The Greatest Savings Crisis in History
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A crisis the size of the TAT crisis, is, inevitably, political. It involves
thousands of citizens, many decision makers from every walk of life and the very
economic and financial fabric of the country.
But, the TAT crisis pales in comparison with other, similar, crises in other
countries in the world.
In Israel in 1983, ALL the banks collapsed on ONE October day, for instance!
The biggest crisis of savings and loans institutions (the equivalent of
Macedonia's Stedilnicas) in history happened in the USA in the years 1986-1987.
A Savings and Loans Association (SLA), or a THRIFT, was a strange banking
hybrid, very much akin to the Building Societies in Britain. On the one hand, it
was a sort of a bank, allowed to take in deposits. On the other hand, it was
allowed to land money only to current or prospective homeowners on the basis of
a mortgage on their house. It was really a mortgage bank and only that. This
limitation on the nature of their asset portfolio, increased the risk associated
with their lending. The SLAs could not diversify their portfolio into other
kinds of assets and so were exposed to the vicissitudes of the residential real
estate markets in their respective regions. Sure enough, when the real estate
markets experienced a normal business cycle slump, the SLAs were
disproportionately affected. Regional economic shocks (such as down spiralling
commodity prices) rocked the value of real estate and the stability of these
lending institutions. The coup de grace was delivered through the inordinately
volatile interest rates. SLAs had to pay short term depositors high interest -
while collecting lower income, in the form of interest payments on their old
loans. This negative spread between the cost of funds and the assets' yield -
eroded the operating margins of the SLAs. When they discovered that the
securities that they were holding were much less valuable than the loans that
they were intended to secure - panic ensued.
Hundreds of thousands of depositors crowded to draw their funds. Hundreds of
SLAs (out of a total of more than 3,000) were rendered insolvent, unable to pay
their depositors. They had to shut up their gates and were put to siege by angry
- at times, violent - clients who lost their life savings.
The illiquidity spread like fire. One stedilnica after the other collapsed,
leaving in their wake major financial crises, ruined businesses and homeowners,
devastated communities. The crisis reached gigantic proportions and threatened
the stability of the whole banking system all over the USA.
The Federal Savings and Loans Insurance Corporation (FSLIC) - which insured
the deposits in SLAs - could no longer pay the claims and, in effect, went
bankrupt. This single event had a chilling effect on the Federal government.
True, the government did not guarantee the obligations of the FSLIC. Still, it
was perceived to be an arm of the Federal Government and the public shock and
outrage were beyond description.
So, the Federal Government was forced to step in. A hasty $300 billion (!)
package was put in place to save what could still be saved. This was the first
step, a right and proper reflex: the injection of liquidity through a special
agency, the FHFB. Everyone involved postponed the mutual accusations, the
criminal charges, the resignations and recriminations to a later stage. First
and foremost the system had to be stabilized and it could be stabilized only
through the restoration of public trust. Public trust could be restored only
with money - and with a lot of it. The visible, unambiguous involvement of the
top level authorities had a positive, long term effect. The "full faith and
credit of the USA" was now behind the SLAs and that was good enough for
everyone.
Now, that the storm was over, it was time for more farfetched, structural
changes.
First, the supervision of banks and banking operations was taken from the
Central Bank, the Federal Reserve. This separation of functions was long
overdue: the Central Bank can hardly be expected to supervise a game the rules
of which it dictates. There was bound to be a bias in its analysis of its
"clients" (not to mention the close personal relationships fostered in years of
common work).
Thus, the following complex structure emerged:
The Federal Deposit Insurance Corporation (FDIC) operates the Bank Insurance
Fund (BIF) and the Savings Associations Insurance Fund (SAIF), separate
insurance funds for banks and SLAs.
Banks pay premiums at one rate to BIF - SLAs pay at another to SAIF.
FDIC is designed to be independent in two ways. Its money comes from premiums
and earnings of the two insurance funds, not from Congressional appropriations.
Its board of directors has full authority to run the agency. The board has laws
to follow, but no boss.
The FDIC regulates banks and SLAs with the aim to avoid insurance claims by
depositors. When an institution becomes unsound, the FDIC can lend it money or
take it over. If it takes over, it can run it and then sell it as a going
concern. It has the authority to close it, pay off the depositors and try to
collect the loans. Often the borrowers cannot pay, so the FDIC ends up owning
collateral for loans, say real estate and trying to sell it.
The Resolution Trust Corporation (RTC) is a direct result of the SLAs
scandal. Prior to 1989, SLAs were insured by the now-defunct FSLIC. The FDIC
insured only banks. Congress had to eliminate FSLIC and put the insurance of
SLAs under FDIC. Still, a great number of SLAs were regarded as "special risk"
cases. They were given over to the jurisdiction of the RTC. It took over SLAs
that failed under FSLIC and later - until August 1992. It operated and sold SLAs
- or paid depositors and closed the relevant SLAs (just like the FDIC does). The
money to finance the RTC came from bonds sold by a new government corporation
(Resolution Fund Corporation, RefCorp). RTC ceased to effectively operate last
year.
