Chapter 19
Savings
Associations
and Credit Unions
Chapter Preview
Consumer banking was almost nonexistent in the early 1800s. Commercial
banks were common, but their business
was primarily restricted to commercial
loans and services. But, in the late 1800s,
a new type of institution opened – the
savings and loan association. This is the
topic of chapter 19.
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19-2
Chapter Preview
• We examine the role of savings and loan
associations, mutual savings banks, and credit
union, collectively known as thrift institutions. We
begin with their history and move into the nature
of the industry today. Topics include:
– Mutual Savings Banks
– Savings and Loan Associations
– Savings and Loans in Trouble: The Thrift Crisis
– Political Economy of the Savings and Loan Crisis
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19-3
Chapter Preview (cont.)
– Savings and Loan Bailout: Financial Institution
Reform, Recovery, and Enforcement Act
of 1989
– The Savings and Loans Industry Today
– Credit Unions
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19-4
Mutual Savings Banks
• Depositors are the owners of the firm
• Stock in the bank is not sold or issued, but rather
depositors own a share of the bank in proportion
to their deposits
• Generally have fewer liabilities than other banks
because deposits are ownership, not a liability
• Principal-agent problem still present, but
managers tent to be more risk-averse
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19-5
Savings and Loan Associations
• Created by Congress in 1816 to promote
home ownership
• About 12,000 S&Ls in operation by
the 1920s
• Regulation was at the state level
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19-6
Savings and Loan Associations
• The Great Depression led to the failure of
thousands of thrift institutions and the loss
of $200 million in personal savings
• The Federal Home Loan Bank Act of 1932
– created the Federal Home Loan Bank Board
• In 1934, the FSLIC was created to
insure depositors
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19-7
Savings and Loan Associations
• S&Ls were successful, low-risk businesses
for many years following the changes.
• The next slide shows the distribution of
S&L assets in 2006. Note that most of the
assets are still held as mortgages, true to
their original intent.
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19-8
Savings and Loan Associations
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19-9
Savings and Loan Associations
vs. Mutual Savings Banks
• Mutual savings banks are concentrated in
the northeast, whereas S&Ls are found
throughout the country.
• Mutual savings banks insure their deposits
with the state or the FDIC. S&Ls may not.
• Mutual savings banks are not as heavily
invested in mortgages and have more
flexibility in their investing practices.
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19-10
Savings and Loans in Trouble:
The Thrift Crisis
• By 1979, inflation was running at 13.3%,
but Reg Q restricted interest on deposits to
only 5.5%.
• Further, money market accounts offered
depositors market interest rates on their
short-term funds.
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19-11
Savings and Loans in Trouble:
The Thrift Crisis
• Financial deregulation and the permissive 1980s
led to several problems:
– Managers lacked expertise in new product lines
– Rapid growth in lending, particularly real estate
– Regulators could not keep pace with the growth
– The moral hazard problem led to excessive risk-taking
– 1981–1982 were particularly bad year for some areas,
such as the Texas real estate market
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19-12
Savings and Loans in Trouble:
The Thrift Crisis
• Rather than close insolvent S&Ls,
regulators adopted the policy of
regulatory forbearance, essentially
sidestepping their responsibility using
temporary Band-Aids.
• This policy led to further risk-taking, as
insolvent S&Ls had nothing to lose by
extreme risk-taking.
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19-13
Savings and Loans in Trouble:
The Thrift Crisis
• To further the problems, insolvent S&Ls
offered higher rates to their depositors to
attract new funding.
• This meant that healthy S&Ls had to
compete with insolvent S&Ls going for
broke. Needless to say, this caused further
problems for the industry.
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19-14
Savings and Loans in Trouble:
The Thrift Crisis
• Competitive Equality in Banking Act of 1987
– Allowed the FSLIC to borrow $10.8 billion to cover
depositors’ losses (not nearly enough)
– Directed the FHLBB to continue regulatory forbearance
• Losses in the S&L industry approached $20
billion in 1989 alone. The collapse of the real
estate market in the late 1980s only worsened
the problem.
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19-15
Political Economy of the Savings
and Loan Crisis
The relationship between voter-taxpayers
and the regulators and the politicians
creates a particular type of moral hazard
problem—the principal-agent problem.
This idea can explain part of the problem
during the S&L Crisis.
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19-16
Political Economy of the Savings
and Loan Crisis
• Regulators and politicians are ultimately
agents for voter-taxpayers.
• To act on taxpayers’ behalf,
regulators seek to minimize the cost
of deposit insurance:
– Restrict S&Ls from holding assets that are
too risky
– Require higher bank capital
– Close insolvent S&Ls
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19-17
Political Economy of the Savings
and Loan Crisis
• However, regulators have an incentive to
“hide” the problem and hope that the
situation corrects itself.
• Regulators are also funded through
Congressional appropriations, which
means that politicians may be able to
influence the actions of regulators.
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19-18
Political Economy of the Savings
and Loan Crisis
• Further, both Congress and the president
passes legislation in the early 1980s that
promoted risk-taking and required
additional oversight.
