarily short-term deposits (like checking accounts) that could be withdrawn on demand by accountholders. In contrast, thrift deposits (called share accounts) were longer term, and because thrift members were also the owners of the association, B&Ls often had the legal right to take up to thirty days to honor any withdrawal request, and even charge penalties for early withdrawals. Offsetting this disadvantage was the fact that because profits were distributed as direct credits to member share balances, thrifts members earned compound interest on their savings.
A final distinction between thrifts and banks was that thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals. This attitude of social uplift was so pervasive that the official motto of the national thrift trade association was “The American Home. Safeguard of American Liberties” and its leaders consistently referred to their businesses as being part of a “movement” as late as the 1930s.
The “Nationals” Crisis
The early popularity of B&Ls led to the creation of a new type of thrift in the 1880s called the “national” B&L. While these associations employed the basic operating procedures used by traditional B&Ls, there were several critical differences. First, the “nationals” were often for-profit businesses formed by bankers or industrialists that employed promoters to form local branches to sell shares to prospective members. The members made their share payments at their local branch, and the money was sent to the home office where it was pooled with other funds members could borrow from to buy homes. The most significant difference between the “nationals” and traditional B&Ls was that the “nationals” promised to pay savings rates up to four times greater than any other financial institution. While the “nationals” also charged unusually high fees and late payment fines as well as higher rates on loans, the promise of high returns caused the number of “nationals” to surge. When the effects of the Depression of 1893 resulted in a decline in members, the “nationals” experienced a sudden reversal of fortunes. Because a steady stream of new members was critical for a “national” to pay both the interest on savings and the hefty salaries for the organizers, the falloff in payments caused dozens of “nationals” to fail, and by the end of the nineteenth century nearly all the “nationals” were out of business.
The “nationals” crisis had several important effects on the thrift industry, the first of which was the creation of the first state regulations governing B&Ls, designed both to prevent another “nationals” crisis and to make thrift operations more uniform. Significantly, thrift leaders were often responsible for securing these new guidelines. The second major change was the formation of a national trade association to not only protect B&L interests, but also promote business growth. These changes, combined with improved economic conditions, ushered in a period of prosperity for thrifts, as seen below:
|Year||Number of B&Ls
Source: Carroll D. Wright, Ninth Annual Report of the Commissioner of Labor: Building and Loan Associations (Washington, D.C.: USGPO, 1894), 214; Josephine Hedges Ewalt, A Business Reborn: The Savings and Loan Story, 1930-1960 (Chicago: American Savings and Loan Institute Publishing Co., 1962), 391. (All monetary figures in this study are in current dollars.)
The Thrift Trade Association and Business Growth
The national trade association that emerged from the “nationals” crisis became a prominent force in shaping the thrift industry. Its leaders took an active role in unifying the thrift industry and modernizing not only its operations but also its image. The trade association led efforts to create more uniform accounting, appraisal, and lending procedures. It also spearheaded the drive to have all thrifts refer to themselves as “savings and loans” not B&Ls, and to convince managers of the need to assume more professional roles as financiers.
The consumerism of the 1920s fueled strong growth for the industry, so that by 1929 thrifts provided 22 percent of all mortgages. At the same time, the average thrift held $704,000 in assets, and more than one hundred thrifts had over $10 million in assets each. Similarly, the percentage of Americans belonging to B&Ls rose steadily so that by the end of the decade 10 percent of the population belonged to a thrift, up from just 4 percent in 1914. Significantly, many of these members were upper- and middle-class men and women who joined to invest money safely and earn good returns. These changes led to broad industry growth as seen below:
|Year||Number of B&Ls||Assets (000,000)|
Source: Ewalt, A Business Reborn, 391
The Depression and Federal Regulation
The success during the “Roaring Twenties” was tempered by the financial catastrophe of the Great Depression. Thrifts, like banks, suffered from loan losses, but in comparison to their larger counterparts, thrifts tended to survive the 1930s with greater success. Because banks held demand deposits, these institutions were more susceptible to “runs” by depositors, and as a result between 1931 and 1932 almost 20 percent of all banks went out of business while just over 2 percent of all thrifts met a similar fate. While the number of thrifts did fall by the late 1930s, the industry was able to quickly recover from the turmoil of the Great Depression as seen below:
|Year||Number of B&Ls||Assets (000,000)|
Source: Savings and Loan Fact Book, 1955 (Chicago: United States Savings and Loan League, 1955), 39.
