The history of the savings and loan industry is nothing less than fascinating. Savings and loan programs or “Thrifts” as they are often referred to, have collectively transformed the national business landscape and defined economic narrative on a number of occasions. In this article, we will explore the history of the industry leading up to the notorious S&L crisis.
In 1831, the first savings and loan association opened in Philadelphia Pennsylvania. It was simply called an “American Building Society” and modeled largely after similar British building programs. The purpose of the entity was to provide both home loans (mortgages), and a systematic structure for savings that the working class of America could utilize.
The industry got off to a slow start. The nature of the first savings and loan associations called for the termination of the association once all members paid off their loan or share of membership. This “create and dismantle” cycle was largely ineffective for long-term industry growth. As more Americans became familiar with the savings and loan programs, more associations adopted a more permanent structure. The stability in a permanent structure also created stability in new membership inflow. In 1880, the savings and loan programs evolved to take on a national form. Taking advantage of mainstream adoption, founders of national associations saw an opportunity in creating entities with national structure and reach. The national thrifts utilized their infrastructure to grow assets faster and pay higher saving rates compared to local competition. Unfortunately, just a little over a decade later, the 1893 depression swept over America. The national thrifts had built their business around the assumptions that rapid growth in membership would continue. When fewer and fewer new members entered the industry, the high promised interest rates and costly infrastructure was too much, leading most national thrifts to close shop.
While the depression of the 1890s may have taken out large national thrifts, the industry as a whole had experienced tremendous growth leading into the 20th century. In 1900, over 5,300 loan and savings organizations were in operation. The entire industry held more than $570 million in assets. In efforts to further stabilize the industry, state regulators began to create uniform standards for association members to abide.
The population of America was growing, housing was spreading westward and thrifts were coming into a steady flow of predictable business. As World War I came to an end, consumer spending increased with a large proportion dedicated to housing. Homeownership was no longer a far off dream, but an actual realization for most families.
Like many industries, the thrift business took a hit during the Great Depression. However, the most significant impact of the era on the industry was the creation of new competition. Following the Great Depression, the federal government created the Federal Home Loan Bank Board, the Federal Housing Administration (FHA), and the Federal Savings and Loan Insurance Corporation (FSLIC). These entities had the infrastructure and the resources to press private thrift enterprises and usher in a new era of lending to consumers.
Following World War II, the thrift industry hit its heyday. Millions of soldiers were returning to prewar life, driving up the demand for housing. The need for housing naturally brought with it a demand for mortgages. Thrifts were happy to underwrite these loans. Despite competition from government entities, savings and loan programs were doing quite well. The average savings and loan association swelled to over $6 million in assets. Strong balance sheets and forecasted growth fueled acquisition sprees. The industry began to consolidate, thus creating stronger players and forcing weaker associations to close shop.
By 1955, savings and loan associations provided roughly 36% of real estate mortgages. In addition, the savings side of the business had grown to such a level of popularity that it controlled 70% of commercial savings deposits. The industry even found a way to monetize the competition from government entities, taking advantage of the secondary mortgage market.
By 1965, the average savings and loan association had increased to $21 million. Thrifts held over 26% of all consumer savings. In addition, 46% of all single-family home mortgages were underwritten by a savings and loan association. The consolidation of the industry created two distinct types of programs with a clear divide between large associations and smaller, more traditional associations. The competition shifted from acquiring new unattended members, to specifically acquiring market share from competitors. An industry trend emerged in the form of rate wars. Both small and large associations alike competed by offering high interest rates on savings.
The fierce competition among thrifts not only created rate wars but also created professional deposit brokers. Individuals in search of the highest possible rate on CDs (Certificate of Deposit), would pay deposit brokers for money they were able to place. Seeing the opportunity, small thrifts and large thrifts alike aggressively increased their rates to generate deposits from deposit brokers further. The high rates offered on savings meant that the thrifts needed to generate higher returns. Chasing higher returns meant chasing more risk. As competition became more and more fierce, corruption rose. A scam referred to as “Linked Financing” began to pop up. Linked financing worked as follows:
1) The deposit broker would steer large amounts of individuals to a specific thrift.
2) The individuals were paid a fee to apply for particular loans.
3) The individuals would then hand over those loans to the deposit brokers.
Ultimately linked financing was one of several contributors that started the decline of the industry. In 1966, the US Congress decided to take action in an effort to curtail the rate wars. The rate wars had not only effected thrifts but were also jeopardizing the health of commercial banks. Congress passed Regulation Q limiting thrifts to offer rates of 0.25% above that of traditional banks. No longer would the savings and loan associations be able to grow through exuberant rate offerings.
The Decline & Crisis
Following Regulation Q, industry growth began to slow. The country as a whole was seeing overall slower economic expansion and thrifts were no exception. While the industry tried to battle unfavorable economic conditions, what happened next was seen by most as inconceivable.