• Yet, in years following, Congress refused to
fund regulators at a necessary level to
monitor S&L activities.
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19-19
Charles Keating and the Lincoln
S&L Scandal
• Charles Keating acquired Lincoln S&L in
1984. Regulators allowed this, despite his
being accused of fraud by the SEC.
• Used the S&L to fund his construction firm
with loans. Quickly changed Lincoln’s
investing, using futures, junk bonds, and
land tracks in Arizona.
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19-20
Charles Keating and the Lincoln
S&L Scandal
• Regulators eventually recommended
seizure in 1986, but he fought in vigorously,
spending millions in lawyer fees.
• He also made campaign contributions to
prominent senators – including John
McCain. His tactics worked! By 1987, no
examiner went near Lincoln – that is, until it
failed in 1989.
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19-21
Savings and Loan Bailout: Financial Institution
Reform, Recovery, and Enforcement Act of 1989
• The Bush administration proposed FIRREA
to provide adequate funding to close
insolvent S&Ls.
• Its major provisions included:
– The Office of Thrift Supervision assumed
regulatory responsibility, replacing the FHLBB
– The FDIC assumed replaced the FSLIC
– The RTC was established to sell assets of
failed S&Ls
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19-22
Savings and Loan Bailout: Financial Institution
Reform, Recovery, and Enforcement Act of 1989
• The bailout cost taxpayers in the
neighborhood of $150 billion.
• The bailout continued to cost depositors as
FDIC insurance rates rose.
• FIRREA essentially re-regulated the thrift
industry and made it easier for regulators to
remove thrift managers.
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19-23
The Savings and Loan
Industry Today
• Despite the problems of the 1980s, the S&L
industry did survive.
• The next two slides show the totals assets
and the number of S&Ls in the U.S.
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19-24
The Savings and Loan
Industry Today
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19-25
The Savings and Loan
Industry Today
19-26
The Savings and Loan
Industry Today
• Consistent with the last two slides, as the
number of S&Ls has fallen, the average
assets held by the average S&L has
increased steadily throughout the last
twenty years.
• The next slide shows this graphically.
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19-27
The Savings and Loan
Industry Today
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19-28
The Savings and Loan
Industry Today
• The next three slides show the following:
– Consolidated balance sheet for the S&L industry
– The net income for S&Ls from 1984-2006
– Average ROE for S&Ls from 1993-2006
• Many economists believe that S&Ls will
disappear based on these findings. However,
this does not appear to be a rapid trend. We may
again see deregulation before all is said
and done.
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19-29
The Savings and Loan
Industry Today
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19-30
The Savings and Loan
Industry Today
The Savings and Loan
Industry Today
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19-32
Credit Unions
• Idea developed in Germany where a group
pooled assets to use a collateral for a loan
• The loan proceeds were then loaned to
members of the group.
• Default was rare since all the group
members knew each other.
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19-33
Credit Unions: Types of Organization
• Mutual Ownership
– Owned by depositors
• Common Bond
Membership
– Defined field of membership
• Nonprofit, Tax-Exempt
Status
– Lower service fee
• Regulation and Insurance
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• Central Credit Unions
– Help with members’
credit needs
– Invest excess funds
– Hold clearing balances
– Provide educational
services
• Credit Union Size
• Trade Associations
National Credit Union Administration
http://www.ncua.gov
19-34
Credit Unions
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19-35
Credit Unions
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19-36
Credit Unions: Types of Accounts
• Regular Share Accounts
– Savings accounts
– Receive no interest
– Do receive dividends
• Share Certificates
– Compatible to CDs
• Share Draft Accounts
– Pay interest
– Write drafts against account
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19-37
Credit Unions: Share Distribution
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19-38
Credit Unions: Type of Loans
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19-39
Credit Unions:
Advantages and Disadvantages
• Advantages
– Employer support
– Tax advantage
– Strong trade associations
• Disadvantages
– Common bond requirement
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19-40
Credit Unions: Memberships
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19-41
Credit Unions: Assets
Chapter Summary
• Mutual Savings Banks: the role of this form
of thrift institution represents the first style
of saving organization was reviewed
• Savings and Loan Associations: since the
Federal Home Loan Bank Act of 1932, this
form of savings institution was very
successful until the late 1980s
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19-43
Chapter Summary (cont.)
• Savings and Loans in Trouble: The Thrift Crisis:
the reasons behind the crisis, including interest
rate volatility, arcane regulations, and increased
risk-taking were discussed
• Political Economy of the Savings and Loan Crisis:
adding the problem, moral hazard on the part of
regulators and politicians added to this costly
failure of the S&L industry
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19-44
Chapter Summary (cont.)
• Savings and Loan Bailout: Financial
Institution Reform, Recovery, and
Enforcement Act of 1989: this sweeping
reform called for significant changes in the
oversight and insurance of the S&L industry
• The Savings and Loans Industry Today:
empirical evidence shows that this industry
is shrinking in some respects, possibly
suggesting its eventual demise
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19-45
Chapter Summary (cont.)
• Credit Unions: the history, form, and role of
credit unions was reviewed
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19-46