Even through fewer thrifts failed than banks, the industry still experienced significant foreclosures and problems attracting funds. As a result, some thrift leaders looked to the federal government for assistance. In 1932, the thrift trade association worked with Congress to create a federal home loan bank that would make loans to thrifts facing fund shortages. By 1934, the other two major elements of federal involvement in the thrift business, a system of federally-chartered thrifts, and a federal deposit insurance program, were in place.
The creation of federal regulation was the most significant accomplishment for the thrift industry in the 1930s. While thrift leaders initially resisted regulation, in part because they feared the loss of business independence, their attitudes changed when they saw the benefits regulation gave to commercial banks. As a result, the industry quickly assumed an active role in the design and implementation of thrift oversight. In the years that followed, relations between thrift leaders and federal regulators became so close that some critics alleged that the industry had effectively “captured” their regulatory agencies.
The Postwar “Glory Years”
By all measures, the two decades that followed the end of World War II were the most successful period in the history of the thrift industry. The return of millions of servicemen eager to take up their prewar lives led to a dramatic increase in new families, and this “baby boom” caused a surge in new (mostly suburban) home construction. By the 1940s S&Ls (the name change occurred in the late 1930s) provided the majority of the financing for this expansion. The result was strong industry expansion that lasted through the early 1960s. In addition to meeting the demand for mortgages, thrifts expanded their sources of revenue and achieved greater asset growth by entering into residential development and consumer lending areas. Finally, innovations like drive-up teller windows and the ubiquitous “time and temperature” signs helped solidify the image of S&Ls as consumer-friendly, community-oriented institutions.
By 1965, the industry bore little resemblance to the business that had existed in the 1940s. S&Ls controlled 26 percent of consumer savings and provided 46 percent of all single-family home loans (tremendous gains over the comparable figures of 7 percent and 23 percent, respectively, for 1945), and this increase in business led to a considerable increase size as seen below:
|Year||Number of S&Ls||Assets (000,000)|
Source:Savings and Loan Fact Book, 1966, (Chicago: United States Savings and Loan League, 1966)92-4.
This expansion, however, was not uniform. More than a third of all thrifts had fewer than $5 million in assets each, while the one hundred largest thrifts held an average of $340 million each; three S&Ls approached $5 billion in assets. While regional expansion in states like California, account for part of this disparity, there were other controversial actions that fueled individual thrift growth. Some thrifts attracted funds by issuing stock to the public and become publicly held corporations. Another important trend involved raising rates paid on savings to lure deposits, a practice that resulted in periodic “rate wars” between thrifts and even commercial banks. These wars became so severe that in 1966 Congress took the highly unusual move of setting limits on savings rates for both commercial banks and S&Ls. Although thrifts were given the ability to pay slightly higher rates than banks, the move signaled an end to the days of easy growth for the thrift industry.
Moving from Regulation to Deregulation
The thirteen years following the enactment of rate controls presented thrifts with a number of unprecedented challenges, chief of which was finding ways to continue to expand in an economy characterized by slow growth, high interest rates and inflation. These conditions, which came to be known as “stagflation,” wrecked havoc with thrift finances for a variety of reasons. Because regulators controlled the rates thrifts could pay on savings, when interest rates rose depositors often withdrew their funds and placed them in accounts that earned market rates, a process known as disintermediation. At the same time, rising rates and a slow growth economy made it harder for people to qualify for mortgages that in turn limited the ability to generate income.
In response to these complex economic conditions, thrift managers came up with several innovations, such as alternative mortgage instruments and interest-bearing checking accounts, as a way to retain funds and generate lending business. Such actions allowed the industry to continue to record steady asset growth and profitability during the 1970s even though the actual number of thrifts was falling, as seen below.
|Year||Number of S&Ls||Assets (000,000)|
Source: Savings and Loan Fact Book, 1980, (Chicago: United States Savings and Loan League, 1980)48-51.
