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HEADS THE S&LS WIN, TAILS THE TAXPAYERS LOSE:
THE POLITICS BEHIND REGULATION AND
DEREGULATION OF THE SAVINGS AND LOAN INDUSTRY

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JILL S. HUERTA

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HEADS THE S&LS WIN, TAILS THE TAXPAYERS LOSE: THE POLITICS
BEHIND REGULATION AND DEREGULATION OF THE SAVINGS AND LOAN
INDUSTRY
By

Jill S. Huerta

A DISSERTATION
Submitted to
Michigan State University

in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY
History

2009

ABSTRACT
HEADS THE S&LS WIN, TAILS THE TAXPAYERS LOSE: THE POLITICS
BEHIND REGULATION AND DEREGULATION OF THE SAVINGS AND LOAN
INDUSTRY
By

Jill S. Huerta

Though it has received little attention from historians, the savings and loan
industry played a vital role in the 19th and 20th century US. financial system. The earliest
savings and loan institutions, which were small, cooperative self-help ventures, filled a
void in the financial marketplace, which offered few home finance options that met the
needs of average workers. Savings and loans allowed Americans with modest means to
participate in the activity of home ownership. During the Great Depression, the Hoover
and Roosevelt administrations created a regulatory structure and a host of programs that
made the federal government a major player in the home finance market in order to
encourage and expand home ownership. This helped savings and loans to become the
largest writers of home mortgages in the country by the mid 1950s. However, by the
early 1970s, changes in the global economic structure and corresponding adjustments to
US. financial markets had made savings and loans less essential. Home finance had
gradually become integrated into the larger US. capital market, which took over the
function of bringing together savers and borrowers previously performed by savings and
loans. As institutions suffered under the new conditions, the federal government chose to

address the problem through partial deregulation of the industry, which ultimately

worsened the problem, delayed the implementation of genuine solutions, and
exponentially increased taxpayer liability.

This dissertation traces the history of the savings and loan industry from its
humble beginnings in 1831 through its collapse in the late 19805. Sitting at the
intersection of politics and economics, it analyzes decisions made by the federal
government to support, regulate, and deregulate the industry in the context of large
economic change. It especially emphasizes the formation of deregulatory policies and
legislation in 1980 and 1982, carefully examining the political forces involved in crafting
laws; and identifying individuals, interest groups, and regions that lobbied for and
benefited from them. This historical narrative, on the most basic level, acts as a case
study of how one industry was affected by and reacted to changes in the trajectory of US.
capitalism over time. On a deeper level, it sheds light on the way in which various
segments of the elite class vied for advantage, viewing economic regulation as an arena
for competition among powerful groups. Most important, this study highlights the
critical historical moment when American capitalism forged a new path. The savings and
loan debacle unfolded just as key transformations were in their infancy. The idea of
deregulation had just begun to captivate the minds of intellectuals and policymakers; and
the financial market was just beginning to become more complex and less transparent.
These trends continued throughout the remainder of the 20th century and became key
features of the financial crisis of 2008. By that time the American economy looked more
like a casino than like a global industrial power. Today, the US. economy continues to

struggle with the wider ramifications.

Cepyright by
JILL S. HUERTA
2009

ACKNOWLEDGEMENTS

In completing this project I have received much support and it is with great
pleasure that I take this chance to express my gratitude. During my time in the doctoral
program at Michigan State University, my advisor, Mark Kombluh, has always been
there when I needed him. His mentoring, both in the classroom and throughout this
project, has profoundly shaped my understanding of US. political economy.
Furthermore, he encouraged me to take on a difficult topic, one with great potential to
deepen our understanding of current political and economic issues, and that has made all
the difference. The other members of my committee have all made key contributions to
my thinking. Lisa Fine has given me invaluable insight into the US. labor movement,
with all its strengths and flaws; Lewis Siegelbaum patiently saw me through thousands of
pages of Karl Marx and other works that proved even more challenging; and David
Bailey taught me how deeply capitalism affects every aspect of American society.
Before her death, Mary Cookingham devoted precious time and energy to enhancing my
knowledge of economic history.

The History Department at Michigan State University has generously supported
my work through numerous assistantships and two Summer Research Enhancement
Fellowships. In addition, the Graduate School’s Dissertation Completion Fellowship
allowed me to devote my full time to writing for several months. During my research,

librarians at Michigan State and the University of Michigan provided frequent and

helpful assistance and the staff at the Jimmy Carter Presidential Library showed me true
hospitality.

On a personal level, many people have helped me find the stamina and focus that
a project such as this requires. My parents, Rhoda and Myron Derman, gave me a
childhood rich with opportunities and taught me the importance of education, self-
discipline, and work ethic. My children, Arthur, Gaby, and Skye, supported me in
countless ways, ranging from cups of coffee and hand-drawn cards during comprehensive
exams to babysitting for their younger brother, J ett, while I finished writing. My husband
and best friend, Jeff, as always, pushed me to ask more of myself. He put his own goals
and aspirations on hold so that I could pursue mine. I only hope that I have done justice

to that sacrifice.

vi

TABLE OF CONTENTS

INTRODUCTION .................................................................................... 1

CHAPTER 1

THE FIRST 100 YEARS .............................................................................. 8
The 19th Century U.S. Political Economy .................................................... 8
The Humble Beginnings of Savings and Loans .............................................. 13
Increasing Competition and Regulation ...................................................... 17
The Great Depression and the New Deal Reshape the Industry ........................... 22

CHAPTER 2

THE NEW DEAL REGULATORY STRUCTURE: 1942-1978 ............................. 37
The War Years ................................................................................... 37
1946-1955: Years of Growth and Prosperity ................................................ 42
1956-1966 ........................................................................................ 57
1967-1978 ........................................................................................ 65

CHAPTER 3

DEREGULATION: THE RESTRUCTURING OF THE NEW DEAL

REGULATORY SYSTEM ........................................................................ 84

CHAPTER 4

MORE DEREGULATION ....................................................................... 129

CHAPTER 5

THE COLLAPSE AND ITS MEANING ...................................................... 175

BIBLIOGRAPHY ................................................................................. 212

vii

INTRODUCTION

If the global economic crisis of 2008 has taught us anything, it is to appreciate the
cenu-ality of the finance system in our modern capitalist economy. It has also highlighted
the complexity of that system and called into question our ability to manipulate it and to
predict the outcomes it will produce. Economists, money managers, scholars, and
policymakers have been humbled. There is much to be learned about the current crisis by
studying the savings and loan collapse of the 19803, as it involves many of the same
features that lay at the center of today’s economic turmoil. The savings and loan debacle
unfolded during the infancy of key trends that affect us today. Financial markets were
just beginning to become more intricate and less transparent, and the deregulatory
impulse was just starting to captivate the minds of intellectuals and policymakers of both
political parties. The savings and loan collapse did not discourage supporters of
deregulation or shake their belief that less government oversight would create better
outcomes. Instead, deregulation picked up momentum and spread until most of the
financial regulation put in place by the New Deal had been undone. This set the stage for
the crisis of 2008. Like the current financial meltdown, the savings and loan disaster
required an unprecedented government bailout. Yet, historians have barely touched this
topic.

To date, the only scholarly historical work covering the S&L crisis is David
Mason’s From Building and Loans to Bail-Outs. In this detailed account of the industry
from its birth in 1831 through the 19803, Mason focuses on four themes: the evolution of

the industry over time; the role played by the thrift trade association in the development

of the industry; the relationship between the industry and the government; and the role
that savings and loans played in making home ownership part of the “American Dream.”
Mason argues that in its first hundred years, S&Ls saw themselves “as being part of a
social uplift movement that was more concerned with improving people’s lives than
making a profit.” That idea remained attached to S&Ls for a long time, Mason contends,
differentiating them from other sectors of the US. financial system even through the end
of the 20th century.1

The small number of works that chronicle the industry’s earlier history were
produced mainly as memoirs by regulators, or as public relations material by people who
worked in the industry.2 A number of journalists have published accounts of the savings
and loan crisis that provide important descriptions about what happened. However,
these books often focus on the more sensational aspects of the disaster, including criminal

cases.3 Finally, economists, have studied the crisis as it unfolded and afterwards.4

 

‘ David L. Mason, From Building and Loans to Bail-Outs: A History of the American Savings and Loan
Industry, 183 [-1995 (Cambridge University Press, 2004).

2 H. Morton Bodfish, History of Building and Loan in the United States (United States Building and Loan
League, 1931); Horace Russell, Savings and Loan Associations (M. Bender, 1960); Josephine Hedges
Ewalt, A Business Reborn: The Savings and Loan Story, 1930-1960 (American Savings and Loan Institute
Press, 1962); Leon T. Kendall, The Savings and Loan Business: Its Purposes, Functions, and Economic
Justification (Prentice-Hall, 1962); AD. Theobald, Forty Five Years on the Up Escalator (privately
published, 1979).

See Martin Mayer, The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry
(Charles Scribner’s Sons, l990); Kathleen Day, S&L Hell: The People and Politics Behind the $1 Trillion
Savings and Loan Scandal (W.W. Norton, 1993); Paul Zane Pilzer, Other People ’s Money: The Inside
Story of the S&L Mess (Simon and Schuster, 1989); Stephen Pizzo, Mary Fricker, and Paul Muolo, Inside
Job: The Looting of America ’s Savings and Loans (McGraw-Hill, 1989); Martin Lowy, High Rollers:
Inside the Savings and Loan Debacle (Praeger, 1991)

’ See R. Dan Brumbaugh, Jr., Thrifis Under Siege: Restoring Order to American Banking, Cambridge:
Ballinger Publishing Company, 1988; R. Dan Brumbaugh, Jr., The Collapse of Federally Insured
Depositories: The Savings and Loans as Precursor, Garland Publishing, Inc., 1993; M. Manfred Fabrituius
and William Borges Savings the Savings and Loan: The US. Thrifi Industry and the Texas Experience,
[950—1988 (Praeger, 1989); Ned Eichler, The Thrifi Debacle, Berkeley: University of California Press,
1989; James R. Barth, The Great Savings and Loan Debacle (The American Enterprise Institute Press,
1991)

My work, which sits at the intersection of economics and politics, chronicles the
federal government’s efforts to support, regulate, and deregulate the industry within the
context of structural change in the US. economy. While my work covers the same broad
time period as David Mason’s book, I emphasize the politics behind the legislative
processes that resulted in regulation and deregulation, focusing on the intricate
negotiations that took place between presidential administrations, members of Congress,
and industry leaders. In critically examining the legislative process, I analyze the
motives behind the govemment’s intimate involvement in housing finance after the
19303, as well as the reasons for radically adjusting the nature of that involvement in the
19803. I also seek to fit the savings and loan narrative into the larger story of the
trajectory of US. capitalism over time. The regulatory structure of financial institutions
closely corresponded with global structural economic changes and the ways in which the
US. capitalist system adjusted to them.

I chronicle the rise of regulation, the forces that created the need for regulatory
reform, and the political milieu that molded both regulation and deregulation. I argue
that the US. political system did not always respond quickly or well to the economic
imperatives of the industry, because other powerful interests, especially commercial 7
banks, stood to lose or gain from changes to the regulatory structure. Thus, multiple and
competing interests struggled to influence legislative outcomes and compromise proved
elusive.

Examining the industry from this perspective has allowed me to illustrate
important themes. On the most basic level, the savings and loan industry provides a good

case study of how the profound structural change to US. capitalism in the early 19703

affected one industry. By the 19703, many S&Ls found that they were old institutions
living in a new world. The new conditions threatened the well-being of the entire
industry and demanded that savings and loan business practices and regulations adapt.
However, those very adj ustrnents eventually resulted in the disappearance of a large part
of the industry. The new economic structure simply had no room for the thousands of
small and simple financial institutions that had served their local communities for more
than 100 years.

The savings and loan story also highlights the role that technology can play in
economic change. The ability of money to move instantaneously from account to
account, investment to investment, challenged the old regulatory structure and enabled
both investment professionals and individual depositors to demand more from their
depository institutions. Technological advances helped to build a national market for
deposits and for mortgage lending, and this ultimately called into question the need for
specialized institutions, like S&Ls, to carry out these tasks.

Finally, examining the results of S&L regulation and deregulation sheds much
light on the way in which various segments of the US. capitalist class compete. Changes
in regulatory structure create losers and winners. This is especially true with regard to
banking, because changes in the allocation of credit have strong reverberations not just
within one industry, but throughout the entire economy. The S&L story is the story of
billions of dollars moving from east to west, from the Rustbelt to the Sunbelt, and
ultimately into the Republican Party. The huge influx of capital funded expansive
economic development in the Sunbelt region, and though many S&Ls in the Sunbelt

failed during the 19803, the effects of the business infrastructure, real estate, and political

campaigns that they funded remain with us today. Though the rise to dominance of the
Sunbelt and the Republican Party in 1980 was based on many factors, the infiision of
large sums of capital into both must be credited for at least part of that ascent.

In chapter 1, I provide background by tracing the S&L industry from its 19th
century beginnings, through its first hundred years. During this time the industry
remained simple and unregulated. I then examine how thrifts fared during the Great
Depression and describe the New Deal overhaul of US. depository institutions. I argue
that New Deal regulation transformed savings and loans from relatively simple self-help
institutions created to fill a gap in the finance market, into a tool of the federal
government, used to vastly expand home ownership and spur consumption. In the
process, these institutions lost many of the sound economic principles which had guided
them for 100 years.

In chapter 2, I follow the industry experience through World War II, postwar
prosperity, and through most of the 19703. During and after the war, the New Deal
regulatory system was remarkably successful. However, by the 19603, inflation and
rising interest rates began to put severe pressure on S&L profitability. Congress’ attempt
to solve the problem with interest rate caps, in some ways made the problem worse,
causing disinterrnediation of deposits from S&Ls to other investments such as money
market funds whenever market interest rates rose above the capped rate. Several studies
undertaken during this era suggested solutions, but conflicting interests within the
financial sector mitigated against regulatory change. The various sectors of the financial

market—S&Ls, mutual savings banks, commercial banks, and credit unions—-sought to

protect their own interests and refused to compromise. Thus, the chance to solve the
problem before a full-scale crisis occurred came and went unrealized.

