How S&Ls Work

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.
Charles Keating was prosecuted for criminal investment practices involving his Lincoln Savings & Loan Association, which collapsed in 1989.
Terry Ashe/Time & Life Pictures/Getty Images

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.

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