Loans and Savings (S&Ls) are specialized banks created to promote homeownership at affordable prices. They get their name from financing mortgage loans through savings that are insured by the Federal Deposit Insurance Corporation. Historically, they offered higher rates on savings accounts to attract more deposits, thereby increasing their capacity to provide loans.
The Early Source of Mortgage Loans
Before the Federal Home Loan Bank Act of 1932, most mortgage loans were short-term and issued by insurance companies, not banks. Then, Savings and Loans gained the ability to offer 30-year mortgage loans with lower monthly payments than what was previously available. This helped make homeownership more accessible.
Establishment of Savings and Loan Banks
Prior to the Great Depression, mortgage loans were 5 to 10-year loans that needed to be refinanced or paid off with a large lump sum. By 1935, 10% of homes in the United States were in foreclosure due to these harsh terms and declining property values. To stop this destruction, the New Deal accomplished three things:
- The Home Owner’s Loan Corporation purchased a million delinquent loans from banks. It then converted them into long-term fixed-rate loans as we know them today and reinstated them.
- The Federal Housing Administration provided insurance for mortgage loans.
- The Federal National Mortgage Association created a secondary market for loans.
Growth of the Mortgage Loan Market
In 1944, the Veterans Administration established a mortgage loan insurance program that reduced payments. This encouraged returning veterans from the war to purchase homes in the suburbs. The program contributed to stimulating economic activity in the home building industry.
Problems of Savings and Loan Banks
In 1973, President Richard Nixon caused rampant inflation by removing the U.S. dollar from the gold standard. Savings and loan banks could not raise interest rates to keep up with rising inflation, causing them to lose deposits to money market accounts. This led to a depletion of the capital that savings and loan banks needed to create low-cost mortgage loans. The industry asked Congress to remove some restrictions on their operations.
The Collapse and Bailout
The collapse of these investments led to the failure of half of the nation’s savings and loan banks. With banks in disarray, government and federal insurance funds began running out of money needed to recover deposits.
In 1989, the administration of George H.W. Bush rescued the industry through the Financial Institutions Reform, Recovery, and Enforcement Act. FIRREA provided $50 billion initially to close failing banks, created the Resolution Trust Corporation to resell bank assets, and used its proceeds to refund depositors. FIRREA prohibited savings and loan banks from making more risky loans. Unfortunately, the savings and loan crisis destroyed trust in institutions that were previously thought to be safe sources of mortgage loans because they were backed by state-managed funds.
Repeating Past Mistakes
Like other banks, savings and loan banks were prohibited by the Glass-Steagall Act from investing depositors’ money in the stock market and high-risk ventures for higher returns. The Clinton administration repealed the Glass-Steagall Act allowing American banks to compete with less regulated international banks. It permitted banks to use federally insured deposits to invest in risky derivatives.
The most popular risky investment instruments were mortgage-backed securities (MBS). Banks sold loans to Fannie Mae or the Federal Home Loan Mortgage Corporation. They then pooled the loans and sold them as mortgage-backed securities to other investors in the secondary market.
Many hedge funds and large banks were buying loans, re-securing them, and reselling them with subprime mortgage loans included in the package. These large institutional buyers insured against the loan-based assumptions by holding credit default swaps (CDS). The demand for pooled and returning securities was so high that banks began selling loans to anyone and everyone. A real estate bubble emerged.
Crise
2006
Everything was fine until real estate prices began to decline in 2006. Mortgage defaults started by homeowners, and the structured finance market collapsed selling mortgage-backed securities and re-packaging. The timeline of the 2008 crisis recounts the critical events that occurred in the worst financial crisis in the United States since the Great Depression.
Washington Mutual was the largest savings and loan bank in 2008. It ran out of cash during the financial crisis when it could not resell its loans in the collapsed secondary market. When Lehman Brothers went bankrupt, Washington Mutual depositors rushed to withdraw. They pulled out $16.7 billion in the following ten days. The Federal Deposit Insurance Corporation took over Washington Mutual and sold it to JPMorgan Chase for $1.9 billion.
Savings and Loan Banks After the Crisis
The gap between commercial banks and savings and loan banks diminished significantly. By 2019, there were only 659 savings and loan banks, according to the Federal Deposit Insurance Corporation. The agency supervised nearly half of them. Today, savings and loan banks are similar to any other bank, thanks to the FIRREA bailout in the 1980s.
Most of the remaining savings and loan banks can offer banking services similar to other commercial banks, including checking and savings accounts. The main difference is that 65% of a savings and loan bank’s assets must be invested in mortgage loans.
Another major difference is the local focus of most savings and loan banks. Compared to banks, which are often large multinational corporations, savings and loan banks are more commonly locally owned and managed, resembling cooperative associations. For this reason, they are often a good place to find the best mortgage rates.
Source: https://www.thebalancemoney.com/what-are-savings-and-loans-history-and-today-3305959
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