In chapter 3, which covers the years 1978-1980, I closely examine the process by
which financial reform was finally accomplished. I argue that an exceptional set of
economic and political circumstances finally allowed the passage of legislation. The feat
proved difficult, but the Carter administration worked hard to facilitate the process. The
resulting legislation, the Depository Institutions Deregulation and Monetary Control Act
(DIDMCA), I contend, was an admirable effort to solve industry problems. However, its
timing was unfortunate. Just as Congress passed the law, the Federal Reserve’s attack on
inflation drove interest rates up to unprecedented heights. Under these unusual
conditions, the implementation of DIDMCA’s reforms actually squeezed S&L
profitability and caused net worth problems for some institutions. This opened the door
for more financial reform.

In chapter 4, I study the Reagan administration’s regulatory and legislative
response to S&L problems, which came in the form of emergency relief and radical
deregulation of the industry. I argue that the response was constrained by a number of
factors, including Reagan’s political debt to a broad coalition of business interests that
had financed his 1980 campaign, the administration’s ideological commitment to
deregulation, and the administration’s desire to privilege military expenditure over
domestic spending. The resulting Garn-St. Germain Act made the problem worse and
significantly increased the cost of an ultimate resolution.

In chapter 5, I trace the disastrous consequences of sudden and drastic

deregulation. I describe the industry’s descent and collapse and explore the reasons for it.

I then examine what this story means, attempting to fit it into the narrative of American

democratic capitalist development.

lle'

CHAPTER 1

THE FIRST HUNDRED YEARS

The executives who ran the savings and loan industry of the 19803 would barely
have recognized the original institutions from which their organizations evolved. The
earliest savings and loans were private, uncomplicated, self-help mutual associations,
created to allow average people to pool their savings in order to purchase homes. And
sinlple these institutions remained for 100 years. Although savings and loans evolved
Slightly as they spread throughout the country, in 1930 they still performed two basic
functions: collecting deposits and writing home loans. Furthermore, the 19til century
POIitical economy in which S&Ls operated considered such endeavors private, and thus
the government imposed no regulation on the industry. The New Deal’s legislative
0v€31‘halrl of the US. banking system, however, marked the end of the unregulated era for
the SaVings and loan industry. For better or for worse, from 1931 onward, S&Ls became
creatures of the federal government, which privileged the social and political goal of

expanding home ownership over the outcomes produced by an unregulated home finance
market-

The 19“ Century U.S. Political Economy
The American savings and loan industry was born in the early 18303, into a
t"midly growing and transforming economy. American capitalism stood somewhere

betWeen its commercial beginnings and the concentrated industrial form it would take by

the end of the century. It was poised to undergo a period of development that would not
only change the economy’s size and scope, but would also permanently alter American
demographics, culture, and daily life. That development was based on technological
innovation, improvements in transportation, and advances in corporate law and finance.1
The tides that gradually and unevenly changed America’s economic landscape

from individual or family-owned workshops to large industrial public corporations and
factories, brought with them immense ripple-effect changes throughout US. society.
New methods of mass production made possible by technological and financial
innovation changed the nature of daily work, and pulled immigrants from Europe and
elsewhere into the country by the millions to brave the difficult conditions and low wages
the new factory system offered.2 Likewise, new methods of production led to massive
urbanization, as native citizens and immigrants alike, moved to where the jobs were. By
1900, New York City’s population topped 3 million, and Chicago and Philadelphia had

reached over 1 million inhabitants.3 The changes wrought by industrialization did not

 

 

l
I F 01' inlprovements in transportation, see George Rogers Taylor, The Transportation Revolution 1815-
8,60 (Rinehart & Company, 1951). For legal changes that affected industrial development, see James
E’Qlard Hurst, Law and the Conditions of Freedom in the Nineteenth-Century United States (The
me’ffi‘sity of Wisconsin Press, 1956) and Scott R. Bowman, The Modern Corporation andAmerican
olrtrcal Thought: Law, Power and Ideology (The Pennsylvania State University Press, 1996). For the
e"'eloplnent and evolution of the corporation see Naomi Lamoreaux, “The Partnership Form of
Or , . tion: Its Popularity in Early Nineteenth Century Boston,” in Jack Beatty, editor, Colossus: The
'g'm of the American Business Corporation, I 784-1855 (Broadway Books, 2001) and Martin J. Sklar,
e C"ofporate Reconstruction of American Capitalism, 1890-1916: The Market, The Law, and Politics,
“Tm“: Fudge University Press, 1988. For changes in corporate structure and the position of the corporation
Bus .111 the US. economy, see Allied Chandler, The Visible Hand: the Managerial Revolution in American
Em ”'ess (Bellmap Press, 1977) and Strategy and Structure: Chapters in the History of Industrial
2 Ferprise (M.I.T. Press, 1962).
or changes in the nature of work, see Harry Braverman, Labor and Monopoly Capital, Monthly Review
3- 1974; David Montgomery, Workers ' Control in America, Cambridge University Press, 1979; David
Montgomery, The Fall of the House of Labor, Cambridge University Press, 1987; David M. Gordon,
chant Edwards, and Michael Reich, Segmented Work, Divided Workers: The Historical Transformation
0; Labor in the United States, Cambridge University Press, 1982; Sean Wilentz, Chants Democratic: New
0"! City and the Rise ofthe American Working Class, 1 788-1850, Oxford University Press, 1984.

S- Census Bureau, Statistical Abstract of the United States, 2003 http://wwwcensus.gov/statab/hist/HS-
Lastrs- viewed March 21, 2007

stop there. They included fimdarnental transformations in everything from consumption
patterns and birth rates to gender relations and religion.

Banking, as Alexander Hamilton had predicted, played an integral role in the
industrialization process.4 As the savings and loan industry first took hold in the US,
national banking was buckling under the concerted attack of Andrew Jackson. After
vetoing the Second National Bank’s charter renewal in 1832, Jackson withdrew
government funds in 1833, making it almost impossible for the institution to function
properly.s State banks reaped the benefits, breaking flee from the much resented
regtll ation carried out by the national bank, and becoming the depositories for federal
funds- The number of state banks rose rapidly, as they filled the void left by the national
bank- In 1831 there were over 400 state banks;6 by 1837, there were 788;7 and by 1840
there were 901.8 Like most corporations during this era, banks operated under individual
Charters, created via special acts by state legislatures, in order to provide what was
VieWed as a valuable public service. State banks extended credit to finance private
economic activities and public improvements. They issued notes that circulated as
money in routine transactions. They handled state fiscal transactions and even generated
1“Venue for states in the form of taxes, charter fees, and dividends, when the state had an

o‘ll’nel‘ship interest in the bank. Charters contained specific conditions and regulations,

\

4
AleXaIIder Hamilton, “Report on a National Bank to the Speaker of the House of Representatives, 1790,”
ilk. S 1’ / anterican almmm .com/hambank.htrn accessed March 22, 2007.
(Th Hoffman, Politics and Banking: Ideas, Public Policy, and the Creation of Financial Institutions
5 IbiiJggns Hopkins University Press, 2001) 57-65.
1 .
VB“? Hammond, “Jackson, Biddle, and the Bank of the United States” The Journal of Economic History,
, 0L 7, No. 1 (Ma , 1947) 5-7.
2032)? Davies, A History of Money: From Ancient Times to the Present Day (University of Wales Press,
482-3.

10

stipulating the kind of credit banks could issue, the geographic distribution of that credit,
the chartering of additional banks, and branching requirements.9

The characteristics and practices of banks varied fi-om state to state and certainly
by region, reflecting differences in economics, climates, geography, and population
density among others. For example, banks in New England tended to be smaller with
fewer branches, and less state regulation. They issued loans to local artisans, farmers,
and merchants, who bank managers usually knew well. In 1819, mutual savings banks
began doing business in the northeastern U.S., generally as philanthropic enterprises.
They offered workers savings accounts with flexible terms, providing easy access to
funds during times of hardship or unemployment. Southern banks tended to be fewer,
1Ell‘ger, and to have more branches. Because of the nature of the southern economy, these
banks wrote a large number of agriculture and real estate loans, and fewer commercial
103113. Also, southern and western state governments played a much larger role in
regulation.10

In the 18303 and 18403 states began passing general banking laws that resembled
genera] incorporation laws. Known as free banking laws, these acts acknowledged banks
as PriVate institutions created for the purpose of profit, rather than publicly chartered
insfitutions created to serve a vital common need." Free banking laws, which most

States adopted by the Civil War, granted uniform conditions and regulations to all

\

9
Egsan Hoffman, 70-74.
M “San Hoffman, 75-77; Howard Bodenhorn, A History of Banking in Antebellum America: Financial
Ma'kets and Economic Development in an Era of Nation Building (Cambridge University Press, 2000) 32—

11 .
MIChigan and New York were the first to pass free banking laws in 1838. See Glyn Davies, 482.

11

incorporated banks. In many states, they served mainly as a formality because charters
had already become standardized.”

Banking remained a state-centered activity until the economic strain of Civil War
lefl the federal government severely short on cash. Initially the government sold bonds to
banks for payment in gold and silver, but the drain on specie became so serious that
eastern banks had to suspend their payment of notes in December of 1861. The federal
government then turned to the printing of greenbacks to finance the war, and Secretary of
the Treasury, Salmon P. Chase, asked Congress to create a national banking system to
coin a stable and integrated currency. The National Banking Acts of 1863 and 1864
implemented a system in which a host of private national banks issued a standardized
Currency, based on bonds purchased from the federal government The law stipulated
that l ‘7 reserve city banks hold fiinds equal to 25% of notes and deposits, half in cash and
up to half in deposits with one of the three central reserve city banks in New York, St.
Loui S, or Chicago. National banks made almost solely commercial loans. The National
Bank Act also established The Office of the Comptroller of the Currency to examine
theSe institutions.13

The National Bank Act sought to replace state banks with national ones. As
further encouragement, the federal government imposed a tax on state bank circulation in

1 866. Furthermore, several subsequent Supreme Court decisions outlawed state bank
netes. While this initially led to a steep drop in the number ofstate banks, they began to

reappear when they discovered they could circumvent prohibitions against issuing

 

\2
B Susan Hoffman, 77-89.
Susan Hoffman, 91-94; Glyn Davies, 491.

12

currency by supplying borrowers with deposit credit rather than notes.l4 States also
enticed banks to use state charters over federal ones by offering more lenient regulations
with regard to capital ratios and lending. The best efforts to nationalize and standardize
banking thus failed and the dual system survived, allowing states to continue granting

charters, along with the federal government.15

The Humble Beginnings of Savings and Loans

The industrial revolution and the migration, irnnrigration, and urbanization that
accompanied it created a great need for housing and a corresponding nwd for home
finance during the 19th century. Despite significant development of the banking industry,
the market offered limited options for home financing, especially for people of average or
modest means. Private state banks preferred to write short term commercial loans,
Payable in 30-60 days. These banks wrote some home mortgages, but under extremely
Conservative terms, requiring high down payments of up to 60% of the appraised value
of the home. Also, banks offered only short loan terms, usually 1, 3, or 5 years.
BC’l‘l‘Ovvers often made interest-only payments, with the full amount due at the end of the
tem- At that time, homeowners had to find a new lender or reapply for approval with _
their current lender, paying renewal fees in the process. In addition, homeowners often
had t0 originate second mortgages, written under even less favorable, sometimes usurious
terms. Mutual savings banks in the northeast invested their money mainly in low risk

We and municipal bonds. Because they offered savers flexibility in withdrawing funds,

Te
t’E‘lsan Hoffman, 94-97. For more on the National Banking Acts, also see William F. Hixson, Dimph of
R erkers (Praeger, 1993) 142-148, and Bray Hammond, Banks and Politics in America from the
‘SeVOIIttion to the Civil War (Princeton University Press, 1957) 724-734.
Ned Eichler, rite Thrifi Debacle (University of California Press, 1989) 5-6.

13

these institutions needed to keep their assets more flexible. Therefore, they wrote only a
small number of mortgages. Though they allowed slightly longer loan terms, they too
required high down payments.16 People also turned to insurance companies to finance
their homes. Life insurance policies sometimes functioned as savings accounts that
people could borrow from once they had accumulated enough cash value. Again, large
down payments were the rule. The only remaining alternative was to borrow privately
from a wealthy individual. ‘7

Few of these options met the home financing needs of the average worker. Thus
early savings and loans, initially referred to as building and loans,'8 originated as self-
help organizations, born to fill a void in the financial marketplace. Savings and loans
allowed average citizens to pool their resources together in order to purchase homes. The
Oxford Provident Building Association, established in 1831 in Frankford Pennsylvania,
was the first savings and loan to operate in the United States. Structured as a mutual
organization, and modeled after similar institutions in England, it was a simple financial
inStitution, with a specialized purpose, and highly restrictive rules about deposits and
loans- Its members, mainly textile workers, each bought shares in the mutual association
which they paid for through a down payment followed by fixed monthly payments. Each
time the association had accumulated enough capital to make a home loan, the funds

Were auctioned off to the member bidding the highest fee and interest rate. Borrowers

 

16
blames R. Barth and Martin A. Regalia, “The Evolving Role of Regulation in the Savings and Loan
Oglsh'y,” in editors Catherine England and Thomas Huertas, The Financial Services Revolution: Policy
\7 cc! ions For The Future (Boston: Kluwer Academic Publishers, 1988) 116.
A S“sap Hoffman, 156. David L. Mason, From building and Loans to bail-Outs: A History ofthe
\gme’ican Savings and Loan Industry, 1831-I995 (Cambridge University Press, 2004) 16-l7.
b . Vings and loans were originally referred to as building and loans, building associations, and sometimes
“‘lding societies. As the structure of buildings and loans slowly evolved, they came to be called savings
and 1(firms. After the New Deal changes to the regulation of financial institutions, S&Ls were also referred

‘0 as thrifts. Technically, the term “thrifis” refers to both savings and loans and mutual savings banks.