The ’70s were met with a concept economist had largely thought was impossible up to that point - Stagflation. Stagflation brought high unemployment, high inflation, high interest rates, and slow economic growth. It was an environment that couldn’t have been worse for Thrifts. At the turn of the decade, inflation reached a staggering 13.5%. At that time, over 4,000 thrifts controlled assets of over $600 billion. However, the real problem was over $480 billion, or 80% of total assets were mortgages that had been written at extremely low fixed interest rates. This equated to roughly 50% of all mortgages in the country.
To make matters worse, the Federal Savings and Loan Insurance Company was low on resources. The economic hit had shrunk the insurance reserves to the point that any substantial collapse of savings and loan programs would exceed available funds. The inability to provide the necessary funds to pay off insured depositors would likely create a potential domino effect and jeopardize the entire industry. Regulators decided the only course of action was Forbearance, allowing insolvent institutions to keep operating as usual.
Congress saw the severity of the issues and responded with the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980. The DIDMCA did a few things one of which, it allowed institutions to charge any loan interest rate they chose. Two years later, in 1982 the Garn-St. Germain Act was passed. This act was set forth in an attempt to further strengthen the industry. An important component of the legislation allowed lenders to provide adjustable rate mortgages. All in all, the effort by the government was made in an attempt to save weaker players in the industry and create an overall course correction of American economics.
For the next three years, things seemed to be working. The thrift industry boomed seeing overall assets grow 56%. Federally chartered savings and loan programs (a result of the DIDMCA) were equipped with the benefits and capabilities of being a regular bank, without the oversight and complicated regulatory headaches. However, the rally was short-lived and ultimately not enough to save the industry. Weaker thrifts had over leveraged their balance sheet to keep up during the time of rate wars. Additionally, many savings and loan associations had expanded out of their area of expertise. Family mortgages no longer made up the majority of balance sheets. Many thrifts had lent funds to commercial real estate ventures and in other structures outside their area of expertise.
To further worsen industry fundamentals, the regression of record oil prices was creating havoc. The ’70s not only brought Stagflation but also historically high oil prices. These oil prices created a boom in real estate values in oil-producing states. Thrifts underwrote the loans on these propped up housing markets. When oil prices collapsed, so too did the real estate values in those given areas. These mortgages were on the balance sheet of many savings and loan associations.
Between 1980 and 1994, close to 1,300 thrifts collapsed. The total value of assets was assessed at $621 billion. In the middle of the collapse, the federal government founded an asset management company called “The Resolution Trust Corporation.” This company was given the task of disposing of the failed thrift balance sheets. Ultimately the Resolution Trust Corporation successfully resolved 78% of total book value on the $621 billion in assets.
Lessons & Observations
Ultimately the contributing factors of the savings and loan crisis are still widely debated. Like many booms and busts, there are multiple culprits at play that create a somewhat perfect storm. Here are a few observations that are worth noting and learning from;
Regulatory Change - Changes in law often affect the field on which the game is played. When new legislation is rolled out, an investor should take a larger look at what macro consequences will unfold. The savings and loan industry experienced a number of regulatory changes. The first taste of these changes came when local state authorities began issuing uniform governing principles. Next, Regulation Q undoubtedly created a game changer as it fundamentally shifted how thrifts competed. In the ’80s, more regulatory change occurred with the DIDMCA and Garn-St Germain Act. Both were deregulatory actions but played a greater role in shaping how the industry would operate moving forward.
Environmental Change - Understanding the macro environment and underlying economic trends is essential when positioning an investment. A large part of the thrift business model was dependent on underwriting fixed-rate mortgages. When inflation and interest rates climbed it created a fundamental problem in the operating environment for savings and loan programs.
Catalyst Change - From the founding years to the mid 20th century, the thrifts of America enjoyed a healthy tailwind in the form of increased housing demand. The need for housing drove the need for mortgages. Once the demand for housing slowed, savings and loan programs needed a new engine for growth. This shift largely led to thrifts overreaching and making less fundamentally sound loans. The catalyst that drove the industry to such great levels was no longer a dependable source of growth.
Behavioral Change - Monitoring behavioral changes within an industry is a great way to understand what narrative really might be at play. During the rate wars, thrifts saw increasing cases of fraud with linked financing scandals. Competition creates a new behavior, and it’s important to take a further look into how that behavior might unfold on a greater level. The additional competition and shift in housing demand further fueled behavioral change within the industry. Savings and loan programs began to reach outside of their core competency and chased higher risk-reward lending opportunities.
Industry Change - Changes in the fundamental components of industry are another sign of a more significant shift occurring. It’s quite simple to monitor the participant expansion and consolidation of an industry by merely tracking the number of establishments that have opened and closed. In addition, monitoring the underlying fundamental components of the industry can reveal further insight into potential trouble (or opportunity). The thrift industry saw consolidation through acquisition, shifts in asset types, and a number of other fundamental metrics that fluctuated and shaped the industry in its entirety.
Overall, learning about the history of an industry and how it played out equips you with a larger repertoire of lessons to operate from going forward. As Ray Dalio has often said everything is just “another one of those.” The Savings and Loan crisis brought down 1,300 programs with $621 billion in assets. While no single event can be credited with creating the crisis, the collective factors were enough to dismantle the industry.
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