What Was the Savings and Loan (S&L) Crisis?

The Savings and Loan (S&L) Crisis was a slow-moving financial disaster. The crisis came to a head and resulted in the failure of nearly a third of the 3,234 savings and loan associations in the United States between 1986 and 1995.

The problem began during the era's volatile interest rate climate, stagflation, and slow growth of the 1970s and ended with a total cost of $160 billion; $132 billion of which was borne by taxpayers. Key to the S&L crisis was a mismatch of regulations to market conditions, speculation, moral hazard brought about by the combination of taxpayer guarantees along with deregulation, as well as outright corruption and fraud, and the implementation of greatly slackened and broadened lending standards that led desperate banks to take far too much risk balanced by far too little capital on hand.

Key Takeaways

  • The savings and loan crisis was the build-up and extended deflation of a real-estate lending bubble in the United States from the early 1980s to the early 1990s.
  • The S&L crisis culminated in the collapse of hundreds of savings & loan institutions and the insolvency of the Federal Savings and Loan Insurance Corporation, which cost taxpayers many billions of dollars and contributed to the recession of 1990–91.
  • The roots of the S&L crisis lay in excessive lending, speculation, and risk-taking driven by the moral hazard created by deregulation and taxpayer bailout guarantees.
  • Some S&Ls led to outright fraud among insiders and some of these S&Ls knew of—and allowed—such fraudulent transactions to happen.
  • As a result of the S&L crisis, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which amounted to a vast revamp of S&L industry regulations.

Understanding the Savings and Loan Crisis

Restrictions placed on S&Ls at their creation via the Federal Home Loan Bank Act of 1932—such as caps on interest rates on deposits and loans—greatly limited the ability of S&Ls to compete with other lenders as the economy slowed and inflation took hold. For instance, as savers piled money into newly created money market funds in the early 1980s, S&Ls could not compete with traditional banks due to their lending restrictions.

Add in a recession—sparked by high-interest rates set by the Fed in an effort to end double-digit inflation—the S&Ls were left with little more than an ever-dwindling portfolio of low-interest mortgage loans. Their revenue stream had become severely tightened.

By 1982, the fortunes of S&Ls had turned. They were losing as much as $4.1 billion per year after having turned a healthy profit in 1980.

How the Crisis Unfolded

In 1982, in response to the poor prospects for S&Ls under current economic conditions, President Ronald Reagan signed Garn-St. Germain Depository Institutions Act, which eliminated loan-to-value ratios and interest rate caps for S&Ls, and also allowed them to hold 30% of their assets in consumer loans and 40% in commercial loans. No longer were S&Ls governed by Regulation Q, which led to a tightening of the spread between the cost of money and the rate of return on assets.

With reward uncoupled from risk, zombie thrifts began paying higher and higher rates to attract funds. S&Ls also began investing in riskier commercial real estate and even riskier junk bonds. This strategy of investing in riskier and riskier projects and instruments assumed that they would pay off in higher returns. Of course, if those returns didn’t materialize, it would be taxpayers [through the Federal Savings and Loan Insurance Corporation (FSLIC)]—not the banks or S&Ls officials—who would be left holding the bag. That's exactly what eventually happened.

This combination of deregulated lending and capital requirements along with a taxpayer-funded guarantee backstop created an enormous moral hazard in the S&L industry. S&Ls were allowed to take greater risks and incentivized to do so excessively. The result was rapid growth in the industry along with ballooning speculative risk.

At first, the measures seemed to have done the trick, at least for some S&Ls. By 1985, S&L assets had shot up by nearly 50%; far faster growth than banks. S&L growth was especially robust in Texas. Some state legislators allowed S&Ls to double down by allowing them to invest in speculative real estate. Still, over one in five S&Ls were not profitable, as of 1985.

Meantime, although pressure was mounting on the FSLIC's coffers, even failing S&Ls were allowed to keep lending. By 1987, the FSLIC had become insolvent. Rather than allowing it and S&Ls to fail as they were destined to do, the federal government recapitalized the FSLIC, exposing taxpayers to even greater risk. For a while longer, the S&Ls were allowed to continue to pile on risk.

S&L Fraud

The "Wild West" attitude among some S&Ls led to outright fraud among insiders. One common fraud saw two partners conspire with an appraiser to buy land using S&L loans and flip it to extract huge profits. Partner 1 would buy a parcel at its appraised market value. The duo would then conspire with an appraiser to have it reappraised at a far higher price. The parcel would then be sold to Partner 2 using a loan from an S&L, which was then defaulted on. Both partners and the appraiser would share the profits. Some S&Ls knew of—and allowed—such fraudulent transactions to happen.

Due to staffing and workload issues, as well as the complexity of such cases, law enforcement was slow to pursue instances of fraud even when they were aware of them.

Savings and Loan Crisis: Resolution

As a result of the S&L crisis, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which amounted to a vast revamp of S&L industry regulations. One of the most significant actions of the FIRREA was the creation of the Resolution Trust Corporation, which had the goal of winding down the failed S&Ls that regulators had taken control of.

FIRREA was passed by George H.W. Bush and provided $50 billion to cover costs and losses associated with the crisis.

The act also put forth minimum capital requirements, raised insurance premiums, limited S&L non-mortgage and mortgage-related holdings to 30%, and required the divestment of junk bonds. When all was said and done, the Resolution Trust Corp. had liquidated more than 700 S&Ls.

