Savings and Loan Scandal

During the 1980s, a large number of savings and loan depository institutions in the United States failed or suffered severe financial distress because of changing financial regulations, widespread financial mismanagement, and a surge of financial crimes perpetrated by, in many instances, officers of the affected institutions. This wave of financial failures, unprecedented since the difficult economic years of the Great Depression, came to be known as the savings and loan scandal. Ironically, the earlier success of the savings and loan institutions in fulfilling their intended mission laid the groundwork for this descent into financial ruin.

The origins of the savings and loan scandal in the United States lay in the changing economic and political environment of the 1970s. Savings and loans institutions, also called thrift institutions, existed since the banking reforms of the 1930s (under Franklin D. Roosevelt's “New Deal” administration) as a major source of residential mortgages for single-family homes. During the housing boom in the United States following World War II, these institutions provided low-interest, fixed-rate, long-term loans to a growing [Page 1857]consumer base of home buyers. The thrifts in turn funded these long-term loans by attracting deposits that, because they could be withdrawn at any time, were short term in nature. This financial framework succeeded in driving the growth of the post–World War II residential building and home-owning boom, especially in the expanding suburban communities surrounding major American cities.

Savings and loans attempted to balance this difference between their short-term deposits and long-term loan obligations by matching the interest rates of their mortgage lendings to the interest rates offered for savings. Throughout the postwar years and into the 1970s, they accomplished this through three incentives: savings interest rates at levels slightly higher than those available to depositors from commercial banks, customer convenience services and savings bonuses, and the protective umbrella of federal deposit insurance for savings.

During the 1970s, however, the conditions underpinning the thrifts' activities changed drastically. Consumer price inflation caused federally set interest rates to rise dramatically, increasing the cost of funds to all savings institutions and forcing thrifts to increase their savings interest rates to continue attracting deposits. Meanwhile, the assets held by savings and loans in the form of mortgage loans remained at fixed rates of interest that were much lower than the cost for new deposits. This trend created economic pressures that had an adverse impact on the financial profitability of the thrift industry.

Accompanying these economic changes were growing political pressures from free market advocates for reduced government intervention in the marketplace. These advocates cited the financial imbalances faced by thrifts and the growing emergence of market-based alternatives to thrifts (such as commercial banks with expanded powers, mutual funds, and even government-chartered mortgage institutions such as Fannie Mae and Freddie Mac) as proof that the savings and loan industry needed deregulation to compete more effectively. With the United States facing both inflationary pressures (from a combination of economic recession and supplier-created oil scarcity) and increasing mistrust of government (in the aftermath of the Vietnam conflict and the Watergate scandal), the sentiment for change was strong within most sectors of the economy.

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