14

had to build or buy their homes within 5 miles of Frankford. They continued their fixed
monthly payments on their shares, in addition to makings payments on loan interest and
fees- I 9
Building and loans expected depositors would leave their money in the
association for its entire existence, and discouraged withdrawals by charging a 5%
penalty and requiring members to wait 30 days before receiving their money. They also
charged penalties for late payments. Associations returned profits to shareholders in the
form of dividends. After 10 years, when each member had purchased a home and repaid
the loan, the Oxford Provident dissolved. A second Oxford Provident, with a new group
of members, followed the first and another followed that one, each dissolving when all
loans had been repaid. This structure was known as the terminating plan. This modest
and simple model kept costs low and risks at a minimum. The members generally knew
03011 other and the community well, making it easy and inexpensive to gather accurate
information about borrowers and property. Personal character served as a strong
°0nSideration in loan approval decisions. Community leaders often acted as officers of
these institutions and frequently carried out their duties voluntarily. For example,

VOIImteer trustees ran the Oxford Provident without compensation.20

\
'9

Sta Vid Mason, 17-18, Hoflinan, 152, Josephine Hedges Ewalt, A Business Reborn: The Savings and Loan
Scary, I 930-1960 (American Savings And Loan Institute Press, l962), 374; Jack W. Cashin, History of
fhgs and Loan in Texas, (Bureau of Business Research, College of Business Administration, The

vel'sity of Texas, 1956) 4-5; Leon T. Kendall, The Savings and Loan Business: Its Purposes, Functions,

ind Economic Justification (Prentice-Hall Inc., 1962) 4-5. For the early history of the savings and loan

‘fstry, also see: M. Manfred Fabritius and William Borges, Savings the Savings and Loan: The US.
9‘1 Industry and the Texas Experience, [950-1988 (Praeger, 1989) chapter 2; R. Dan Brumbaugh, Jr.,
\ ms Under Siege: Restoring Order to American Banking (Ballinger Publishing Company, 1988) chapter

26
JoSephine Ewalt, 374-5; David Mason, 17-l 8; James R. Barth, The Great Savings and Loan Debacle
e American Enterprise Institute Press, 1991) 9-10; John Cashin, 4-5.

15

Most 19‘11 century workers regarded banks with great suspicion. However,
building and loans did not have the look or feel of banks. These were grassroots,
cooperative institutions, serving local communities. They were owned by their
members—the average workers who deposited their hard-eamed dollars—and dividends
were distributed equally among shareholders. They operated with little overhead and
much volunteerism and among people who knew each other well. In essence, they served
as a means for circumventing the banking system, which excluded most workers by
writing home loans under terms that were out of reach. Savings and loan historian David
Mason has compared building and loans to other 19th century cooperative movements and
associations such as the Knights of Labor, Farmers’ Alliances, and Populism. He argues
that leaders of the early building and loan industry self-consciously defined their
institutions as part of a social movement. In promoting building and loans to potential
Working class members and social reformers, they described their institutions as a means
for self-improvement. To workers, they touted their organizations as a way to become
Wealthy through the development of thrifty habits. To reformers, they praised the
POSitive effects on individual morality that resulted from homeownership. Movement
l"'a‘d'ers also highlighted the de-radicalizing effects of building and loans, pointing out that
homeowners were much less likely to oppose the capitalist system.21

Building and loans began in the Northeast and Mid Atlantic states and
Spread fi'om there to the Midwest. By the time of the Civil War, building and loans
existed in seven states; and by 1890 all states had at least one. As these institutions
Spread, their structure evolved. By about 1850, the terminating plan had been largely
rePlaced by a serial plan in which new members could join an existing building and loan

\

21
David Mason, 22-28.

16

by purchasing shares on set periodic dates. By the 1870s, the permanent plan, in which
new members could join and purchase shares on a rolling basis and in any denomination,
dominated. Over time, building and loans came to separate their services to savers and
borrowers. Those who bought shares and deposited their money did not necessarily have
to become borrowers, though institutions still expected shareholders to keep their money

in the institution long term, and imposed penalties for withdrawal in most states until the

1930s.22

Increasing Competition and Regulation
During the late 18808, national savings and loans began to appear, mainly in the
Midwest and South. These nationals hired promoters to sell shares either through the
mail or by opening local branches. They claimed to be facilitating the movement of
money from areas of surplus to regions of need, but many of them used fraudulent
Practices to make their owners wealthy. While local savings and loans were usually self-
helP ililStitutions, nationals existed for the sake of profit. They paid their promoters and
managers large salaries, resulting in operating expenses that were significantly higher
than ‘11086: of the locals. National institutions spread quickly. By 1893, over 290 national
Savings and loans spanned the country, and at their most successful point, nationals did
b‘J‘Siness in every state, controlling $139 million in assets.” In 1892, thirteen state
asSOCiations formed The US. League of Local Building and Loan Associations, largely
to lobby against the nationals. As the national and local savings and loans competed for

“1088, both types of mstltutlons called for leglslatron regulatlng the other. Local
22\

J am
77”? es R. Barth and Martin A. Regalia, 115-116, 120; David Mason, 22-29; R. Dan Brumbaugh, Jr.,
23 J is Under Siege: Restoring Order to American Banking (Ballinger Publishing Company, 1988) 3-4.

Vid Mason, 32-33.

 

l7

associations managed to influence the passage of restrictions on nationals in many states,
including blocking the opening of branches and limiting officers’ salaries. Some states
also passed laws calling for particular industry standards. These laws were usually
written by local thrift leaders, in an attempt to privilege their local associations over
national ones. The death blow was delivered to the nationals during the Depression of
1893, with half of them failing between 1893 and 1897. The combined effect of the
League’s success in generating a less favorable regulatory environment, the economic
strife of the depression, and the fact that many nationals were fraudulent schemes, led to
their disappearance altogether. However, the failure of so many nationals hurt the
reputation of savings and loans in general because most of the public did not understand
the difierence between locals and nationals. The newly formed League had to engage in
much damage repair to restore the industry’s reputation.24
The League set about doing this by emphasizing the ways in which home
ownership improved the individual. They adopted as their motto, “The American Home
The Safe-Guard of American Liberties.”25 This was not merely public relations banter.
AS historian David Mason argues, building and loans should be viewed as a social
movement, in fitting with the Knights of Labor and Populism. Their creators believed
that hOme ownership developed individual morals and character. They publicized their
i1lsfitmions as a means for reducing strikes and other forms of social unrest. They
fo‘m‘ied these institutions to help average people cope with their changing environment.

[asoll also emphasizes the spirit of cooperation and inclusion in the building and loan

2.\

1 996David Mason, 34-3 8; Mark Carl Rom, Public Spirit in the my: Tragedy (University of Pittsburgh Press,
) 26-27; Barth and Regalia, 120; Susan Hoffman, 158; John Cashin, 15-19; Leon Kendall, o.
een Day, S&L Hell: The People and the Politics Behind the $1 Trillion Savings and Loan Scandal

23
(W a“
-W_ NOrton & Company, 1993) 40. This motto appeared on the League’s letterhead until 1992.

 

l8

movement. Women, for example, participated heavily in both membership and
management of these organizations. Furthermore, ethnic groups often formed their own
institutions, holding meetings in local taverns, to lift up fellow group members and draw
their communities closer together.26
Regulation of building and loans developed slowly and varied by state. During
the l 8608, some industry leaders sought state oversight to protect them from competition,
to ensure safe operation, and to enhance public confidence in thrifis. Ohio, Pennsylvania,
and Illinois led the way in enacting regulation. New York was first to require the filing
of annual reports with a banking commissioner and in 1887 it required state
examinations. The failure of so many national building and loans in the 18903, led to an
increase in regulatory statutes, which industry leaders desired and often drafied
themselves, through the League. By 1900, all states had some form of regulation, usually
limited to reporting and examination requirements. Besides guarding against hand and
insider abuse with varying degrees of intensity, examiners confirmed that thrifis used
their deposits only to write home mortgages, keeping the industry simple and the risks
low, States also restricted the number of charters granted in order to limit competition.”
In 1913, Congress significantly expanded federal involvement in and regulation
of commmial banking with the passage of the Federal Reserve Act. Responding
sonleWhat to the panic of 1907, the system sought to impose order and coordination on
the nation’s banking system by providing a lender of last resort to solvent banks

xpenencmg a parnc-mduced run.28 The act also sought to create a more elastlc currency

2.5\

27 32"?! Mason, 22-27, 54; Kathleen Day, 40-41.

23 W30}! Mason, 70-74, Barth and Regalia, 117; Susan Hoffman, 158.

Get. “138111 F. Hixon, Triumph of the Bankers: Money and Banking in the Eighteenth and Nineteenth
e8 (Praeger, 1993) 177-179; Glynn Davies, 501.

19

that would self-adjust based on the credit needs of business, and to respond to critics who
claimed that the national bank system funneled money to the reserve city banks,
particularly New York, which then channeled the funds into the stock market.29 Thus,
the Federal Reserve System divided the country into 12 districts, each with its own
reserve bank. The law required that all national banks become members, but gave state
banks the option to belong or not. Member banks were to deposit their reserves in the
district reserve bank, and could borrow funds to cover withdrawals or to make loans. The
Federal Reserve Board had the responsibility of supervising the district banks. Over
time, the Federal Reserve System became a means for conducting national monetary
policy by adjusting reserve requirements and interest rates.30
No such system existed for savings and loans, which at this time, were regulated
only at the state level. The Wilson administration made an overture to the industry in
1 9 1 9, inviting the League to a housing conference. The administration had drafted an act
for the building and loan industry that looked much like the Federal Reserve System, but
industry support was split and the bill failed in Congress. It would be more than 10 years
before the federal government became involved in the industry again31
During the late 19“1 and early 20‘“ centuries, savings and loans grew considerably,
from 5598 institutions throughout the country in 1893 to about 12,000 by 1930.

Toeethcr, the roughly 12,000 institutions held about 10% of the savings accumulated by

\

29

Nflyn Davies claims that from 1914 to 1928, the Federal Reserve system indeed became dominated by

- w Yerk “where policy was determined predominantly by the demands of Wall Street and of the
Gov Onal money market, moderated, if at all, by whatever influence the Washington Board of

Of Nemors could exert against the dominant personality of Benjamin Strong, Governor of the Reserve Bank
30 ew York.” Glyn Davies, 505.
8 “$811 Hoffman, 111-125; R. Dan Brumbaugh, Jr., Thifls Under Siege: Restoring Order to American
Egghng (Ballinger Publishing Company, 1988) 142-144; Robert L. Heilbroner and Aaron Singer, The
3 l "0in Transformation of America: 1600 to the Present (Wadsworth, 1999) 212.

“d Mason, 74-75.

20

the American public and wrote mortgages on over 2 million homes. This amounted to
22% of all mortgages. Small institutions dominated the industry, with most possessing
less than one million dollars in assets, and fewer than 90 associations having more than
ten million dollars in assets.32
Building and loans offered more favorable home loans than other financial
institutions. Nonetheless, these were not the mortgages that we are familiar with today.
Even savings and loans, required large down payments, 33-60% by the 1920s, 25-35% by
1930, with many people taking out second mortgages to meet that requirement. S&L
loan terms, though twice as long as those offered by commercial banks, still proved to be
short, 8-12 years. Frequent refinancing meant that borrowers carried the risk of
fluctuating interest rates, gaining or losing ground when rates changed.33
During the early 20th century, savings and loans began to face mild competition
from private commercial banks and other mortgage companies. Commercial banks
acquired the right to offer savings accounts in the early 19008, and they had good reason
to take advantage of the new opportunity. The American public was saving more money,
and for Federal Reserve member banks, reserve requirements were lower for savings
accoUDts than for demand deposits. Thus, individual savings became a cheap source of
Capital, which an expanding and innovating national economy clamored for in order to
u“derialre larger projects.34 Commercial banks also became more interested in writing

llmortgages, though national banks could not write loans secured by real estate until

32\

J .
33 D°Sephlne Ewalt, 3-5; Barth and Regalia, 1 15-1 16; David Mason, 61; Susan Hoffman 156.
B avid Mason, 52-59.
“uh and Regalia, 120.

21

1927.35 Savings and loans also faced competition from mortgage brokers and mortgage
companies which wrote about 5% of all home loans by 1929. In general, however, the

developing competition did not present a major problem to the industry.36

Thus, the first 100 years of the S&L industry were relatively sedate, characterized
by steady growth and slight evolution of structure and practices, the beginnings of
regulation, and the creation of the League. The basic mode of operation remained the
same. Institutions used short term fimds, in the form of deposits, to invest in fairly short
term assets, mortgages. The borrowers carried as much or more of the risk as the lenders.

In addition, savers had incentive to investigate and closely follow the soundness of their
depository institutions; not a difficult task since savings and loans remained simple
institutions that performed very few functions in a local market. Ifan institution became

unsound, discipline was administered by savers who had an incentive to place their funds

elsewhere.37

The Great Depression and the New Deal Reshape the Industry

 

\
35 ,

Man“! Mayer, The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry
ggharles Scribner’s Sons, 1990) 30.

37David Mason, 65.
_ enneth Snowden agrees that building and loan members had incentives to monitor all the activities of

K
the InStitutions to which they belonged, because greater profitability meant higher dividends and quicker
a“ Payrm‘fs. “Given this common ‘profit motive’, the entire membership had incentives to assure that the
that lation made safe loans, that other members paid dues, interest and premium charges promptly, and
l the administrative expenses of the association were kept to a minimum.” However, he argues that the
Rathca nature of building and loan markets was not attributable to the need to monitor fellow members.
builde‘r’ he contends that the main reason for localization was the fact that organizers and directors of
e mg and loans were homebuilders who were interested in providing a means for financing homes that
y {Huh in the local community. They therefore acted as directors for little or no compensation and
Day “9d local real estate professionals to act as secretaries. Real estate agents also worked for little or no
that Befmuse they too needed building and loans to finance home purchases. In essence, Snowden argues
mlCling and loan staffs and boards were filled with conflicts of interest, but ones that balanced each
011;; Real estate professionals who had incentive to write more, even perhaps risky loans were held ill
and by homebuilders who wanted only to sell homes they had built. See Kenneth A. Snowden, “Building
Loan Associations in the US. 1880-1893: The Origins of Localization in the Residential Mortgage

M
a'ket,” Research in Economics (1997) 51, 227-250.

22

While many believed that the unfettered and unregulated market tended to create
sensible and rational business practices, the Great Depression showed that it could also
wreak havoc, chaos, and suffering. By 1933, the unemployment rate had grown five fold.

The Federal Reserve’s index for industrial production, 110 in 1929, fell to 91 in 1930 and
plummeted to 58 by 1937. The economy witnessed severe deflation as business people
and average Americans alike cut their spending. Wholesale prices dropped almost a third
from 1 929 to 1932. Investment practically stopped. The American economy functioned

at a fraction of its potential capacity. And banks failed in large numbers—20% by
193 3 .33

Bank failures became so severe that by the time Roosevelt took office in March of
l 93 3, the system barely functioned}9 The new president declared a banking holiday
from March 6-9, with some Federal Reserve banks reopening on the 9'“. By June, the
American banking system stood forever altered, and the government had become a major
player in the U.S. financial system. The Glass-Steagall Act, passed in June of 1933,
addressed some of the ills that leaders perceived had caused the Great Depression. The
act separated commercial banking from investment banking to discourage speculation on
the StOCk market using deposits. Perhaps its most significant provision involved the ,
creation of the Federal Deposit Insurance Corporation (FDIC) to insure individual
dePOSits up to $5,000. This controversial modification to the banking system persuaded

people that it was safe to deposit their cash in banks again. The act also sought to reduce

\

3 8
(Hitseph Finkelstein, 7he American Economy: From the Great Crash to the Third Industrial Revolution
13‘ Le Davidson, Inc., 1992) 9-10, 17. For more on the Great Depression and the New Deal, see William
of}? uclltenburg, Franklin D. Roosevelt and the New Deal (Harper & Row, 1963), Alan Brinkley, The End
3 F eform: New Deal Liberalism in Recession and War (Vintage Books, 1995).

