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CHAPTER 25
Saving
Associations and
Credit Unions
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All rights reserved.
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Consumer banking was almost non-existent
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 25.
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25-1
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 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:
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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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25-2
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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25-3
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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25-4
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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25-5
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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25-6
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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25-7
Savings and Loan Associations
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25-8
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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25-9
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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25-10
Savings and Loans in Trouble:
The Thrift Crisis
 Financial deregulation and the permissive 1980s
led to several problems:
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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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25-11
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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25-12
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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25-13
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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25-14
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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25-15
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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25-16
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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25-17
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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25-18
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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25-19
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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25-20
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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25-21
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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25-22