What Is the Garn-St. Germain Depository Institutions Act?

The Garn-St. Germain Depository Institutions Act was enacted by Congress in 1982 to ease pressures on banks and savings and loans which increased after the Federal Reserve raised rates in an effort to combat inflation. The act followed the establishment of the Depository Institutions Deregulation Committee by the Monetary Control Act, which had the primary purpose of phasing out interest rate ceilings on bank deposit accounts by 1986.

The Garn-St. Germain Depository Institutions Act was named after sponsors Congressman Fernand St. Germain, a Democrat from Rhode Island, and Senator Jake Garn, a Republican from Utah. Co-sponsors of the bill included Congressman Steny Hoyer and Senator Charles Schumer. The bill passed the House with a substantial margin of 272-91.

Key Takeaways

  • The Garn-St. Germain Depository Institutions Act eased bank pressure and was intended to combat inflation.
  • This act was named after Congressman Fernand St. Germain and Senator Jake Garn. Congressman Steny Hoyer and Senator Charles Schumer were cosponsors.
  • Title VIII of the Garn-St. Germain Depository Act allowed banks to offer adjustable-rate mortgages.

How the Garn-St. Germain Depository Institutions Act Works

Inflation in the United States had spiked significantly in the mid-1970s and again after the Federal Reserve aggressively began raising rates into the 1980s in hopes of reversing the trend. Investors flocked to mutual fund money markets to obtain higher interest rates, and corporations developed alternatives such as repurchase agreements.

Traditional banks were caught in the middle as they were paying more for their deposits than they were earning on mortgage loans which had been made in earlier years at much lower interest rates. Also unable to get out from under lower rates of interest on their own long-term holdings, banks were becoming illiquid as they were unable to obtain enough deposits to fund their existing loans. At the same time, Fed Regulation Q restricted banks and savings and loans (known as S&L or thrifts) from raising their deposit interest rates.

Title VIII of the Garn-St. Germain Depository Act, "Alternative Mortgage Transactions," authorized banks to offer adjustable-rate mortgages. However, the act also had substantial benefits for consumer real estate owners, because it allowed consumers to place their mortgaged real estate in inter vivos trusts without triggering the due-on-sale clause that allows banks to foreclose and collect the balance due on a mortgaged property when ownership of that property is transferred. This made it easier for property owners to pass real estate to minors and heirs, and also allowed the wealthy to protect their real estate holdings from creditors or lawsuit settlements.

Many analysts believe that the act was one of the contributing factors to the Savings and Loan Crisis, which resulted in one of the largest government bailouts in U.S. history, costing approximately $124 billion.

Unintended Consequences

The Garn-St. Germain Depository Institutions Act removed the interest rate ceiling for banks and thrifts, authorized them to make commercial loans, and gave the federal agencies the ability to approve bank acquisitions. Once regulations were loosened, however, S&Ls began engaging in high-risk activities to cover losses, such as commercial real estate lending and investments in junk bonds.

Depositors in S&Ls continued to funnel money into these risky endeavors because their deposits were insured by the Federal Savings and Loan Insurance Corporation (FSLIC).

Ultimately, many analysts believe that the act was one of the contributing factors to the Savings and Loan Crisis, which resulted in one of the largest government bailouts in U.S. history, costing approximately $124 billion. Long-term consequences included the preponderance of 2/28 adjustable-rate mortgages, which may have ultimately contributed to the sub-prime loan crisis and the Great Recession of 2008.