600% 1930-1933, 8812 banks failed. The average annual rate of failure for banks during the 19208 was

° See Glyn Davies 512.

23

competition among banks by prohibiting the payment of interest on demand deposits and

limiting the interest banks could pay on savings to a rate established by the Federal
Reserve Board. The Fed exercised this power under Regulation Q. These provisions
were intended to alleviate earnings pressure on banks by lowering their interest costs and
thus eliminating the need for risky, high-yielding investments.40 The prohibition of
interest on demand deposits also removed the incentive for small banks to deposit their
funds in larger city banks that might channel those funds into the stock market.“

The Banking Act of 1935 made the FDIC a permanent institution and gave the
Federal Reserve Board greater powers to manipulate the money supply, through reserve
levels, discount rates, and the buying and selling of government secmities. The
Securities Act of 1933 was the first federal regulation that dealt with the offering of
Pablic securities by a private corporation and the Securities Exchange Act of 1934

Created the Securities and Exchange Commission (SEC) to supervise and regulate the

S‘-”°011dary securities markets in order to protect investors.42
Saving and loan institutions encountered considerable hardships during the Great
Depression, although they did not, generally, experience the kind of runs on deposits and
failures suffered by commercial banks. Ironically, their greatest losses came fi'om the
fail‘ll‘e of commercial banks that served as depositories for their cash and as a source for
SI“)1‘t—term borrowing. Many S&Ls either lost their deposits in failed commercial banks
0" fQUnd their short-term loans called by distressed banks. At the same time, savings and
bans faced falling deposit levels and rising withdrawals, as savers, strained by the
depression, needed their fimds to pay for the cost of living. Withdrawals hit savings and

 

\
A0
Glyn Davies, 515; Heilbroner and Singer 289-291.

1
“2 Susan Hoffman, 120-130.
JOlin Finkelstein, 17-18; Susan Hoffman 135-6; Heilbroner and Singer 290-291.

24

loan institutions particularly hard because almost all their assets were tied up in illiquid
mortgage loans and their reserve levels were notoriously low. Many associations found
they could not pay out immediately when members made withdrawals. They had the
right to take 30 days to pay, but by tradition they had always paid immediately. Some
thrifts became “fi'ozen,” meaning depositors could not withdraw their funds at all.43 In
addition, increasing unemployment led to rising mortgage default levels. Savings and
loans therefore found themselves owners of a considerable amount of real estate that had
plummeted in value. The result of all these problems was an unprecedented number of
faillms in the 1930s, a problem with national economic significance because it “severely
limited the flow of funds to housing.”44 In fact, Morton Bodfish, the US. Savings
L68gue’s chief executive during the Great Depression argued that “One-half of the
c(>1-111ties in the United Sates as a result of the Great Depression now had no mortgage
loan institutions or facilities?”
Housing comprised a large enough sector of the overall economy and an
mpOrtant enough political issue to make this unregulated market outcome unacceptable
to the federal government. Both the Hoover and Roosevelt administrations pursued a
who 1e new economic mission in the wake of the suffering and chaos of the 1930s. For
the first time, the US. government assumed responsibility for “putting a floor lmder GNP
and a ceiling on unemployment and guaranteeing a minimum standard of living.”46 The

Smugs and loan industry, represented by the US. League, urged the federal government

 

‘\
3: 05:1 Eichler, The Thrifi Debacle (Berkeley: University of California Press, 1989), 8-9; Ewalt, 14-21;
44 Vld Mason 77-79.
., Barth and Regalia, 124.
0l'tin Bodfish, History of Building and Loan in the United Sates (U .8. Savings and Loan League, 1935)

362.
Ned Eichler, 2.

25

8n

to provide relief and support for their industry. The Hoover and Roosevelt

administrations, as well as Congress, responded with a barrage of legislation relevant to
the savings and loan industry. These laws created a new relationship between the federal
government and financial institutions as well as between the federal government and
homeowners. They made the savings and loan industry a quasi-public endeavor, a
creature of politics, rather than a solely private undertaking.
Herbert Hoover initiated the first federal intervention of this era to affect savings
and loans. A strong believer in the importance of home ownership, Hoover took an
interest in housing long before he became President. During his tenure as Secretary of
Commerce, he created the Division of Building and Housing, which published advice on

hOusing-related issues such as zoning, building codes, architecture, building materials,
house plans, and financing.“ As president, Hoover not only tried to help the industry
Solve its temporary emergency, but also began devising a system to permanently inject
federal flmds into the housing finance market. In 1932, per Hoover’s suggestion,
C()llgr'ess created the Reconstruction Finance Corporation (RFC) to provide temporary
loans to struggling businesses, including financial institutions, railroads, life insurance
coll11:)anies, industrialists, and agriculture. The temporary measure, however, hardly ,
tal‘geted S&Ls. Of the $2 billion lent by the RFC in 1932 and 1933, the S&L industry
reCeived only $125 million.48 To provide a more permanent solution to the industry’s
capital shortage, in the fall of 1931, Hoover held the President’s conference on home
ownership, which triggered discussion and study of the home finance market. Hoover’s

proposal involved the creation of a Federal Home Loan Bank System, which would

\

47
r. SuSan Hothnan, 150-151.
DaVid Mason, 79-81.

26

operate much like the Federal Reserve, advancing capital to lending institutions through
district federal banks.”
According to Horace Russell, the various sectors of the US. financial market
disagreed about the need for this legislation. Russell served as counsel to the League and
to the Federal Home Loan Bank Board and wrote a first-hand account of the savings and
loan industry during this era. Banks and insurance companies, which he characterized as
“in and out of the mortgage market as investors,” for the most part opposed the
legislation, explained Russell. However, savings and loans, which stood to benefit from
the legislation, had an interesting reaction. Initially many associations supported only
temporary assistance fiom the government, arguing that once the crisis abated, member
institutions would once again be able to generate all the capital they needed. Over time,
the industry position changed, but early opposition to public housing in general and to a
Pernlanent government role in the industry explained, “why the Federal Home Loan Bank
Symm and related enterprises have been developed with a minimum of Government
intervention and control and with a maximum of local management responsibility upon a
SO‘JIld basis,” Russell argued.50
David Mason too discusses resistance to Hoover’s plan. Bankers and insurance
executives opposed the plan because they objected to the creation of such a “narrowly
defined” permanent institution, he argues. They also saw the plan as an over-reaction to
a temporary crisis situation. Some S&L industry leaders also objected, notes Mason.

They were hesitant to see the “federal government directly involved in the mortgage

F
1e PSephine Ewalt covers Hoover’s introduction of this proposal and the process by which it became
Bglslation. See Josephine Ewalt, chapter 4; Horace Russell, Savings and Loan Associations (Matthew
slender & Company, 1960) 40.

Horace Russell, 39-42.

27

business and insisted that any program created to help lenders be temporary. . .”5 1

However, eventually the industry leaders accepted the new government role and worked
to mold it towards their own preferences, notes Mason, quoting Morton Bodfish’s
explanation that “we must do something, or something may be done to us.” Josephine
Ewalt, Assistant Vice President of the U.S. League, claimed that mortgage bankers also
opposed the legislation, explaining that they, like commercial banks, and insurance
companies, “looked with disfavor on legislation that would give savings and loan
associations a new place in the economy.”52
Objections notwithstanding, the Federal Home Loan Bank Act, drafted by the
Commerce Department, the Federal Reserve, and the U.S. League,53 was passed and
Signed by Hoover in July of 1932. This was possible, argues David Mason because
o13F><>nents did not “wage a coordinated attack to defeat the bill, as both the Mortgage
Bankers Association and the American Bankers Association put up only nominal
l’eSi stance.” The League, on the other hand, lobbied tirelessly.S4 As the bill moved
throngh Congress, savings and loan representatives testified supportively before Congress

and the U.S. League helped to recruit business leaders outside the industry to testify as

 

SI
,2 David Mason, 78-83.
,3 JoSeplrine Ewalt, 52.
l)aVWid Mason lists all three of these groups as responsible for the drafting of Federal Home Loan Bank
Ct- - see David Mason, 33. Horace Russell especially credited Morton Bodfish, then the young Vice
Preslclent of the U.S. League, William E. Best, the League’s president, and J.F. Cellarius, the League’s
of for contributing to the legislation. He did not mention his own role, but this may have been out
u3<>desty because in his book’s preface, his publisher claimed that Russell “is considered the dean of
advl Sets in this field, having drafted most of the laws, regulation and forms under which Savings and [can
880C iations presently operate.” See “Publisher’s Preface,” in Horace Russell, Savings and Loan
1 SPciations (Mathew Bender & Company) 1960, iii. Russell did acknowledge his role in supporting the
egrs lEltion by testifying before the House Committee on Banking and Currency. See Horace Russell, 43.
30, Susan Hoffman also claims that the U.S. League worked closely with the Commerce Department in
:‘fling the legislation. She adds that as the bill was in Congress, the League worked with members of the
h (“1.8% to adjust the original drafi and that “they orchestrated substantial support for the measure during the
earfngs, drumming up telegram campaigns and gathering date and preparing analyses requested by the
immigration and congressional committees.” See Susan Hoffman, 165.
Vid Mason, 86.

28

well. After the bill’s passage, the League sent out bulletins explaining the new system
and urging its members to participate.55 Susan Hoffman also credits the Hoover
administration for their vision in creating the Federal Home Loan Bank system and their
work with Congress in facilitating the bill’s passage.56
The act sought to provide more funds to all institutions that wrote mortgages,
including savings and loans, savings banks, and insurance companies. Modeled alter the
Federal Reserve System, the Federal Home Loan Bank System established 12 regional
banks, with stock owned by member institutions and the government. Members
borrowed from regional banks against mortgages on their books. Susan Hoffinan claims
11131: the rules regarding borrowing were set up by the Hoover administration to promote a
“flow of society’s financial resources into home ownership,” and to encourage the long-
term amortized mortgage to become the industry standard. Mortgages written under a
Variety of terms qualified as collateral for borrowing purposes. However, institutions
using long-term, fully amortized, loans as collateral were permitted to borrow more. In
addition, mortgages used as collateral had to be for 1-3 family residences worth no more
than $20,000. This prevented the funds fi'om flowing into rental housing and encouraged
financial institutions to write mortgages with favorable terms for middle and working
elaSS families trying to buy standard, not overly luxurious homes.57
Another purpose of the Federal Home Loan Bank system lay in providing a
Stefidy stream of capital for home purchasing across all regions of the country, or as
Horace Russell explained, for the purpose of “transferring excess savings in one area and

not required in that area for home mortgage credit to other areas of the country where
\

55
,, JOseplrine Ewalt, 49-57.
,7 Susan Hoffinan, 167.
Susan Hoffman, 160-164; David Mason, 82-86

29

such savings are temporarily deficient and where there is a greater demand, therefore, for

home mortgage capital.”58 Thus, Federal Home Loan Banks could lend to and borrow

fiom each other and place deposits in other Federal Home Loan Banks in order to spread
mortgage fimds throughout the cormtry. The system also allowed member banks to hold
their deposits in their Federal Home Loan Banks rather than in commercial banks, where

they had experienced painful losses during the Great Depression. The new legislation

also helped the suffering home construction industry.”
In terms of administration, the act provided for a Federal Home Loan Bank Board

(Fl-11.83) to supervise the regional banks. It was to be composed of five members,
appointed by the President with the consent of Congress, and a Chairman selected by the
President. The FHLBB appointed about 1/3 of the directors of the regional Federal Home

1.0811 Banks while member thrifis appointed the other 2/3 of the directors. The Federal

Home Loan system remained in place until 1989.60
In April of 1933, the federal government intensified its campaign to boost housing

and the savings and loan industry with the passage of the Home Owners’ Loan Act.
Again, the savings and loan industry played a vital role in the legislative efl‘ort. Horace
l{‘lssell, former president of Atlanta’s largest Savings and Loan, and Federal Home Loan
Bank Board general counsel drafted the legislation, with input from other members of the
Bank Board and the Roosevelt administration.61 This act created the Home Owners’

Loan Corporation (HOLC) in response to the astronomically high rate of home

 

\
53

59 Honce Russell, 0.

I id., The Federal Home Loan System is also discussed in Walter J. Woerhide, The Savings and Loan
- by: Current Problems and Possible Solutions, Quorum Books, 1984, chapter 1. Also see Lawrence J.
xhgllte, The S&L Debacle: Public Policy Lessons for Bank and Thrifl Regulation, Oxford University Press,
60 a Chapter 4.

5, Ibid, Walter Woerhide, 4; Lawrence White, 54.

Vid Mason, 91.

30

foreclosures during the early years of the depression. By 1933, 40% of the nation’s $20
billion of home mortgage debt was in default. By June of 1933 an average of 1000
foreclosures occurred each day. The HOLC bought distressed mortgages from private
lenders, compensating them with low-yielding, yet reliable bonds. Then the organization
refinanced with the borrowers, offering more favorable terms, including lower interest
rates, 15-year amortization, and interest only payments. Loans also covered taxes, liens,
and essential maintenance. For the first time, the federal government became a direct
lender to homeowners.62 The terms offered by the HOLC were so much more favorable
than standard private market terms, that many borrowers intentionally defaulted on their
mortgages in order to become eligible for HOLC refinancing.63 These lending activities
spanned from June of 1933 to June of 1936, during which time the HOLC refinanced 1/6
0f the nation’s total mortgage debt, including $770 million of mortgages held by savings
and loans, $525 million held by commercial banks, $410 million held by mutual savings
banks, $165 million held by insurance companies, and $196 million held by mortgage
fine-tree companies.64 Designed to be temporary, the HOLC terminated in 1951 after
I‘etllrning a small profit to the national treasury. Its major significance lay in its
Pioneering of longer term, fixed-rate home loans that eventually came to represent the
industry standard.“
The Home Owners’ Loan Act also authorized the FHLBB to charter federal

Savings and loan institutions and provided matching funds for every $1 of local savings

\
62

,3 JOSephine Ewalt, 36-41.
Ibid, Josephine Ewalt, 40. Ewalt noted thm there was an additional problem with this phenomenon. It
es people’s sense of responsibility to their debts. The moratoria on foreclosure enacted in many states
foso contributed to the problem. “. . .the public psychology created by legal arrangements to postpone any
“ reClosure was detrimental to general borrower observance of contract,” she explained.
,, J0seplrine Ewalt, 36-41; Susan Hoffman, 168-172.

