The 2008-2009 banking and credit crisis has been dubbed the worst since the Great Depression's wave of bank failures. But another banking crisis, which took place during the 1980s and early 1990s, ranks as one of the worst global credit disasters in history.
Often overlooked amid the clamor of the 2008 credit bubble collapse, what became known as the S&L crisis ultimately led to a massive taxpayer-funded rescue of an industry that had essentially collapsed.
While smaller in magnitude than the bank crisis of the 1920s and 1930s, the S&L crisis pushed the state and federal regulatory and deposit banking insurance systems to their limits, ultimately leading to widespread changes to the regulatory environment. These events may come as a surprise to anybody too young to remember. (Learn how the FDIC is helping to keep your money in your pockets; check out Are Your Bank Deposits Insured?)
Ironically, during both the credit troubles growing out of the subprime debacle of 2008 and at the time of the S&L crisis, Sitting republican presidents took actions that contradicted their free market rhetoric, largely in the form of big government bailouts for failing financial institutions. (Government bailouts go way back; read about the biggest ones in Top 6 U.S. Government Financial Bailouts.)
Rising Bank Failures in the Early 1980s
According to data from the Federal Deposit Insurance Corporation's (FDIC) Division of Research and Statistics, between 1980-1994, a total of 1,617 commercial and savings banks failed. $206.179 billion in assets were held in those failed institutions.
In another study using FDIC data, 1,043 thrifts failed or were otherwise resolved from 1986-1995. Those institutions represented assets totaling $519 billion. The banking crisis of the 1980s was therefore a two-headed beast – one head related to the failure of savings and loans (the S&L crisis), which represented the bulk of the assets and number of banks, and the other linked to the failure of large commercial banks.
Contrast the above with bank failure data leading up to the 1980s and the magnitude of the crisis becomes evident. From 1965-1979, for example, just 0.3% of all existing banks failed.
Bank failures eventually reached a post-Depression record of 279 in 1988, representing $54 billion (nominal) assets as the crisis deepened throughout the 1980s. While relatively small in terms of total number of banks and bank assets, and in light of the ultimate costs, it led to the first ever operating loss for the FDIC. Those losses continued until the end of 1991.
Factors Contributing to the Crisis
There is no single factor that led to the surge in failed banking institutions in the United States during the 1980s and early 1990s. Prior to the onset of the crisis, the legislative and regulatory environments were changing. The Depository Institutions Deregulation and Monetary Control Act of 1980 removed many restrictions on thrifts and credit unions; the Garn-St. Germain Depository Institutions Act of 1982 gave thrifts greater latitude to invest in real estate loans; and the Tax Reform Act of 1986 fundamentally altered the banking landscape and engendered conditions that contributed to the banking crisis. (For further readings, check out The History Of The FDIC and The Globalization Of Financial Services.)
Given the changes in regulatory and economic environments, this induced unrestrained real estate lending beginning in the late 1970s and continuing throughout the early 1980s. Many analysts consider this to be the primary cause of the banking crisis of that time. Severe economic downturns in the early 1980s and early 1990s, and the collapse in real estate and energy prices during this period, were both outcomes and key precipitating factors in an increasingly unstable financial environment. Fraud (primarily looting or control fraud) and other types of insider misconduct played a major role in the overall crisis, as well.
Government Interventions to Remedy the Problem
While government intervention in the banking sector has been cited as one of the major contributing factors to the financial crisis of the 1980s, subsequent action by government also helped rescue the sector and bring about its reconstitution, although fundamentally altered. As the S&L crisis worsened in the late 1980s, a series of regulatory and legislative changes resulted, with an alphabet soup of agencies and institutions created.
The Office of Thrift Supervision (OTS) was established, with the authority to charter and regulate S&Ls, and the Resolution Trust Corporation (RTC) was setup in 1989 to dispose of the failed thrifts that fell into the hands of regulatory bodies. In response to the deepening crisis, Congress also enacted the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), in which taxpayers began to foot the bill. FIRREA replaced the Federal Savings & Loan Insurance Corporation (FSLIC) and allowed for the transfer of the failed FSLIC's assets, liabilities and operations to the just-created FSLIC Resolution Fund (FRF), which was run by the government's Federal Deposit Insurance Corporation (FDIC). (Learn more in Financial Regulators: Who They Are And What They Do.)
Social Costs and Taxpayer Burden
The U.S. General Accounting Office estimated that the cost of the crisis was $160.1 billion – $124.6 billion of which was paid by the U.S. Government from 1986-1996. These figures don't count state bailouts or money from thrift insurance funds. Most of the money was paid to depositors as compensation for money milked by insiders. The Federal National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE) noted that "evidence of fraud was invariably present, as was the ability of the operators to 'milk' the organization through high dividends and salaries, bonuses, perks and other means. The typical large failure was one in which management exploited virtually all the perverse incentives created by government policy."
The banking crisis of the 1980s was essentially a crisis of thrift institutions, with some large commercial bank failures thrown into the mix. A rapidly-changing bank regulatory environment, increased competitive pressures, speculation in real estate and other assets by thrifts, and unstable economic conditions were major causes and aspects of the crisis. The resulting banking landscape is one where concentration of banking has never been greater. While the number of banks on the FDIC's rolls declined from 14,392 to 7,511 between 1984-2004, the proportion of the assets in the banking sector held by the 10 biggest banks increased sharply, to almost 60%, by 2005. The Gramm-Leach-Bliley Act, passed in 1999, removed the remaining legal barriers and allowed giants in commercial banking, investment banking and insurance to combine operations under one corporate tent. (If you want to read about a more recent financial crisis, check out The 2007-08 Financial Crisis In Review or The Fuel That Fed The Subprime Meltdown.)