How S&Ls Work

President Bill Clinton considers his words during a 1996 press conference about the Whitewater Savings & Loan scandal.
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Making the rounds at a cocktail party, you might enter a conversation about the banking industry. Inevitably, someone mentions savings and loan institutions or S&Ls. Sighs and groans abound.

Savings and loan associations, also known as thrift banks (as in thrifty or savings-minded), have a bad rap because of the massive savings and loan crises of the 1980s and 1990s. Hundreds of banks failed during this crisis, costing the federal government and taxpayers billions of dollars. Add this extensive collapse to the widespread allegations and prosecutions of S&L officials for criminal activity, and you had quite the party.


But the history of savings and loans is not just a saga of collapse, failure and crime. These specialized banking institutions go way back to the Old World. And the 1980s crisis didn't wipe S&Ls off the face of the Earth. The thrift industry, though vastly reformed, transformed and reduced during the late 1980s and early 1990s, lives on today.

First, let's take a look at the roots of the savings and loan associations. You may think they came about in the spendthrift era of Wall Street. But the truth is actually closer to Pride and Prejudice. Read on.


How a Savings and Loan Association Makes Money

Treasury Secretary William Woodin cheerfully looks on as President Roosevelt signs the 1933 Emergency Banking Bill, one of the steps the federal government took to save the U.S. financial industry during the Great Depression.
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A savings and loan association (S&L) is an institution that lends money to people who want to buy a house, make home improvements or build on their land. Members of an S&L deposit money into savings accounts, and this money is lent out in the form of home mortgage loans. Borrowers pay interest on their home loans, and this interest is passed on to the members and the bank itself.

Originally, the purpose of an S&L was to develop communities. S&L members primarily consisted of local individuals interested in making money through high-yield savings accounts. Their savings accounts were investments in the community. Like any other investment, S&L depositors stood to gain money. And they helped out their neighbors in the process.


The model for this community-minded financial organization goes back to 18th century England, where building societies collected money from members to finance the building of a house for each member [source: Encyclopedia Britannica]. This style of home financing spread to the United States in 1831, when the Oxford Provident Building Association of Philadelphia was founded. Similar financial institutions, then called building and loan associations (B&Ls), popped up in communities across the country. Working with a small number of local investors, B&Ls made money solely by financing mortgages.

The community-minded benevolence of building and loan associations, although generally beneficial to local development, eventually backfired. B&L bankers generally didn't make real estate investments -- that is, home loans -- based on how profitable their ventures would be. Without profits to weather the storm, building and loans were vulnerable to collapse during a weak economy, such as the Great Depression of the 1930s. Many B&Ls failed during this period.

President Franklin D. Roosevelt's banking laws of the early to mid-1930s created federal agencies to regulate banking practices in the United States. These agencies included the Federal Deposit Insurance Corporation, which insured depositor accounts at commercial banks (the everyman's bank) and the Federal Savings and Loan Insurance Corporation, which insured accounts at building and loan associations, now called savings and loan associations.

As you can see, S&Ls had a very narrow business focus for a long time -- real estate investment financed through savings accounts. As the 20th century wore on, one weakness of S&Ls became apparent -- vulnerability to rising interest rates.

Like other banks, S&Ls depend on loans from other banks to meet the costs of financing mortgages and paying interest on deposit accounts. But, just as you pay interest on­ a home loan, car loan or credit card, banks pay interest on the money they borrow. When interest rates rise -- often due to inflation -- banks have to pay more interest on the money they've borrowed. This reduces the bank's profits.

Next you'll see how such interest rate hikes contributed to the infamous S&L crisis of the 1980s and 1990s.



The Decline and Reforms of Savings and Loan Associations

Charles Keating was prosecuted for criminal investment practices involving his Lincoln Savings & Loan Association, which collapsed in 1989.
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The savings and loan crisis is considered the most widespread failure of financial institutions in the United States since the Great Depression [source: Curry and Shibut]. Hundreds of S&Ls -- with a combined worth of $519 billion -- failed.

The roots of the S&L crisis may go back to the 1960s, when rising interest rates started to cause problems for savings and loan associations. The S&Ls couldn't adjust interest rates on their fixed-rate home loans to reflect the higher interest rates they were paying on borrowed funds. They were also offering high-yield savings accounts. So they couldn't make as much money. In 1989 the New York Times reported that even a 1 percent rise in interest rates could cause banks to lose billions of dollars in profits [source: Stevenson].


Another major cause of the crisis was deregulation. The Depository Institutions Deregulation and Monetary Control Act of 1980 lifted the restrictions on S&L business practices. Previously, S&Ls could only offer savings accounts and home loans. Deregulation allowed S&Ls to offer commercial banking services and other types of loans. The purpose of deregulation was to allow S&Ls to pursue potentially profitable investments to offset the losses they were accruing from rising interest rates.

But deregulation also reduced federal supervision of S&L investment and accounting practices, which enabled many banking officials to effectively steal money from depositors' savings accounts. This demon seed was nourished by a huge growth in real estate following the Tax Reform Act of 1981, which created a number of tax incentives for real estate investors [source: FDIC]. With this real estate explosion, S&Ls bloomed out of control in the early and mid-1980s. Unfortunately, a vast number of the real estate ventures S&Ls entered were high-risk and high-cost.


It doesn't take an economic genius to guess what happened next. Real estate ventures collapsed. Interest rates rose. S&Ls lost profits, and associations around the country dropped like flies. The problem was so bad that the Federal Savings and Loan Insurance Corporation didn't have enough money to cover depositors of the failed banks. As a result, many failing S&Ls stayed open and continued to accrue losses. This made it even harder to close or bail out these banks when S&L reforms came along in the late 1980s.

The reform of the S&L industry came partially in the form of the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) of 1989. FIREEA created the Office of Thrift Supervision, a new division of the FDIC to supervise the S&L industry -- goodbye, deregulation. In addition, it used U.S. taxpayer dollars to cover the losses incurred by failed S&Ls. The mammoth cost to the federal government and taxpayers -- the money not supplied by the federal insurance fund -- is estimated at $153 billion [source: Curry and Shibut].

Today, S&Ls are more like commercial banks, offering traditional banking services. Although no bank is immune to failure, the regulated and closely supervised S&L industry in the U.S. is much healthier after the reforms of 1989 and the 1990s.

If you'd like to know more about savings and loan associations and related topics, you can follow the links on the next page.



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  • Brune, Jeffrey A. "Savings and Loans." The Electronic Encyclopedia of Chicago. Chicago Historical Society, 2005. (Accessed May 19 2008)
  • Curry, Timothy and Shibut, Lynn. "The Cost of the Savings and Loan Crisis: Truth and Consequences." FDIC Banking Review, Vol. 13, No. 2, 2000. (Accessed May 19, 2008)
  • Encyclopedia Britannica. "savings and loan association." Encyclopædia Britannica. 2008. Encyclopædia Britannica Online. (Accessed May 19 2008)
  • FDIC. History of the Eighties--Lessons for the Future. Ch. 4, "The Savings and Loan Crisis and Its Relationship to Banking." (Accessed May 19, 2008)
  • FDIC. "The S&L Crisis: A Chrono-Bibliography." 12/20/02. (Accessed May 19, 2008)
  • Freudenheim, Milt. "Federal Jury Orders Keating To Pay Investors $3.3 Billion." The New York Times, July 11, 1992. (Accessed May 19, 2008)
  • Investopedia. "Thrift Bank." (Accessed May 19, 2008)
  • Stevenson, Richard W. "Savings Industry vs. Rising Rates." The New York Times. 3/13/1989. (Accessed May 19, 2008)