Marir Carl Rom, 30-33; David Mason, 91-92..

31

invested in a federally chartered savings and loans, with a limit of $100 million. In 1934,
the federal government raised matching funds to $3 of federal funds for every $1 of local
savings, and in 1935, Congress allowed state-chartered savings and loans to participate in
this program as well.66 Home loans written by federal savings and loans had to be
located within 50 miles of the institution’s main office, and the homes had to be
appraised for $20,000 or less, again to encourage home ownership dollars to flow to those
in the middle and working classes. Also, the act stipulated that federal charters had to be
mutual organizations. With the Home Owners’ Loan Act, the government began
injecting flmds directly into the housing market."7

A year later, the government took yet another step in nurturing home ownership
with the passage of the National Housing Act of 1934. This act, which Horace Russell
also drafted, created the Federal Savings and Loan Insurance Corporation (F SLIC), to
insure deposits up to $5,000 in savings and loan institutions that became members.
FSLIC charged insurance premiums of 'A of 1% of insured deposits.68 Membership was
mandatory for federally-chartered savings and loans, and optional for state-chartered
institutions. The insurance offered by FSLIC stipulated that depositors of a failed
institution be compensated with either an equal account in another insured institution, or
With a 10% cash payment of their deposits, with the balance following within one year.

F SLIC’s deposit insurance sought to encourage funds in the form of individual personal

—‘

:: Josephine Ewalt, 44-47; Susan Hoffman, 168-172..
68 Susan Hoffman, 168-172.

Lawrence White laments that Congress never considered that FSLIC or the FDIC should charge risk-
based premiums for deposit insurance. This, he claims, would have protected the solvency of both funds.
The choice to charge level premiums, he explains, was based on the belief that regulation would prevent
large losses to the funds and on the lmwillingness of banks to pay higher premiums. R. Dan Bnrmbaugh
also discusses the perverse incentives set up by flat premium deposit insurance in R. Dan Brumbaugh, Jr.
The Collapse of Federally Insured Depositories: The Savings and Loans as Precursor, Garland Publishing,
Inc., 1993.

32

savings, to flow into housing via deposits in savings and loans.69 Similar insurance, of
course, had already been extended to deposits in commercial banks a year earlier by the
Federal Deposit Insurance Corporation (FDIC). However, unlike the FDIC, which was
an independent executive agency that need be concerned only with the protection of its
fund, FSLIC fell under the jurisdiction of the Office of Management and Budget (OMB).
This meant that although FSLIC funded itself through the collection of premium from
members, the OMB had the power to review the agency’s expenditures.70

The National Housing Act also included two other provisions to encourage home
financing. Through the formation of the Federal Housing Administration (FHA), the
government created federally guaranteed mortgage insurance. This encouraged banks
and other financial institutions to write mortgages by reducing the risk of default, a true
deterrent in the 1930s. It obviously also “fathered a severe form of competition for the
savings and loan association. It not only stimulated the mortgage lending activities of
commercial banks, which was one of its original purposes, but also brought into being
and fostered continually and energetically the mortgage banking business as it is known
in mid-century.”71 The initiative to provide federally guaranteed mortgage insurance
was the first piece of legislation promoted by the Bank Board that the S&L industry
Opposed. The objectors were quelled only by the act’s inclusion of deposit insurance for
thrifis, argues finance professor, William Woerhide."2 FHA mortgages would also act as
an eXperimental model for more liberal mortgage terms. During the post WWII era,

banks and thrifts examined the loss history of FHA loans that required lower down

‘

6’ Josephine Ewalt, loo-102; Susan Hoffman 173-175; David Mason 93-95.
:‘1’ Mark Carl Rom, 59.
n Josephine Ewalt, 137-138.

Walter J. Woerhide, 4-10.

33

payments and offered longer amortizations, and found that these loans did not lead to
disastrous or even unprofitable results.73 In addition, Title HI of the National Housing
Act authorized the FHA to charter a national mortgage association to buy FHA-insured
mortgages, which it did in 1937 with the creation of the Federal National Mortgage
Association, more commonly known as Fannie Mae. Again, this served as a means of
promoting the housing industry. By buying existing mortgages, Fannie Mae fi'eed capital
that could be used to finance more new housing.74 The U.S. League actually opposed this
part of the bill and tried, to no avail, to have it removed.75 In fact the League objected to
many of the provisions of the National Housing Act. Horace Russell wrote a memo to
the Federal Home Loan Bank Board warning that the legislation would, among other
problems, put into effect a discredited mortgage plan, encourage the development of
mortgage companies, and encourage speculation. It also “discourages the conservative
plans of home financing,” and played into the hands of “Wall Street Finance,” Russell
protested. He later admitted that: “the former program did serve substantially to attract
commercial bank funds and insurance company funds and promoted home building and
the employment of labor. Also, it further encouraged a long term, high percentage,
monthly amortized home mortgage loan and improved the quality of home
Gonstr'uction.”76 The League’s position was not surprising given that the legislation
Promoted competition fi'om other financial institutions.

In just a few Short years, this collection of legislation, much of it requested and

formulated by the industry itself, fundamentally changed the nature of savings and loan

—;

:3 Eichler, 12-14.
75 Eichler, 12-14. New Deal legislation discussed above is also covered in Russell, chapters 6-10.
76 David Mason, 93-95

Horace Russell, 87-93.

34

institutions in an effort to accomplish the political and social goal of expanding home
ownership. To do this, Congress passed legislation that manipulated the outcomes
provided by an unregulated home finance market. The federal government provided
savings institutions with cheap capital to use for home loans. It encouraged the mortgage
industry standard to become the long term, fixed-rate, amortized loan, with the risk of
interest rate change carried by the lender. The government directly invested in savings
and loan institutions, and encouraged other financial institutions to enter the mortgage
business through federally guaranteed mortgage insurance. Federal authorities created
Fannie Mac to purchase federally guaranteed loans, freeing up even more capital for
home loans. Perhaps most important, the U.S. government offered federal insurance on
savings and loan deposits. While savings and loans remained simple institutions,
collecting deposits and investing almost solely in home mortgages, an important aspect of
the business had changed. Investors could no longer be counted on to scrutinize the
business practices of their associations. They had no incentive to do so because their
investments were backed by the full faith and credit of the U.S. government. This job
would be left to regulators. The simplicity and low-risk philosophy followed so closely
by early savings and loans had, to a large degree, been lost.

What had been gained? Obviously, slowing the rate of foreclosure and increasing
home ownership had stimulating effects on the ailing American economy. However,
perhaps the govemment’s multi-front effort to encourage home ownership accomplished
more. Many have argued that Roosevelt’s New Deal saved the American capitalist
System by tempering its harshest characteristics, by introducing just enough mollifying

features to make the system palatable to a suffering population that might otherwise have

35

become revolutionary. Perhaps housing policy Should be viewed in this light. The
government’s entrance into the housing market allowed huge numbers of ordinary
Americans to become property owners. A realm of economic activity that had previously
been closed to the majority of Americans became available to an ever-widening group.
Whether intended or not, this must have given first-time homeowners the feeling that
they finally had a stake in the system, a feeling of inclusion. By 1930 only 2/5 of
Americans owned the homes they occupied. With the host of new housing policy put in

place in the early 19308, that was about to radically change.

36

bi

f- )
l""‘l"

[fl

CHAPTER 2
THE NEW DEAL REGULATORY STRUCTURE: 1942-1978

The New Deal reforms to the savings and loan industry initially seemed to be an
undisputed success. Following World War II, in response to a severe housing shortage,
the federal government heightened its efforts to support homebuilding and to encourage
home ownership. This, combined with strong demand for housing, led to a massive
residential construction boom during the 19405 and 19503. Savings and loan institutions
played an important role in financing this boom. Thus, this era was one of phenomenal
expansion, growth, and profitability for the industry. However, by the mid 19605,
conditions changed. A booming economy fueled by government spending at home and
abroad, eventually brought about inflation and high interest rates. This put savings and
loans under strain. At the same time, new forms of competition emerged during this era
for both the savings and the lending functions. Studies undertaken suggested some of the
right solutions, but political obstacles prevented these recommendations fi'om becoming
legislation. It truly proved to be a missed opportunity. Savings and loans became old
institutions trying to succeed in a new system. The lack of flexibility imposed on them
by the New Deal regulatory structure and failure of the political system to bring about
reform where it was sorely needed made it nearly impossible for them to adjust to the
changing economy and put the industry on an unfortunate path towards disaster.

The War Years

 

The United States’ participation in World War II brought about economic and
political changes that significantly affected the savings and loan industry. First and

foremost, the war brought about a decisive and rapid recovery from the Great Depression

37

that had ailed the nation for more than a decade. Keynesian federal military spending
utilized the full capacity of the American economy and even led to economic expansion.
Thus, full employment and rising incomes put money into people’s pockets. However,
wartime consumer goods shortages made it difficult for people to Spend their new
windfalls, and therefore led to increased savings among all financial institutions. Savings
and loans saw a 60% increase in deposits during the war.I

At the same time, mortgage lending fell as wartime restrictions on residential
construction limited new housing starts. In April of 1942, Construction Conservation
Order L-41 prohibited residential building outside of defense area housing without
special authorization. Remodeling projects too were almost entirely prohibited.2 Savings
and loans continued to invest in mortgages on existing homes, which were on the rise as
people who had “doubled-up” during the hard times of the Depression could once again
afford their own homes. Soon, the one million homes that sat vacant because of defaults
during the Depression were once again occupied and real estate prices began rising.
Savings and loans, as a group, also invested half a billion dollars in the only residential
construction permitted: war housing. However, S&L balance sheets were still skewed
With surplus deposits that needed to be invested. Government war and defense bonds
Proved to be the solution.3

The choice to help finance the war through the purchasing of government
securities made a certain amount of sense. The U.S. League of Savings and Loans had a
hiStory of portraying the industry as patriotic, especially during the Progressive Era,

emphasizing S&L efforts to Americanize immigrants by teaching them thrifty habits and

‘ Robert Heilbroner and Aaron Singer, 307-309; David Mason 120.
2 Josephine Hedges Ewalt, 220.
3 Ibid., 208-209.

38

helping them become homeowners.4 Also, regulatory restrictions and tax incentives
severely limited other investment options. Therefore, in July of 1942, the officers of the
United States Savings and Loan League asked their institutions to add $100 million in
government bonds to their investment portfolios by the end of the year. The League then
appointed a representative for each state to ensure that the state’s S&Ls filled their quota
of government bond purchases. By the end of the war, savings and loans had financed
$3.5 billion, or about 1.3% of the $270 billion U.S. war debt. Government bonds, which
amounted to 1.2% of the industry’s total assets in 1940, represented 28% of total assets
by 1945.5 Still, in 1945 savings and loans had an abnormally high amount of cash on
hand.6 In addition, savings and loans sold defense and war bonds to the public, with
many institutions going to great lengths to procure higher sales. This included setting up
booths in hotels and on Sidewalks to make purchasing more convenient for the public and
developing direct payroll deductions with local businesses. The $1.6 billion of bond
sales accomplished by the industry, no doubt, enhanced its image of patriotism.7

Overall, profits for the industry ran abnormally high during the war years. The
plentiful nature of savings meant that institutions paid a lower than usual rate of return on
deposits. On the other hand, because of the long-term nature of mortgage loans, savings
and loan portfolios were dominated, not by wartime mortgages written at lower interest
rates, but by mortgages written at the higher rates of the past. Thus, the spread between

deposits and loans worked in the industry’s favor. In addition, wartime Shortages and

 

 

:David Mason, 42-46.

Josephine Hedges Ewalt, 204—206, 210; Francis X. Cavenaugh, The Truth About the National Debt: Five
Myths and One Reality (Harvard Business School Press, 1996) 26. Also see Leon T. Kendall, The Savings
and Loan Business: Its Purposes, Functions, and Economic Justification (Prentice-Hall, Inc. 1962) 8.

Harold W. Torgerson, “Developments' 1n Savings and Loan Association, 1945-53,” The Journal of

Finance, Vol. 9, No. 3 (September, 1954) 294, hgp: //www. istor,o_rg[ sale/2976565 Saccessed November
2007.
7Josephine Hedges Ewalt, 206-208.

39

rationing dampened business Spending, so that many institutions did without new office
equipment and put off plans to remodel, dropping expenditures even further. The only
expense that increased during the war was labor, since most associations continued to pay
partial salaries, usually about 10%, to employees serving in the armed forces. Rapid
turnover of temporary replacements also increased training costs. In addition, in 1941,
the Department of Labor informed the industry that the Fair Labor Standards Act did
indeed apply to savings and loans, subjecting associations to minimum wage and
overtime regulations to which they did not previously adhere. Finally, in 1940, the
industry was required to pay a 1% Social Security withholding tax on payroll for the first
time. Despite the higher labor costs, savings and loans enjoyed the most favorable
difference between income and expenses during World War II than at any time in the
industry’s prior history.8

While the thrift industry managed to make wartime economic changes work in its
favor, industry leaders were far less pleased with wartime political changes that affected
the regulatory structure. On February 24, 1942, Executive Order 9070 created the
National Housing Agency, a super-agency that consolidated the Federal Home Loan
Bank Board (F HLBB), the Federal Housing Administration (FHA), and the U.S. Housing
authority, the agency in charge of public housing. The new structure, intended to more
efficiently coordinate housing construction and finance, reduced the Federal Home Loan
Bank Board from a S-member board to a single commissioner, minimizing the industry’s
prestige and influence with lawmakers. As discussed in chapter 1, the industry had
grown accustomed to a high degree of involvement in legislation and regulation. U.S.

League officials played a key role in shaping the industry’s regulatory structure during

 

' Ibid, 210-212.

40

the?