Despite such growth, there were still clear signs that the industry was chafing under the constraints of regulation. This was especially true with the large S&Ls in the western United States that yearned for additional lending powers to ensure continued growth. At the same time, major changes in financial markets, including the emergence of new competitors and new technologies, fueled the need to revise federal regulations for thrifts. Despite several efforts to modernize these laws in the 1970s, few substantive changes were enacted.
The S&L Crisis of the 1980s
In 1979 the financial health of the thrift industry was again challenged by a return of high interest rates and inflation, sparked this time by a doubling of oil prices. Because the sudden nature of these changes threatened to cause hundreds of S&L failures, Congress finally acted on deregulating the thrift industry. It passed two laws (the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Act of 1982) that not only allowed thrifts to offer a wider array of savings products, but also significantly expanded their lending authority. These changes were intended to allow S&Ls to “grow” out of their problems, and as such represented the first time that the government explicitly sought to increase S&L profits as opposed to promoting housing and homeownership. Other changes in thrift oversight included authorizing the use of more lenient accounting rules to report their financial condition, and the elimination of restrictions on the minimum numbers of S&L stockholders. Such policies, combined with an overall decline in regulatory oversight (known as forbearance), would later be cited as factors in the later collapse of the thrift industry.
While thrift deregulation was intended to give S&Ls the ability to compete effectively with other financial institutions, it also contributed to the worst financial crisis since the Great Depression as seen below:
|Year||S&L Failures||Assets (000,000)||Year||Total S&Ls||Industry Assets (000,000)|
Source: Statistics on failures: Norman Strunk and Fred Case, Where Deregulation Went Wrong (Chicago: United States League of Savings Institutions, 1988), 10; Lawrence White, The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation (New York: Oxford University Press, 1991), 150; Managing the Crisis: The FDIC and RTC Experience, 1980‑1994 (Washington, D.C.: Resolution Trust Corporation, 1998), 795, 798; Historical Statistics on Banking, Bank and Thrift Failures, FDIC web page http://www2.fdic.gov/hsob accessed 31 August 2000; Total industry statistics: 1999 Fact Book: A Statistical Profile on the United States Thrift Industry. (Washington, D.C.: Office of Thrift Supervision, June 2000), 1, 4.
The level of thrift failures at the start of the 1980s was the largest since the Great Depression, and the primary reason for these insolvencies was the result of losses incurred when interest rates rose suddenly. Even after interest rates had stabilized and economic growth returned by the mid-1980s, however, thrift failures continued to grow. One reason for this latest round of failures was because of lender misconduct and fraud. The first such failure tied directly to fraud was Empire Savings of Mesquite, TX in March 1984, an insolvency that eventually cost the taxpayers nearly $300 million. Another prominent fraud-related failure was Lincoln Savings and Loan headed by Charles Keating. When Lincoln came under regulatory scrutiny in 1987, Senators Dennis DeConcini, John McCain, Alan Cranston, John Glenn, and Donald Riegle (all of whom received campaign contributions from Keating and would become known as the “Keating Five”) questioned the appropriateness of the investigation. The subsequent Lincoln failure is estimated to have cost the taxpayers over $2 billion. By the end of the decade, government officials estimated that lender misconduct cost taxpayers more than $75 billion, and the taint of fraud severely tarnished the overall image of the savings and loan industry.
Because most S&Ls were insured by the Federal Savings & Loan Insurance Corporation (FSLIC), few depositors actually lost money when thrifts failed. This was not true for thrifts covered by state deposit insurance funds, and the fragility of these state systems became apparent during the S&L crisis. In 1985, the anticipated failure of Home State Savings Bank of Cincinnati, Ohio sparked a series of deposit runs that threatened to bankrupt that state’s insurance program, and eventually prompted the governor to close all S&Ls in the state. Maryland, which also operated a state insurance program, experienced a similar panic when reports of fraud surfaced at Old Court Savings and Loan in Baltimore. In theaftermath of the failures in these two states all other state deposit insurance funds were terminated and the thrifts placed under the FSLIC. Eventually, even the FSLIC began to run out of money, and in 1987 the General Accounting Office declared the fund insolvent. Although Congress recapitalized the FSLIC when it passed the Competitive Equality Banking Act, it also authorized regulators to delay closing technically insolvent S&Ls as a way to limit insurance payoffs. The unfortunate consequence of such a policy was that allowing troubled thrifts to remain open and grow eventually increased the losses when failure did occur.
