S&Ls: Much More Than Sleaze
It may have been the financial scandal of the century, yet the savings and loan crisis remains shrouded in mythology. Every S&L story features sleazy bankers and politicians. The scandal has become a giant caricature: a classic example (it is said) of how greed, corruption and inept regulation cost taxpayers between $500 billion and $1 trillion. Well, not exactly.</br></br>In many ways, the popular perception is badly distorted. Ignored in its infancy, the scandal has been sensationalized in its maturity. Its costs, though huge, have been exaggerated, and its causes have been overdramatized. This makes good copy but bad history. There was more than sleaze to this. As the crisis fades into folklore, we need to pause and recall what actually happened and why. Let's start by puncturing some common myths.</br></br>In fact, the big villain was inflation. Until the 1970s, S&Ls were a safe business. They took deposits at 3 or 4 percent and then lent the money as long-term home mortgages at 6 or 7 percent. Profits were almost guaranteed. Rising inflation destroyed this formula. Short- term deposit rates rose, leaving S&Ls with tens of billions of dollars in mortgages at lower rates. Losses exploded. By 1982, only 15 percent of S&Ls were profitable, and two-thirds were technically insolvent. Assets (mainly mortgages) were worth less than liabilities (mainly deposits).</br></br>After that, there was plenty of inept management and bad government regulation. But everything flowed from the inflation. The Reagan administration and Congress gambled that the industry could be saved. S&Ls' lending powers were broadened to permit more lucrative loans on office buildings and other commercial construction projects. The gamble backfired. S&Ls - not experienced in these areas - made billions of dollars of lousy loans. A bad situation became worse.</br></br>We can now see what happened. Because deposits were insured by the government, S&Ls could tap unlimited amounts of funds. They lured the funds with high interest rates. S&Ls then played with taxpayers' money. If new investments succeeded, the S&Ls would become profitable. If not, taxpayers would pick up the losses. Some S&Ls were taken over by high-fliers: the Charles Keatings of the world. But criminality was not the main problem; recklessness was. No one really knows how much outright fraud raised the bailout's cost. Estimates vary from 3 to 25 percent, according to a recent report by the Congressional Budget Office.