Pris

app:

5311

WE

W0

in 1

ho

the New Deal, and they found this loss of power disturbing. As U.S. League Vice
President, Josephine Ewalt explained, “Savings and loan leaders were shocked and
apprehensive and they protested. It took years for the protest to be effective but the
savings and loan business never ceased to make clear its stand that the new arrangement
was ill-advised and unjust.” 9

To further the industry’s dismay, the appointed commissioner, John Fahey,
became a controversial figure because he viewed the regional federal home loan banks as
servants to the public rather than to the member associations that owned them. Industry
leaders, on the other hand, believed these banks served as tools to the industry, which
would then pass on the benefits they received to the public. Fahey also viewed new
growth-oriented and aggressive savings and loan leaders with great suspicion. The clash
in outlooks became ugly, eventually leading to Fahey’s consolidation of two regional
home loan banks and his seizure of a healthy association, led by one of his enemies.
Opposing industry leaders fought back by persuading Congress to form a Special
Subcommittee to Investigate the F HLBB and the owner of the closed institution brought
his case to court. Acknowledging the disadvantage of putting all regulatory power into
the hands of one person, Congress ruled in July of 1947 that a three-person board should
replace the commissioner, though F ahey remained president of that board for the time
being. In December of 1947, Truman chose not to reappoint F ahey and the new board
reopened the closed association, thereby ending the conflict, and appeasing some of the

disgruntled industry leaders. '0 The Board however, did not regain its previous clout and

 

9 Josephine Hedges Ewalt, 218-220, quote from 218; David Mason, 123.
'° David Mason 123-125.

41

independent status until 1955 when it was removed from the National Housing Agency. ”
While the restoration of the board’s former stature took a while, S&Ls emerged from the
war years in good financial condition, and ready for the challenges they would face

during the post war period.

1946-1955: Years of Growth and Prosperity

The decade immediately following World War II brought immense economic
growth and prosperity for the United States in general as well as for the savings and loan
industry. Though political leaders and average citizens alike feared that the economy
would follow the path of the post World War I economy into recession, the worrying
proved unfounded. '2 The years after World War II witnessed unprecedented prosperity.
Between 1945 and 1960, real Gross National Product (GNP) rose 52% and per capita
GNP rose 19%, while prices inflated only slightly. ‘3 Spending on personal consumption
(measured in constant 1954 dollars) rose 24% between 1947 and 1960 and consumption
spending per capita rose 22%. With a baby boom at hand, the population rose rapidly
between 1946 and 1964, and innovations occurred across numerous industries.l4

At the center of the economic take-off stood an enormous housing boom that both

resulted from and fueled economic growth. As discussed above, demand for housing had

 

" Jack W. Cashin, History of Savings and Loan in Texas (Bureau of Business Research, College of
Business Administration, The University of Texas, 1956) 140.

’2 The expectation of hard economic times following WWII is discussed in Robert Sobel, The Great Boom
[950-2000; How a Generation of Americans Created the World ’s Most Prosperous Society, (Truman
Talley Books, St. Martin’s Press, 2000) chapter 1. Sobel pokes fun at economists, members of Congress
and businesspeople who predicted a postwar recession. He even tells the story of a Fortune journalist who
predicted a declining birth rate after the war that would create labor shortages and keep older Americans in
the jobs longer.

‘3 Robert Heilbroner and Aaron Singer, 307-309; Mansel G. Blackford and K. Austin Kerr, Business
Enterprise in American History (Houghton Mifflin Company, 1990) 346-347.

14 Robert M. Collins, More: The Politics of Economic Growth in Postwar America (Oxford University
Press, 2000) 40.

42

increased during the war, but was stunted by federal restrictions on residential
construction. The government did not lift these restrictions until 1946, fearing that an
unregulated home market would bring about heavy inflation.15 Thus, a significant
amormt of pent-up demand existed. Fortunately for those who needed homes, the federal
government established and continued to support a number of programs that facilitated
new residential construction and financing, particularly in the suburbs.

Savings and loans played a major role in financing this tidal wave of residential
housing construction. S&Ls not only provided credit for individuals buying homes, but
also flmded builders undertaking large suburban development projects. In fact, by 1954,
the savings and loan industry was the largest source of home mortgages, writing 36.2% of
non-farm home loans.16 All aspects of the business thrived, and return on assets and net
worth for savings and loan associations rose throughout this post-war decade."

Savings, already pouring in during the war, teemed into S&Ls during the postwar
years, increasing 210% between 1945 and 1953.18 This occurred because savings and
loans could offer higher rates of return on deposits than their commercial bank
competitors, who were subject to interest rate ceilings on deposits under the Banking Act
of 1933. Not surprisingly, S&Ls set their rates higher than those offered by commercial
banks in order to attract funds. For example, in 1955, S&Ls paid depositors an average
of 2.9% interest; commercial banks paid an average of 1.4%; government bonds paid an

average of 2.8%; and local bonds paid an average of 2.6%.19 S&L interest rates also

 

" David Mason, 129; Josephine Ewalt, 24o.

" I965 Savings andLoan Fact Book (United States Savings and Loan League, 1965) 50; David Mason,
139.

‘7 Ned Eichler, the 17am Debacle (University of California Press, 1989) 22-23.

" Harold W. Torgerson, 285.

‘9 I965 Savings andLoan Fact Book, 16.

43

tended to be high after 1952 because of a change in tax law. Savings and loans
historically enjoyed the privilege of exemption from federal income taxes. The benefit
stemmed from the fact that they did the important work of providing credit for
homeowners. Furthermore, “[a]s mutual organizations, more closely resembling
nonprofit organizations than profit-oriented stock associations such as commercial banks,
they seemed further to merit this preferential treatment in the eyes of the Congress.”20 In
1952, the federal government required savings and loans to pay income taxes for the first
time. However, the new law provided various means for institutions to eliminate or
lower tax bills, which most of them did.” For example, associations could put aside
reserves up to 12% of the value of their withdrawal accounts, without paying income tax
on those funds. In addition, dividends paid to members and money spent on advertising
and promotion reduced gross taxable income. Thus, strong motives existed to pay out
high dividends, advertise heavily and attract a large flow of savings.22 Given the high
demand for home financing, growing S&L deposits flowed directly into housing,
somewhat justifying government policies that encouraged deposits to flow into savings
and loans rather than into commercial banks.

On the lending Side of the business, savings and loans buzzed with activity during
these years. As the war ended, S&Ls developed new mortgage products to accommodate
the plethora of new homebuyers. For example, they created the Uniform Savings Loan

Plan, which ofi'ered a 20-year payment period, an option to defer payments temporarily

 

2° Kenneth R. Biederman and John A. Tuccillo, Taxation and Regulation of the Savings and Loan Industry
(Lexington Books, 1976) 5; R. Dan Brumbaugh, Jr., Thrifts Under Siege: Restoring Order to American
Banking, (Ballinger Publishing Company, 1988) 147-148.

2' The savings and loan industry fought hard against the imposition of taxes on their institutions, which the
banking industry demanded because it was subject to income tax. The U.S. Savings and Loan League was
not able to defeat the law completely, but did manage to insert provisions to greatly reduce the net effects
of such legislation. See Josephine Hedges Ewalt, 300-301.

2’ Harold w. Torgerson, 290-291; John Cashin, 137-13.

44

after the first three years, and the ability to borrow additional funds later for home
improvement.23 Savings and loans were also intricately involved in the development and
implementation of Veterans Administration (VA) loans under the Servicemen’s
Readjustment Act of 1946. As Congress considered and altered the bill, the U.S. League
Legislative Committee held conferences with the American Legion’s Rehabilitation
Committee to discuss methods for financing VA loans. Out of these conferences came
the idea of a government guarantee for part of the loan, which Congress adopted in the
final act. The government guarantee made lenders more comfortable with financing a
higher percentage of the property value, thereby lowering down payments. The lender
also charged veterans a below-market interest rate, by about 1/:t%. Once the act became
law, representatives of the U.S. League and the Veterans Administration met, along with
federal regulators to work out the many regulations necessary for the program to run
smoothly.24

Savings and loans were the first financial institutions to write VA loans in their
communities. The industry advertised VA loans, printed information pamphlets, and
worked with veterans organizations to reach perspective borrowers. According to U. S.
League Vice President Josephine Ewalt, the industry worked so hard to promote VA
loans because leaders feared that failure of this plan would result in direct government
lending to veterans, which the industry saw as a threat to its special role in housing. In
1945, of the $192 million of VA loans made, S&Ls originated $175 million of them. In
1946, the first year of heavy volume, S&Ls wrote $1.25 billion of the $2.3 billion in

home loans to veterans. In 1946, VA loans comprised 35% of all mortgages written by

 

2’ David Mason, 133-134.
2‘ Josephine Hedges Ewalt, 229-233; Leon r. Kendall, s.

45

ant ems. .ult ......-.. \H a...

savings and loans. Ironically, VA loans permanently changed the parameters of S&L
lending. Because of their favorable experience with government guaranteed VA loans,
S&Ls came to realize that lending up to 90% of the value of a home, could indeed be a
safe investment. By the late 19503, associations allowed loans of 90% of value without
government guarantees.25

Though savings and loans enjoyed great success and growth during this era, not
everything went the industry’s way. Government influence in housing finance grew
considerably during the decade following World War II. In fact, for many industry
leaders, the government became too large of a presence in their industry and in housing in
general. In addition to guaranteeing VA loans, the federal government, through the FHA,
continued its program of guaranteeing mortgages for moderate and lower income
Americans, who would otherwise struggle to meet the terms of conventional financing.
In the 1950s, Congress made the requirements for FHA loans more lenient, allowing a
greater number of Americans to qualify. Congress also allowed the FHA to guarantee
financing for apartments and inner-city housing projects. Furthermore, the Federal
National Mortgage Association (FNMA, commonly referred to as Fannie Mae), created
in 1938, continued buying FHA-insured loans from lenders, thereby increasing the
volume of funds available for new mortgages. In 1954, Congress authorized Fannie Mac
to buy and sell all types of govemment—insured loans, and to sell mortgage-backed

securities, which channeled investment dollars into the home mortgage market. Savings

‘

2’ Josephine Hedges Ewalt, 242-245; Leon T. Kendall, 8-9. Though the Servicemen’s Readjustment Act of
1946 provided exciting new opportunities to a large number of veterans, Ira Katznelson reminds us that
fllose benefits were not enjoyed equally. Because the law allowed the states to implement and administer
"3 Provisions, black veterans in southern states faced racial discrimination in trying to exercise their
benefits, he explains. Though the black community was originally hopeful optimistic about the promise of
such legislation, the results proved disappointing. See Ira Katznelson, When Affirmative Action Was White:
chap(Intold History of Racial Inequality in Wentieth-Cenaay America (W .W. Norton & Company, 2005)
ter 5.

46

and loans did not necessarily support or make heavy use of these programs. S&Ls
disliked the bureaucratic processes involved in writing FHA loans and objected to the
govemment-set interest rates. Furthermore, savings and loans during this time tended to
keep mortgages in their portfolios instead of selling them.26 But industry leaders disliked
these programs for a more important reason. Though the industry supported and favored
government regulation that made it easier for savings and loans to write mortgages, the
FHA and Fannie Mae also made it easier for commercial banks and mortgage bankers to
write mortgages. These government operations encouraged competition. Savings and
loans bad to make the terms of their financing more favorable just to compete with these
programs, and the writing of so many loans by new actors, perhaps, detracted fiom the
argument that had procured so many privileges for S&Ls: that they were the main
institutions meeting the American public’s need for mortgage firnds. FHA loans indeed
met much of the public’s need for financing. Between 1945 and 1954, FHA mortgages
increased by over 450%, and by 1954, FHA and VA loans together comprised over half
of all mortgages on new homes. Furthermore, the vast majority of them were written by
commercial banks and mortgage companies.27

The federal government engaged in a number of other activities to support the
growth of the housing market during these years. In 1950, Congress passed a bill that
lowered the rate that S&Ls paid for deposit insurance fiom 1/8% of insured savings to

1/12%, and in that same year raised the limit covered by deposit insurance from $5,000 to

 

2‘ David Mason, 143-145; Josephine Hedges Ewalt, 139-145; Norman Strunk and Fred Case, Where
Deregulation Went Wrong: A look at the Causes Behind Savings and Loan Failures in the I 9803 (U.S.
League of Savings Institutions, 1988) 21-22.

27 David Mason, 145; For example, in 1954, S&Ls wrote $209 million in FHA loans; commercial banks
wrote $669 million; and mortgage companies wrote $682 million. See 1965 Savings and Loan Fact Book,
56.

47

$10,000 per account.28 Of course, the Federal Home Loan Banks continued to advance
funds to member savings and loans to increase the capital available for mortgages. In
1949, regulators modified the federal charter, simplifying it, increasing maximum loan-
to-value ratios, and allowing for immediate firll withdrawal of member deposits. The
new charter, known as charter N, also allowed savings and loans to use more customer-
friendly words to describe their transactions. Technically, savings and loan members did
not have deposits with their institutions — they paid investment dollars towards shares in
the mutual association. Yet, the new charter allowed S&Ls to use terms such as
“deposit,” “withdrawal,” and “savings account.” The American Bankers Association
objected to the new terms, arguing that they made S&Ls sound the same as banks, but to
no avail. Many states followed suit with the federal government’s charter improvement,
offering similar advantages in their state charters, to prevent institutions from converting
their charters.29

Federal, state, and local governments also assisted homebuilding by constructing
miles upon miles of highways that allowed builders to develop new areas. State and local
governments provided the necessary infrastructure for residential development such as
water and sewer lines, roads, and public schools.30

The unprecedented construction boom had stimulating economic effects across a
myriad of industries, including concrete, cement, and lumber. It put people to work
building sewers, roads, schools and other community services. Furthermore,

suburbanites relied heavily on their automobiles for transportation and purchased them in

 

2' Josephine Hedges Ewalt, 293-294, 297.
2’ David Mason, 140-141.
3° Ned Eichler, 20.

48

ever increasing numbers, giving a boost to the auto industry.31 Building the necessary
highways kept road workers employed and busy. The suburban construction boom also
stimulated numerous retail industries, since new homes created the need for consumer
goods, such as appliances and furniture.32 Homebuilding clearly increased American
consumption.33
With stimulating effects such as these, it is no wonder the government
implemented a host of policies to encourage housing. Since savings and loans played
such an important role in home financing, it seems reasonable that the government would
put into practice a wide spectrum of policies aiding the industry. However, the U.S.
League’s extremely active participation in drafting legislation and formulating
regulations caused the Department of Justice to bring a case against the League, alleging
that it violated the newly passed Lobbying Registration Act of 1946.34 Though the
Department of Justice eventually dismissed the case, Congress took up the cause and the

House Committee on Lobbying Activities conducted an investigation of the League in

1949. The investigation, which studied the League’s role in housing legislation passed

 

3' Vehicle registration increased hour 31 million in 1945 to 62.7 million in 1955. See David Mason, 132.
32 Robert Heilbroner and Aaron Singer, 310; David Mason, 132.

