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The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation

September 1, 1991


The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation

By Lawrence White
Oxford University Press
308 pages

With all the attention focused on the problems of the savings and loan industry in recent years, casual observers—and even expert economists—have probably felt overwhelmed at various times. What we've needed is one source that provides an encyclopedic rendering of the S&L debacle; and, in Lawrence White's new book, that is exactly what we get. Anyone with a serious interest in financial intermediaries, and the regulation of them, is advised to read this book.

However, my recommendation is not unqualified. On the one hand, while I acknowledge the value of this book for its succinct explanation of the S&L crisis, on the other hand, I expected more. Lawrence White, an economist well-known for his professionalism and integrity, served on the Federal Home Loan Bank Board (FHLBB) from November 1986 through August 1989. Certainly, I did not expect any tabloid-style revelations of S&L treachery from White, but I had hoped that his tenure at the FHLBB during those critical years would have produced new insight into the causes and consequences of the crisis. Unfortunately, there is no evidence of such insight here.

White provides an accurate description of recent events that led to the current S&L problem. Before 1980, 75 percent of S&Ls' assets were held in long-term mortgages. When interest rates shot up through the early '80s, most S&Ls were caught between the "rock" of paying high short-term rates to depositors and the "hard place" of receiving low-interest payments from their home loans. When the real estate and energy markets tumbled, especially in the Southwest, S&Ls felt additional pressure. To make matters worse, the response from regulators at the time was to reduce the number of federal examiners, to increase the asset powers (and hence the gambling opportunities) of S&Ls, and to devise creative accounting methods that kept failing S&Ls open long after they were rightfully bankrupt.

Moral hazard was rampant. Faced with the certain demise of their institutions if events stayed their course, and buoyed by the presence of federally insured funds, S&L executives played high-stakes poker with depositors' funds. Most lost. Deregulation provided new and enticing methods to earn money, but unsophisticated mortgage lenders were generally unsuccessful, if not downright corrupt—the headlines are full of stories about illegal S&L dealings. In the meantime, real estate markets continued to deteriorate and supervision remained lax.

Bad judgment and bad luck are in abundance throughout this saga and many are to blame, as White duly notes, but the question remains: Why did policymakers err so consistently? From 1966 to 1985, nearly every regulatory or legislative decision regarding S&L policy was misguided, White claims. As far as I'm concerned, the fault lies not only with the decisions but with the policymaking coalition that made those decisions.

In a section describing his recommendations for change, White rightly makes a case for enhanced regulatory powers, but he abandons the benefits of market discipline by advocating 100 percent deposit insurance. This is troubling, especially in light of the fact that we are passing through an era of financial troubles wherein regulatory oversight largely failed, and defacto 100 percent deposit insurance helped create an environment of financial irresponsibility. Advocating stricter regulation with 100 percent deposit insurance is like warning a paroled criminal that jail sentences have been toughened while at the same time handing him a loaded gun.

White also decries the lack of "voices in the wilderness" in the early 1980s that, he seems to imply, should have warned us about the inherent problems of the DIDMCA and the Garn-St. Germain Act. But this claim comes off as a weak excuse for policymakers' mistakes. Contrary to White's argument, there were warnings that the FDIC and FSLIC were heading for trouble. Notable, among others, was John Kareken's prophetic article "Deposit Insurance Reform or Deregulation is the Cart, Not the Horse," published in the Minneapolis Fed's Quarterly Review, Spring 1983. This oft-cited article clearly, and well before the problem was publicly recognized, warned of the impending dangers of our deposit insurance system.

So, while White effectively retraces the steps that led to the current S&L mess, and in so doing provides a warning for the future, he misses the chance to go one step further and investigate the policy apparatus that allowed such a debacle to occur. Even so, this book is a must read. It's a one-source guide to the thrift industry and the recent dilemma, and I know I will refer to it frequently.