Here’s Edward Harrison’s take on the Savings and Loan Crisis, which he calls "an informal history." – Ilene
Courtesy of Edward Harrison of Credit Writedowns
Here is a good video from Bill Black on the origins of the Savings & Loan crisis in the U.S. The roots of the crisis go back to the stagflation of the 1970s when interest rates spiked under Paul Volcker. As S&L’s borrowed short and lent long, it meant a mismatch between their long-lived and low-yielding S&L assets and the shorter high-interest S&L demand deposits and liabilities. Many savings and loans became deeply insolvent.
The right thing to do would have been to address the problem straight away and have the regulator seize insolvent institutions, likely resulting in hundreds of billions of losses for taxpayers. Instead, a legislative ‘fix’ was found which allowed the S&L’s to masquerade as solvent institutions, which incented many S&L executives to load up on risk as a ‘fix’ for their insolvency. A lack of regulatory oversight then created a Gresham’s law of bad behaviour driving out good. In describing this phenomenon in this last financial crisis in the UK, I wrote:
The Bradford and Bingleys of the world used lower interest rates to justify jacking [the maximum mortgage debt to income limit] constraints up to 3.5 times or four times income. Eventually these constraints hit six times in the UK.
How do you compete against that as a bank? All of the business is going to Bradford and Bingley and you are getting stuffed. I guarantee you shareholders won’t like that. As an executive, you better find the holy grail of prudent but profitable lending or follow Bradford and Bingley on the road to easy money. Otherwise, you will be out of a job.
Eventually, even the prudent relax their standards too – that’s how risky behaviour drives out good when risk is rewarded. See my comments in “James Galbraith: How financial stability creates instability.”
–On the sovereign debt crisis and the debt servicing cost mentality
In the S&L days, the result was a criminogenic environment ripe for fraudsters to enter the marketplace. Rates came down, but the competitive landscape had changed. Therefore, many S&L’s loaded up on high risk assets like junk bonds – and not just the insolvent ones. Looting was also commonplace. When the economy turned down, loans went bad in spades and bond defaults skyrocketed. The result was a wave of insolvencies, bank runs and crisis as well as over 1,000 felony convictions of financial executives.
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