33 Economist and former staff member of the House and Senate Banking Committees, Robert Dagger, has
argued that U.S. economic policies followed the logic of national security, “the highest domestic political
priority of any country.” In order to fight the Cold War, the U.S. first provided capital to and then became
the “consumer-of-last-resort” for Japan, Germany, and ally countries surrounding the former Soviet Union
and China. This policy required the U.S. to become a “high consumption, low savings economy,” Dugger
argues. This provided additional motivation for the government’s strong support of the housing market,
since homebuilding and purchasing had such a stimulating effect on U.S. consumption. In fact, Dugger
referred to housing as “the Lord’s work.” Interview of Robert H. Dugger by Jill S. Huerta, November 21.
2008. Also see Robert H. Dagger, “Cold War Roots of U.S. Economic Problems,” The Globalist July 20,
2008, ht_tp://www.theglobalistconr/Stogld.aspx?Story1d=7077 accessed l/15/2009.

3‘ Three members ofthe U.S. League had registered with Congress as lobbyists, but the organimtion itself
had not. See “Loan League Cited on Lobby Charges,” Special to New York Times (1857—Current file);
March 31, 1948; ProQuest Historical Newspapers, 2.

49

during the prior three years, ultimately found nothing inappropriate about the League’s
political activities.”

The committee’s report published on October 31, 1950, however, offers a glimpse
into the League’s tireless effort to secure favorable legislation for the industry, especially
by its chairman, Morton Bodfish. The report contains documents subpoenaed by the
Congressional Committee, which dealt with legislative initiatives covering the period
1947-1950. These included internal League correspondence, correspondence with
members of Congress, communications with member associations regarding grass roots
political activism, and public relations materials. The fact that over 700 pages of such
communications made it into the final report speaks to the vast time and resources the
League dedicated to influencing the political and legal environment in which the industry
operated.36

These documents reveal that executives of the U.S. League viewed their political
position as unfavorable during this era. This stemmed partly from the absorption of the
Federal Home Loan Bank Board into the wartime super-agency for housing, The
National Housing Agency mandated by Executive Order 9070 in 1942. While the order
was supposed to be a wartime measure, several pieces of legislation considered by ,
Congress in 1946 threatened to make this agency permanent, including Reorganization
Plan No. 1, and the Wagner-Ellender-Taft bill. The League expressed its negative
outlook in its “Report of Federal Legislative Committee 1946.” In discussing the

activities of the legislative committee during the year, the report explains, “much of our

—__

’5 David Mason, 137.
stouse Committee on Lobbying Activities, Lobbying Activities of United States Savings and Loan League,
81 Cong, 2'“I session, October 31, 1950.

50

activity has necessarily been of a negative or defensive nature because of the injurious
implications of some of the proposals. . 3’37
The 1947 report proved even more pessimistic, breaking the news that
Reorganization Plan No. 3, which Truman sent to Congress, had passed the House
without debate in June and passed the Senate in July. Plan No. 3 differed from Plan No.
1 in that it created a 3-person Federal Home Loan Bank Board, instead of a l-person
Commissioner. However, the plan still placed the board under the supervision of an
executive agency, the Housing and Home Finance Agency. The League’s main problem
with this setup lay in its opposition to the public housing efl‘ort of the administration.
The Housing Act of 1949 obligated the federal government to “guarantee a decent home
and suitable living environment for every American family.” Under the act, the
government would build 810,000 units of public housing during the next six years and
engage in a slum-clearance program. The League viewed public housing as inefficient
and detrimental to the private housing market, arguing that the government’s presence in
the home construction market would increase the price of homebuilding. Also, the
League saw public housing as a socialist initiative and League officials often pulled out

their Cold War rhetoric to describe it as such.38 The 1947 Legislative Committee report

lamented:

 

’7 Ibid., 35.

3’ David Mason, 153-4. Two years later, in a letter to Senator Taft, Morton Bodfish, chairman of the

league’s executive committee, criticized Tafi for supporting a public housing bill and reminded the

senator, “You will recall our concern at the time Reorganization Plan No. 3 was adopted that, instead of
coordination and economy, the plan would lead to a continuous program of expanding and enlarging the
Agency’s influence and control. It is perfectly clear that every bill prepared by the Housing and Home
Finance Agency is going to be generous with the funds, controls, personnel, and powers allocated to the
Government housing offices.” Bodfish even played the Cold War card, warning the Republican Taft that
“Some of my English fi'iends feel that, in the socialization of England, the deciding votes were supplied by
the Conservatives who thought they could safely provide ‘a little socialization.’ The parallel in our country

51

Thus our efforts to disentangle the agency which supervises our
institutions and which they support from the public-housing activities of
the Government have come to naught for the time being at least. The
consolidation under the National Housing Agency, efi‘ected under the war
powers given the president and regarded as a temporary expedient to
expedite war housing, has now become permanent, until changed or
dissolved by act of Congress.39

The phrase “until changed or dissolved by act of Congress,” perhaps displays the
League’s resolve to continue the battle for an independent Board with all its previous
fervor.40 The League’s outlook was not all gloomy. Always pragmatic, League officials
pointed out:

We do not feel our fight for the independence of the Federal Home Loan
Bank Board has been entirely in vain, however, as the powers given the
over-all agency have been much more restricted than those proposed last
year and the Board, as such, have been restored, even though it is
composed of three, rather than the original five men, with wide and rather
vague powers vested in the chairman. It remains for us to adjust our
thinking to the situation and cooperate to the best of our ability and do
everything possible to develop an understanding of and a sympathetic
interest in our aims and objectives.“1

The documents in the investigative report also illustrate a very close relationship
between the U.S. League and the Federal Home Loan Bank Board. The chairman of the
board, William Divers, apparently made decisions with the industry’s interests and
desires closely in mind, and remained open to negotiation with leaders of the industry his
board regulated. For example, in a 1949 memo written by League chairman Bodfish to a
League lobbyist, Steven Silpher, he states, “Divers is concerned over the branch question
and seems anxious to work out some position with us that will give us a more solid and

unified front.” Later in the same memo, Bodfish explains that Divers “is already anxious

‘

is clear...” House Select Committee on Lobbying Activities, Lobbying Activities of United States Savings
and Loan League, 81" Cong, 2"“ session, October 31,1950,95-96.

:Ibid., 66.

”Ibid. ,;65-66 quote fiom 66.

Ibid: 66

41

52

to ‘go over all this legislation together and see what we can work out.”’ 42 Though
Divers engaged in consultation and negotiation with the League, they did not view him as
a pushover. For example, in a letter to Bodfish, A.D. Theobald of the League Legislative
Committee complained of “Bill Divers’ past performance of slipping out from under like
a watermelon seed when you put your finger down on it whenever there is any question
of his making a commitment to support legislation. . .” Whether or not Divers always did
what the League wanted him to do, the League’s correspondence with him indicates that
he worked closely with them on guiding legislation through Congress.

Documents in the Congressional investigative report also reveal that the League
maintained close contact and relationships with key members of Congress, particularly
the League’s Executive Chairman Morton Bodfish. The report contains 130 pages of
correspondence between the League and legislators, many of whom seem to have close,
even affectionate relationships with Bodfish. For example, after Truman’s pocket veto of
the FSLIC insurance premium reduction bill in 1946, Bodfish wrote a letter to
Representative Spence, a Democrat fiom Kentucky, and chairman of the House Banking
and Currency Committee. He began the letter with, “My Dear Mr. Spence: Your letter of
August 26 was greatly appreciated, especially your reassuring statement, ’We will try
again,’ on the insurance premium reduction.” He goes on to say, “But, certainly you did
everything humanly possible, at every step of the way, to obtain its enactment into
law. . .” In gratitude for Spence’s help, Bodfish expressed, “I had only favorable reports
from the Filth District as to the progress of the campaign in Kentucky and do not believe
you need to be greatly concerned. However, if you feel there is a time when our people
can be helpful, you know you have only to send us the word.” Apparently Spence did

\

’2 Ibid, 109.

53

send the word, because prior to the election, Bodfish sent a letter to all League members
in Spence’s district, reminding them to vote for him, “as chairman of the powerful
Banking and Currency Committee, which must pass initially on all bills having to do with
finance, housing, or housing credit, he [Spence] has great influence and prestige. . .He
deserves the active support of everyone interested in our thrift and home-financing
institutions and their activities.”43

Bodfish’s fiiendliness was by no means limited to Democrats like Spence. For
example, he enjoyed a very beneficial friendship with Representative Jesse Wolcott, the
Republican chairman of the Banking and Currency Committee. The Congressional report
contains several letters fi'om Bodfish to Wolcott, including one in April of 1947 thanking
the Congressman for introducing four bills sought by the savings and loan industry and
asking the Congressman to “find it possible, despite the many and heavy demands upon
your time and that of the committee, to get committee approval of these four bills. . .and
advancement to the House floor.”44

The League did more than simply court Congressmen. It became intricately
involved in the drafting of legislation. Abner Ferguson and Horace Russell, the League’s
attorneys in Washington and Chicago continually drafted legislation to present to fiiends
in Congress. F tuthermore, they consulted with these Congressmen on strategy. For
example, in January of 1947, Abner Ferguson wrote Morton Bodfish regarding his visit
with Congressmen Riley and Spence, and Senator Taft, “I left with Riley and Spence

revised drafts of the bills they have introduced and they have suggested that when the

bills come up for hearing they ask that the new drafts be substituted for the bills as

 

‘3 Ibid., 154.
“ Ibid., 165.

54

introduced.” Besides being skilled drafters of legislation, Ferguson and Russell seemed
to be well-connected with members of Congress, visiting them often and sending drafts
of bills back and forth. They also testified at Congressional committee hearings when
legislation affecting the savings and loan industry was being considered. Interestingly,
collaboration on legislation seemed to go in both directions. At least some of the time,
Congressmen sought the advice of the League on how to best proceed with pending bills.
For example, in a 1947 letter regarding the bill to reduce the premium on deposit
insurance, Brent Spence told Morton Bodfish,:

I have introduced the bill as introduced in the last session and

subsequently Abner Ferguson brought me a copy of your proposed bill. I

told him I thought it would probably be good strategy to submit this bill to

the committee when the bill I introduced is considered. However, if you

think it would be desirable to introduce the bill as prepared by you, I will

be very glad to do so, and will be pleased to discuss the matter with you

when you come to Washington.45
In another letter to Bodfish regarding a bill on conservatorship, Representative Charles
Fletcher asked him to, “Please take a look at the conservatorship bill of Congressman
King and let me know what you think at your earliest convenience.” Horace Russell
answered the letter for Bodfish, suggesting some changes in the wording and giving the
bill his blessing.‘6 The League seemed to play this kind ofan active role in all the *
legislative efforts of this era. Morton Bodfish seemed to be particularly well connected.
In a critical Washington Post article about a League dinner, the journalist referred to
Bodfish as “ace lobbyist,” and complained that he “managed to corral so many

Congressmen for his jamboree that it took 45 minutes to introduce them?” Bodfish and

 

‘5 Ibid., 158.
“ Ibid.
‘7 1bid., 56.

55

the League were well connected and influential, and the legislation they wrote and
lobbied for made the business environment very favorable for the industry.

Despite the League’s disappointment with the industry’s place in the regulatory
structure, the postwar decade proved to be a golden age for savings and loans as they
enjoyed an unprecedented rate of growth. Free from significant competition, and
operating under special conditions, such as freedom to set deposit rates and exemption
from much of the income tax, the industry flourished and wrote almost half of all U.S.
home mortgages. Furthermore, in 1955, the League finally won its battle to make the
Federal Home Loan Bank Board an independent government agency. League Vice
President Josephine Ewalt celebrated this success: “A new era of prestige for the savings
and loan business and its instrumentalities in Washington was inaugurated by this step.
Numerous subsequent developments are traceable to it.”48

However, all was not perfect. In 1954, the economy experienced a short mild
recession that caused many S&L members to withdraw savings. Yet, demand for home
mortgages remained high, leaving institutions short on funds. Savings and loans tried to
comteract the trend by raising dividend rates and they raised additional money by
increasing their borrowings from the Federal Home Loan banks, but the higher rates did
not result in retention of funds. Furthermore, in September of 1955, the FHLBB issued a
moratorium on advances, arguing that liberal lending by regional banks to members
would cause inflation. Thus, the industry faced a credit crunch, which significantly

affected growth rates at the end of 1955.49

 

" Josephine Hedges Ewalt, 307.
‘9 David Mason, 160.

56

1956-1966

While savings and loans did well during the second half of the 19503 and the first
half of the 1960s, these years did not prove to be the “golden years” that preceded them.
The industry continued to grow, but the return on net worth dropped fiom its high point
of 1955. Furthermore, institutions had to cope with increased competition on both the
saving and the lending sides of the business. The industry also became less unified on a
number of issues. Disparities in region, size, and form of ownership led associations to
pursue different strategies and to take opposing positions on a number of important
issues, making it diflicult for the League to lobby effectively. The industry and its
regulators faced many challenges. Furthermore, changing economic conditions
complicated the state of thought about financial sector regulation. In 1961, the
Commission on Money and Credit released recommendations based on its 3-year study of
the U.S. financial industry. While the study prompted little immediate change, it signaled
that change would soon be knocking on the industry’s door.

In terms of growth, savings and loans faced obstacles that they did not encounter
during the previous decade. The U.S. economy slowed a bit as manufacturing finally
caught up with and satisfied the pent-up demand for goods created during World War II.
In fact, these years witnessed three minor recessions in 1954, 1958, and 1961.

Production caught up with demand in housing construction as well, with the average
annual increase in new housing starts between 1955 and 1965 amounting to a weak

2%.50

 

’° David Mason, 159-160; 1966 Savings and Loan Fact Book (United States Savings and Loan League,
1966) 19.

