What do you believe were the causes of this scandal? It looks like the inability to charge S&L banks different amounts for deposit insurance, depending on how risky the loan was, led to shitty lending practices…
Also what exactly is regulation Q? I read this attempt at price fixing helped cause the S&L scandal, but I couldn’t understand the specifics…
The S&L crisis occurred because of bad deregulation. Under previous regulation, S&Ls were limited to loan on owner-occupied single-family residences and their deposits were insured by the Federal Savings and Loan Insurance Corporation (FSLIC). In the 1980’s, the S&Ls were permitted to loan on commercial and industrial real estate, which generally have a higher risk of default than homes. Nonetheless, the FSLIC continued to insure the S&L deposits and didn’t increase the premiums that the S&Ls paid for this insurance. The S&Ls made increasingly risky loans and many went under when these loans defaulted.
The lesson is that partial deregulation can be worse than regulation. If the government-backed FSLIC insurance had been withdrawn at the same time that the permitted lending requirements were liberalized, the banks would have had to underwrite their loans more carefully. As it was, the S&Ls made reckless loans with higher returns and the knowledge that the FSLIC would bail them out if things went wrong.
Regulation Q prohibited the payment of interest on demand deposits (checking accounts). This dated back to the Glass-Stiegal act of the 1930’s. In the 1980’s, mutual funds emerged as an alternative to checking accounts. These funds were permitted to pay a return on the money invested but also issued checks that could be used like regular checks. The argument is that these accounts put increasing pressure on the S&Ls to pay interest on demand deposits and led to revisions in the law that allowed S&Ls to pay this interest. The increasing pressure to earn a return on these deposits supposedly forced S&Ls to invest in riskier mortgages.
The situation is similar to the most recent housing crisis, except that this time it was Fannie Mae and Freddie Mac who were buying the increasingly risky loans. The difference is that, in the early 1990s, we quickly sold the defaulted properties at reduced prices so that they were all back in productive use by 1995 (I appraised many of these properties for the Resolution Trust Corporation). This time, the properties are being kept out of productive use by a plethora of government programs.