Savings and Loan Crisis: Aftermath

The S&L crisis was arguably the most catastrophic collapse of the banking industry since the Great Depression. Across the United States, more than 1,000 S&Ls had failed by 1989, essentially ending what had been one of the most secure sources of home mortgages.

The S&L market share for residential mortgages before the crisis was 45% (1980); after, it was 27% (1990).

The one-two punch to the finance industry and the real estate market most likely contributed to the recession of 1990-1991, as new home starts fell to a low not seen since World War II. Some economists speculate that the regulatory and financial incentives that created a moral hazard that led to the 2007 subprime mortgage crisis are very similar to the conditions that led to the S&L crisis.

Everything's Bigger in Texas

The crisis was felt doubly hard in Texas where at least half of the failed S&Ls were based. The collapse of the S&L industry pushed the state into a severe recession. Faulty land investments were auctioned off, causing real estate prices to plummet. Office vacancies rose significantly, and the price of crude oil dropped by half. Texas banks, such as Empire Savings and Loan, took part in criminal activities that further caused the Texas economy to plummet. The bill for Empire's eventual default cost taxpayers about $300 million.

Savings and Loan Crisis: State Insurance

The FSLIC was established to provide insurance for individuals depositing their hard-earned funds into S&Ls. When S&L banks failed, the FSLIC was left with a $20 billion debt that inevitably left the corporation bankrupt, as premiums paid into the insurer fell far short of liabilities. After the FSLIC's dissolution in 1989, the responsibilities of the defunct institutions were transferred to the Federal Deposit Insurance Corporation (FDIC) that oversees and insures deposits today.

During the S&L crisis, which did not effectively end until the early 1990s, the deposits of some 500 banks and financial institutions were backed by state-run funds. The collapse of these banks cost at least $185 million and virtually ended the concept of state-run bank insurance funds.

The Keating Five Scandal

During this crisis, five U.S. senators known as the Keating Five were investigated by the Senate Ethics Committee due to the $1.5 million in campaign contributions they accepted from Charles Keating, head of the Lincoln Savings and Loan Association. These senators were accused of pressuring the Federal Home Loan Banking Board to overlook suspicious activities in which Keating had participated. The Keating Five included:

  1. John McCain (R–Ariz.)
  2. Alan Cranston (D–Calif.)
  3. Dennis DeConcini (D–Ariz.)
  4. John Glenn (D–Ohio)
  5. Donald W. Riegle, Jr. (D–Mich.)

In 1992, the Senate committee determined that Cranston, Riegle, and DeConcini had improperly interfered with the FHLBB's investigation of Lincoln Savings. Cranston received a formal reprimand.

When Lincoln failed in 1989, its bailout cost the government $3 billion and left more than 20,000 customers with junk bonds that were worthless. Keating was convicted of conspiracy, racketeering, and fraud, and served time in prison before his conviction was overturned in 1996. In 1999 he pleaded guilty to lesser charges and was sentenced to time served.

Savings and Loan Crisis FAQs

Do Savings and Loans Still Exist?

Yes, they do. As of 2019, it is estimated there were 659 savings and loan institutions in the U.S. This is down from 3,371 in 1989.

How Many People Were Prosecuted for the Savings and Loan Crisis?

More than 1,000 bankers were convicted by the Justice Department after the Savings and Loan Crisis.

How Was the S&L Crisis Different or Similar to the Credit Crisis of 2007–2008?

Both crises were a result of boom and bust cycles. Both banks and thrifts were involved in financing the booms and then were negatively hit when the situation took a downturn. Speculation was present in both crises, with real estate being a big part as well as poor risk management in the institutions.

Commercial real estate was a critical area of causing issues as commercial real estate lending standards were loosened in the 1980s. Most of the banks that failed were small but both crises saw large banks having trouble and needing assistance from the government. In both crises, taxpayer money was used to save these institutions.

The Savings and Loan Crisis, however, involved three recessions, was longer in length, while the 2007-2008 crisis was just one recession and shorter in length. In the Savings and Loan crisis, bank failures were gradual and spread over time, whereas in the 2007-2008 crisis, bank failures were rapid.

What Could Regulators Have Done Better to Solve the Savings and Loan Crisis?

Savings and loans should not have been allowed to use federally insured deposits to make risky loans. Regan also cut the budget of the regulatory staff at the FHLBB, removing its ability to investigate poor loans. Certain states also passed laws that allowed savings and loans to invest in speculative real estate, which should not have been allowed.

At the time, banks were also not using mark-to-market accounting, which requires the values of assets to be continuously adjusted to reflect their true value. So banks were not devaluing their assets on their books if they lost value, making them look more profitable than they were.

How Were Commercial Banks Affected by the Savings and Loan Crisis?

Both savings and loans and commercial banks have been taxed heavily to pay for the Savings and Loan Crisis. At the end of the 1980s, Congress removed the walls that separated commercial banks and S&Ls, whereby much of the S&L industry today has been folded into the regular banking industry.

The Bottom Line

The Savings and Loan Crisis of the 1980s and 1990s was the first large banking crisis after the Great Depression. The crisis resulted in thousands of savings and loan institutions closing and billions of dollars lost, hurting customers and taxpayers. The crisis led to many banking reforms being put in place, but not enough so to avoid another crisis that occurred between 2007–2008, leading to the Great Recession. Lessons are still being learned from the S&L Crisis and further regulations in the banking industry are needed.