Savings and loan crisis

Definition

The savings and loan crisis was a financial disaster that occurred in the United States during the 1980s and early 1990s, characterized by the insolvency of numerous savings and loan associations (thrifts) due to risky lending practices and regulatory failures. This crisis not only led to the collapse of around a third of the nation's thrifts but also prompted significant government intervention and reforms in banking regulations, ultimately reshaping the landscape of corporate governance within financial institutions.

5 Must Know Facts For Your Next Test

1. The savings and loan crisis resulted in the failure of approximately 1,000 savings and loan institutions, leading to a total cost of about $160 billion to taxpayers.
2. Many savings and loan associations engaged in high-risk investments, including commercial real estate and junk bonds, which contributed significantly to their downfall.
3. The crisis prompted the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in 1989, which aimed to restructure the thrift industry and improve regulatory oversight.
4. The savings and loan crisis highlighted significant flaws in existing regulatory frameworks, leading to reforms that enhanced corporate governance practices within financial institutions.
5. The aftermath of the crisis saw the creation of the Resolution Trust Corporation (RTC), tasked with managing and disposing of assets from failed thrifts.

Review Questions

• How did risky lending practices contribute to the savings and loan crisis, and what implications did this have for corporate governance?
  • Risky lending practices were at the heart of the savings and loan crisis, as many thrifts engaged in high-risk investments without adequate oversight or risk management strategies. This recklessness not only led to significant financial losses but also exposed weaknesses in corporate governance structures within these institutions. The crisis underscored the need for stronger regulatory frameworks and better governance practices to ensure responsible decision-making and protect depositors' interests.
• Discuss the role of regulatory forbearance during the savings and loan crisis and its impact on financial stability.
  • Regulatory forbearance played a critical role during the savings and loan crisis, as regulators often allowed insolvent institutions to continue operating rather than taking immediate corrective actions. This approach ultimately exacerbated the situation, as failing thrifts accumulated further losses, putting more pressure on the financial system. The experience highlighted how inadequate regulatory oversight can lead to systemic risks, prompting calls for reforms to strengthen corporate governance within financial institutions.
• Evaluate the long-term effects of the savings and loan crisis on the banking sector's regulatory landscape and corporate governance practices.
  • The savings and loan crisis had profound long-term effects on the banking sector's regulatory landscape, leading to significant legislative reforms aimed at preventing future crises. The establishment of the Resolution Trust Corporation and new regulations under FIRREA were pivotal in restoring confidence in financial institutions. Additionally, the crisis catalyzed improvements in corporate governance practices by emphasizing transparency, accountability, and effective risk management in banks. As a result, these changes helped shape a more resilient banking sector capable of better safeguarding depositors' funds.

Related terms

thrift institutions: Financial institutions that primarily accept savings deposits and make loans, primarily focusing on residential mortgages.

regulatory forbearance: A practice where regulators allow financial institutions to operate despite being technically insolvent, often leading to worse outcomes over time.

FDIC: The Federal Deposit Insurance Corporation, a government agency that provides deposit insurance to depositors in U.S. commercial banks and savings institutions.