The Office of Thrift Supervision (OTS) was also established in 1989 and it
also supervises SLAs.
This used to be the function of the Federal Home Loan Board (FHLB), which was
dismantled by Congress in 1989. OTS is a department within the Treasury
Department, but law and custom make it practically an independent agency. It
supervises around 1500 thrifts with assets of circa 1 trillion Dollars.
The Federal Housing Finance Board (FHFB) regulates and examines SLAs - but
with emphasis on their liquidity. It aids their financial stability through
lines of credit from twelve regional Federal Home Loan Banks (FHLB). Those banks
and the thrifts make up the Federal Home Loan Bank System (FHLBS). Many FHFB
regulations are intended to make sure that SLAs lend for housing - the reason
that Congress created this bank-like system, separated from the banks.
FHFB gets its funds from the System and is independent of executive branch
supervision.
A host of other supervisory and regulatory agencies and treasury departments
is involved in the American banking system. But at least one thing was achieved:
a clear, streamlined, powerful regulatory hierarchy. SLAs (and banks, for this
matter) utilized the confusion generated by the overlapping areas of activity
and authority of the numerous previous agencies. No one agency had the full
picture. Now, all became obvious: insurance was the FDIC's job, supervision was
the OTS's and liquidity was the realm of the FHLB. This may, arguably, be the
biggest benefit which stemmed from this, otherwise, nerve - wrecking crisis.
The process was not devoid of mistakes. Healthy thrifts were coaxed and
cajoled to purchase less sturdy ones. This weakened their balance sheets
considerably and the government reneged on its promises to allow them to
amortize the goodwill element of the purchase over 40 years. Despite all this,
the figures are unequivocal:
Thrifts numbered 2,898 in 1989. Six years later, their number shrank to 1,612
and it is forecast to go down to less than 1,000 at the turn of the millennium.
A process of consolidation is evident: SLAs merge, become bigger, stronger,
better capitalized. They resemble banks, in this sense.
This last development was so overwhelming, that Congress decided to demand
that each SLAs should have a bank charter by the year 1998. Paradoxically, the
very success of the SLAs in healing themselves led to their elimination. Why
have two kinds of banks if all the operational parameters are equal? Why use two
names, two separate insurance and supervision bureaucracies and two sets of
regulations to monitor and regulate essentially the same kind of entities? This
was absurd. While in the height of the crisis the ratio of the SLAs equity to
their assets was less than 1% - it reached almost 10% (!) in 1994 - better even
than banks.
This remarkable turnarounds (one of the most stunning in human financial
history) was brought about by serendipity as much as by careful planning.
Interest rate spreads became highly positive (SLAs were able to collect interest
- for, instance, by investing in government securities - which was much higher
than the interest that they paid for their sources). The stock exchanges soared
and enabled the SLAs to offer new stock at excellent prices. This, together with
the persistent pruning of the weeds in the field of good SLAs, with downsizing
of the bloated bureaucracies of the SLAs and with the on going consolidation
process - led to the revitalization of these banking institutions.
The overall banking markets shrank as other types of financial intermediaries
joined the fray - but the health of the SLAs was guaranteed.
As this new found health became more and more evident, the legislative bodies
eased up. Congress began to implement the gradual repeal of the draconian
Glas-Steagall law (which forbade banks from dealing with a whole range of
financial activities). They realized that the more diversified the financial
institution is - the healthier it is likely to be. Limiting a bank to certain
types of assets or to a certain geographical location was dangerous. Congress
began, therefore, to lift these restrictions.
One element need not be neglected in this discourse: the relative absence of
political intervention in the handling of the crisis. It was managed by the
Federal Reserve - an able, utterly professional, blatantly a-political body.
This is the most autonomous central bank in the world. It is never afraid to
face the two biggest powers in the world: the President of the USA and Public
Opinion - and it does this often. It thrives not on conflict but on the proper,
impartial management of the economy.
This, by all means, is the biggest lesson to be learnt.
About the Author
Sam Vaknin is the author of "Malignant Self Love - Narcissism Revisited" and
"After the Rain - How the West Lost the East". He is a columnist in "Central
Europe Review", United Press International (UPI) and ebookweb.org and the editor
of mental health and Central East Europe categories in The Open Directory,
Suite101 and searcheurope.com. Until recently, he served as the Economic Advisor
to the Government of Macedonia.
His web site:
http://samvak.tripod.com
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Article Published/Sorted/Amended on Scopulus 2007-11-10 10:58:03 in Economic Articles
