Question

In 300 words or more please explain the Savings and Loans Crisis. Your answer should include the main events that caused it and the effects of the S&L crisis in the financial world.

Answer 1

The Savings and Loans crisis (popularly known as the S&L crisis) occurred during the period 1986 to 1995. This crisis was the failure of more than 1,000 savings and loan associations in USA. The main cause of the crisis can be attributed to certain public policies that were in force before the 1980s. Firstly and most importantly the S&L crisis mainly happened due to the extension of Federal deposit insurance to S&Ls in the year 1934. The flaw was that all S&Ls were charged with the same insurance premium irrespective of the quantum of risk associated with it. Secondly the S&Ls were forced by the federal policy to borrow short and lend long. This did not work well in favor of S&L as the S&Ls were mainly funded through short term deposits. This led to maturity mismatching for the S&Ls. Thirdly interest rate restrictions locked the S&Ls to below market rates on several mortgages. The problem was further augmented by the federal ban on adjustable rate mortgages which came into effect in the year 1981. This increased the maturity mismatching problem for the S&Ls. There were also restrictions put in place for the S&Ls to set up branches. Moreover there were restrictions from a nationwide banking perspective and this prevented S&Ls to optimize their operations by not being able to expand across state lines. All these reasons collectively led to the Savings and Loans crisis.

The effects of the S&L crisis in the financial world were significant as well as rampant. The immediate aftermath of the S&L crisis was that it led to a slowdown in the financial world. However it led to long term systematic reforms that aimed to fill the loopholes and ensure that a robust structure and framework is put in place. The Federal Home Loan Bank Board was abolished along with the Federal Savings and Loan Insurance Corporation. The Federal Housing Finance Board was created. Other effects were policy changes like requiring the S&Ls to meet minimum capital standards, raising of deposit insurance premiums etc. All this served the purpose of strengthening the framework under which the S&Ls functioned.

(353 words)