In 1989, the federal government finally created a program to resolve the S&L crisis. In August, Congress passed the Financial Institutions Reform Recovery and Enforcement Act (FIRREA), a measure that both bailed out the industry and began the process of re-regulation. FIRREA abolished the Federal Home Loan Bank Board and switched S&L regulation to the newly created Office of Thrift Supervision. It also terminated the FSLIC and moved the deposit insurance function to the FDIC. Finally, the Resolution Trust Corporation was created to dispose of the assets held by failed thrifts, while S&Ls still in business were placed under stricter oversight. Among the new regulations thrifts had to meet were higher net worth standards and a “Qualified Thrift Lender Test” that forced them to hold at least 70 percent of assets in areas related to residential real estate.
By the time the S&L crisis was over by the early 1990s, it was by most measures the most expensive financial collapse in American history. Between 1980 and 1993, 1,307 S&Ls with more than $603 billion in assets went bankrupt, at a cost to taxpayers of nearly $500 billion. It should be noted that S&Ls were not the only institutions to suffer in the 1980s, as the decade also witnessed the failure of 1,530 commercial banks controlling more than $230 billion in assets.
Explaining the S&L Crisis
One reason why so many thrifts failed in the 1980s was in the nature of how thrifts were deregulated. S&Ls historically were specialized financial institutions that used relatively long-term deposits to fund long-term mortgages. When thrifts began to lose funds to accounts that paid higher interest rates, initial deregulation focused on loosening deposit restrictions so thrifts could also offer higher rates. Unfortunately, because thrifts still lacked the authority to make variable rate mortgages many S&Ls were unable to generate higher income to offset expenses. While the Garn-St. Germain Act tried to correct this problem, the changes authorized were exceptionally broad and included virtually every type of lending power.
The S&L crisis was magnified by the fact that deregulation was accompanied by an overall reduction in regulatory oversight. As a result, unscrupulous thrift managers were able to dodge regulatory scrutiny, or use an S&L for their own personal gain. This, in turn, related to another reasons why S&Ls failed — insider fraud and mismanagement. Because most thrifts were covered by federal deposit insurance, some lenders facing insolvency embarked on a “go for broke” lending strategy that involved making high risk loans as a way to recover from their problems. The rationale behind this was that if the risky loan worked the thrift would make money, and if the loan went bad insurance would cover the losses.
One of the most common causes of insolvency, however, was that many thrift managers lacked the experience or knowledge to evaluate properly the risks associated with lending in deregulated areas. This applied to any S&L that made secured or unsecured loans that were not traditional residential mortgages, since each type of financing entailed unique risks that required specific skills and expertise on how to identify and mitigate. Such factors meant that bad loans, and in turn thrift failures, could easily result from well-intentioned decisions based on incorrect information.
The S&L Industry in the 21st Century
Although the thrift crisis of the 1980s severely tarnished the S&L image, the industry survived the period and, now under greater government regulation, is once again growing. At the start of the twenty-first century, America’s 1,103 thrift institutions control more than $863 billion in assets, and remain the second-largest repository for consumer savings. While thrift products and services are virtually indistinguishable from those offered by commercial banks (thrifts can even call themselves banks), these institutions have achieved great success by marketing themselves as community-oriented home lending specialists. This strategy is intended to appeal to consumers disillusioned with the emergence of large multi-state banking conglomerates. Despite this rebound, the thrift industry (like the commercial banking industry) continues to face competitive challenges from nontraditional banking services, innovations in financial technology, and the potential for increased regulation.
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Citation: Mason, David. “Savings and Loan Industry, US”. EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003. URL http://eh.net/encyclopedia/savings-and-loan-industry-u-s/