57

Savings and loans also faced an earnings squeeze as short term interest rates rose,
relative to long term rates between 1961 and 1964. This resulted partly from Kennedy
administration and Fed policy aimed at bolstering the dollar in light of a growing balance
of payments deficit in the U.S. The higher short term rates encouraged foreign investors
to buy Treasury bills rather than turning in their dollars for gold. At the same time, the
Kennedy administration sought to encourage long term investment in plants and
equipment by keeping long term interest rates low. This combination proved challenging
for thrifts, which routinely borrowed short and lent long.5 I

In addition, savings and loans met mounting competition from a number of
sources. In 1961, James J. Saxon took over as Comptroller of the Currency. Committed
to modernizing commercial banking and expanding banks powers, Saxon issued more
than 6000 regulations during his tenure. Under him, commercial banks became active
participants in the mortgage market, after a change in regulations allowed them to ofl'er
loan terms similar to those of savings and loans. By the mid 1960s, commercial banks
wrote more than 14% of residential mortgages?2 Furthermore, on the savings side, bank
regulators took significant steps to help banks compete with S&Ls. Since 1933, the Fed
had held the authority to set ceilings on the rates commercial banks could pay on savings
under Regulation Q. The ceilings were not particularly important at first because market
interest rates tended to stay below the ceiling rate. However, by the 19605, this was no
longer true, and banks began to suffer from disintermediation as depositors moved their

funds fi'om savings accounts to other higher yielding investments such as Treasury bonds

 

" Donald D. Hester, “U.S. Banking in the Last Fifty Years: Growth and Adaptation,”
http://wwwssewiscedu/econ/grchive/prOOZ-19 4, accessed 12/5/08.

’2 David Mason, 160-161; “About the occ: James J. Saxon, Comptroller ofthe Currency, 1961-1966”
http://www.occ.treas.gov/saxon.htm accessed 12/10/08.

58

and commercial paper.53 Bankers urged the Fed to raise Regulation Q limits. In 1965,
the Fed responded, setting ceiling rates equal to S&L rates and banks collected 60% of all
new savings, while thrifts collected only 19%. Savings and loans, especially those in the
Slmbelt states responded with rate increases of their own, and in 1966 a rate war ensued.
The Federal Home Loan district banks tried to stop the chaotic competition by refusing
advances to institutions that paid deposit rates over 4.25%, however, the effort failed to
change behavior. The burden and risk of such fierce competition convinced FHLBB
chairman Home and President Linden Johnson to recommend that Congress pass a bill
mandating rate controls for the thrift industry. The League, which was intimately
involved in the legislative effort, strongly opposed rate controls, but they proved unable
to block them and instead focused on modifying the legislation. The Interest Rate
Control Act of 1966 put a ceiling on interest rates that thrifis could pay, but made that
ceiling 1/4 % higher than the rate the Federal Reserve allowed banks to pay on
deposits—an attractive provision for the S&Ls. The rationale for this privilege related to
the special role of S&Ls in housing finance. The rate control law, however, had a one
year term and had to be renewed by Congress annually to stay in effect. The law also
beefed up the power of the F HLBB by granting it the right to issue cease-and-desist
orders when institutions engaged in unsafe practices.54

To deal with capital shortages brought about by disintermediation, some banks

turned to the Eurodollar market. Created after World War II, the Eurodollar market is the

 

’3 Richard N. Cooper and Jane Little, “Competition and Opportunity,” Regional Review, Federal Reserve
Bank of Boston, October 3, 2001, www.bos.fi'b.org/economic/nerr/rr200l/q3/compet.htm.

54 David Mason, 160-161, 180-185; Josephine Hedges Ewalt, 315-317; Martin Mayer, 3436; M. Manfied
Fabrituius and William Borges, Saving the Savings and Loan: The U.S. Thrm Industry and the Texas
Experience, [950-1988 (Praeger, 1989) 47-52; Frederick E. Balderston, Thrifis in Crisis: Structural
Transformation of the Savings and Loan Industry, (Ballinger Publishing Company, 1985) 5.

59

market for American dollar deposits housed in banks outside the United States. Because
regulations for U.S. banks operating outside the country were different from those
operating fi'om within, Eurodollar deposits were not originally subject to Regulation Q or
reserve requirements. Therefore, banks that were large enough to have foreign branches
could work around the regulations, collecting dollars abroad by paying higher rates of
interest than regulations would allow them to pay at home. This gave those institutions
an advantage over both smaller commercial banks and savings and loans.’5

During the 19503, banks and S&Ls also faced minor, though increasing
competition for investment capital from mutual funds. After 1940, the Securities
Exchange Commission regulated companies offering mutual funds using criteria similar
to those used for stocks and bonds. Mutual funds also diversified their investments,
making the funds safer. Therefore, on a small scale, investors began to trust such firnds
with their money, with investments in mutual funds growing at 45% per year during the
1950s. Of course, savings and loans also continued to face competition hour the federal
government in the form of VA and FHA loans, as discussed above.56 Finally, savings
and loans competed with each other for savings by ofl‘ering higher rates of return, or
through gifts offered for starting new accounts. Some S&Ls even tried to attract
customers by paying dividends more fiequently, for example quarterly rather than semi-
annually.”

Along those lines, perhaps the most significant change during this time was the
development of a national market for savings and loan deposits. This occurred because

of uneven demand for housing across the country. The rise of the defense industry during

 

’5 Richard N. Cooper and Jane Little, “Competition and Opportunity.”
’6 David Mason, 161-163.
’7 Josephine Hedges Ewalt, 314-316.

60

and after World War II drew population to the Sunbelt states of the south and west,
especially California. Between 1940 and 1960, California’s population grew 125%. In
Los Angeles, for example, the population grew from 6.9 million in 1940 to 10.6 million
in 1950. During the 19503, the population increased over 54%. The demand for home
finance in California skyrocketed, and savings and loans scrambled to fund both
perspective homeowners and builders and developers. Since demand far exceeded what
regional markets could raise, S&Ls in California began to look for funds outside the
region in the 19503. By 1960, 18.5% of California savings and loan deposits came fiom
outside of the state, and institutions attracted these firnds by paying higher rates of return
than competing banks and S&Ls.58 Advertising in eastern and mid-westem newspapers
like The New York Times and The Christian Science Monitor, California thrifts offered
higher interest rates than residents of those regions could cam on more local investments.
California associations often collected these funds through brokers who charged a 2%
commission. In this manner, outside funds financed much of the state’s residential
development. 59 By 1960 the FHLB Board passed a regulation limiting brokered deposits
at each institution to 5% of total savings present at the beginning of the year.60

Deposits did not serve as the only means to move money fi'om east to west.
California S&Ls also sold some of their mortgage portfolio to eastern investors. In 1965,
for example, California institutions originated about $3 billion in loans and sold about

one fourth of them, mostly to eastern investors.“ Commercial banks in Arizona used

 

5’ Lynne Pierson Doti and Larry Schweikart, “Financing the Postwar Housing Boom in Phoenix and Los
Angeles, 1945-1960,” Pacific Historical Review, 1989; David Mason, 175; Walter J. Woerheide, 7-8.

’9 Kathleen Day, S&L Hell: The People and the Politics Behind the $1 Trillion Savings and Loan Scandal
(WW Norton & Co., 1993) 68; Martin Mayer, 35. Banks offering these investments included Wachovia in
North Carolina and Franklin National in New York. Also see Walter J. Woerheide, chapter 1.

‘° Josephine Hedges Ewalt, 318; Mayer 65-66.

"Ned Eichler, 25-26.

61

similar means to deal with excess demand for mortgages created by their wartime and
postwar population boom. For example, one Phoenix firm alone, sold mortgages that it
originated and serviced to over 20 investors in the eastern United States. By 1953, these
investors had infused over $30 million dollars into Phoenix area mortgages.62

The fact that California S&Ls procmed their firnds from outside the region and
paid a higher price for them changed the way they conducted business. To be profitable,
California institutions had to earn more on their loans. Thus, they tended to charge
buyers higher rates of interest. They also sought to write more speculative construction
and apartment loans, which generated higher profit than individual mortgages. The
state’s S&Ls encouraged builders to borrow fi-om them rather than from the FHA and VA
in a number of ways, including being more lenient in approval requirements. Many
institutions financed builders with little equity or accepted forms of income that the FHA
and VA rejected. Some institutions in the state bought land for builders and charged
them a small fee to develop that land. In return for lenient requirements, savings and
loans collected large fees. The state’s S&Ls derived twice as much of their income fiom
fees as institutions in other states. In pursuing higher yielding investments, California
institutions suffered a much higher rate of loan delinquencies, which rose for the entire
industry during the early 19603. However, in California, the rate grew at 60% per year as
compared to 35% per year for the rest of the industry. Furthermore, S&Ls in California
tended to be larger than in other states. California savings and loans averaged $100
million in assets, as compared to the average in the rest of the nation of $20 million.
Some institutions grew to be very large. Within the state of California, the ten largest

savings and loans possessed 44% of S&L assets. The three largest firms controlled 30%

 

‘2 Lynne Pierson Doti and Larry Schweikart, 180-181.

62

of the total. The state also housed the two largest S&Ls in the country, which each had
over $2 billion in assets. No other institution in the U.S. had acquired even $1 billion in
assets."3
Such vast differences in size, location, and manner of doing business created
divergent interests within the industry. Managers of smaller savings and loans disliked
the high interest rates offered by large institutions in California and other Sunbelt states.64
In an era of increasing consumer awareness of deposit rates, smaller institutions had no
choice but to compete with those rates or lose deposits themselves. Furthermore, some
associations, particularly those in the Sunbelt, who faced higher mortgage demand than
they could meet, wanted to change their ownership structure from mutual to stock in
order to raise funds. Though federal savings and loans were required to use mutual
ownership until 1976, many states began to allow their chartered institutions to convert to
stock ownership. California was the first, with 23 states following suit by 1967. As a
result, savings and loan holding companies began to develop, creating controversy within
the industry. Many felt that holding companies presented a conflict of interest, since they
could own other savings and loans or financial institutions that competed with each other.
Those against stock ownership also argued that publicly-owned institutions would forget
their original mission to benefit members of the local community and would instead look
for high-yielding, but riskier investments to earn lofty profits for investors. The larger,

southwestern, stock-owned associations increasingly held different opinions about the

industry’s future and this lack of industry unity made it difficult for the League to lobby

 

‘3 Ned Eichler, 24-29.

6‘ Federal Home Loan Bank Board Chairman James McMurray did not like the higher rates either. To
discourage the paying of such high dividends, he formed a new FSLIC reserve that required each instiution
to pay in 2% of their insured savings. Later, he linked the reserve requirement to total asset growth,
making reserves most burdensome for fast-growing institutions. See David Mason, 178-182.

63

Congress effectively. Particularly awkward and difficult was the fact that the large
California S&Ls possessed so much wealth and thus immense political power.65

The increasing complexity of the U.S. financial sector, growing competition
among financial intermediaries, and problematic trends in the U.S. economy such as a
slower growth rate, lack of sensitivity in price levels, and rising unemployment led to the
formation of the Commission on Money and Credit in 1957. The Committee for
Economic Development (CED), a nonpartisan, non-profit public policy group, had
suggested that Congress form such a commission to undertake a broad study of the U.S.
financial system in 1948 and again in 1951. However, Congress did not appropriate the
fimds. In his 1957 State of the Union Message, President Eisenhower also asked
Congress to authorize such a commission, composed of members of Congress and p1ivate
citizens. When Congress again failed to provide ftmding, the CED funded the study
itself, along with the Ford and Merrill Foundations. In addition to financial
intermediaries, the commission studied several wide-ranging economic issues such as
fiscal and monetary policy, public and private debt, and taxes. Its membership
represented a broad spectrum of expertise, including 8 members who already served on
the Council for Economic Development, 10 members from the financial industry, and 3
union officials. After 3 years of intense study and information-gathering, the commission

published its report in 1961 P“

 

‘5 David Mason, 175-177; Walter J. Woerhide, 13.

6‘ Robert Z. Aliber, “The Commission on Money and Credit, Ten Years Later,” Journal of Money, Credit
and Banking, Vol. 4, No. 4. (Nov., 1972) 915-929, http://www.jstor.org/stable/1991234 accessed
12/1/07; Karl Brlmner, “The Report of the Commission on Money and Credit” The Journal of Political
Economy, Vol. 69, No. 6 (Dee, 1961) 605-607, hgpzllwwsztorcrg/stable/ 1828352 accessed 12/1/07;
Money and Credit: The Report of the Commission on Money and Credit, Their Influence on Jobs, Prices,
and Growth (Prentice Hall, 1961).

According to commission member Robert Aliber, the report represented a new
way of thinking about financial regulation. Prior to this, he argues, regulators gave little
consideration to how regulation of one type of financial intermediary affected others.
This report, on the other hand, looked at the position of the various intermediaries --
commercial banks, mutual savings banks, and savings and loans — relative to each other.
“The Commission in effect accepted a general equilibrium view of the financial structure
and sought a rational structure for the relationship among intermediaries.” Committee
recommendations, Aliber argues, more closely reflected philosophy than empirical study.
They included the suggestion that financial intermediaries be made more similar in
function and regulation. The commission encouraged the elimination of interest rate
controls and leniency in branching restrictions for all types of institutions. However, the
final report did warn that regulators Should continue to limit investment options for
thrifis—savings and loans and savings banks—to avoid risk.‘’7 The study conducted by
the Commission on Money and Credit signaled the need to adjust to changing economic
conditions. President Kennedy and his administration received the report favorably, but
no immediate legislation was passed. However, the report remains a testimony to the fact
that by the 19603, experts understood that to remain healthy, the financial industry would
have to be at least partially deregulated.

1967-1978

During the late 19603 and 19703, savings and loans faced numerous challenges
and obstacles in an increasingly complex and difficult economic environment. The U.S.
economy entered its first troubled era since WWII. Interest rates, which had remained

relatively stable since the New Deal rose considerably during the 19703, making it

 

‘7 Robert z. Aliber, 921-927, quote iiom 926.

65

difficult for S&Ls to attract funds and raising the cost of funds they did collect. New
financial instruments wooed depositors away from their local savings and loans, which
were limited in how much interest they could pay under Regulation Q. Three major
studies of the industry were conducted during this time, and deregulatory
recommendations did find their way into legislative bills, but consensus proved illusive,
and none of the measures passed. While the FHLBB took some actions to solve the
industry’s problems, a far-reaching solution was not yet implemented.

The problems that converged on the U.S. economy in the early 19703 involved
global forces that had been building for some time. The mass production, mass
consumption mode of production that had brought about such a long era of prosperity
began to falter. As Japan and Germany rebuilt their economies American style, their
products began to compete with those of American manufacturers. Mass production at
home and abroad finally satisfied the exceptionally high post-war demand for consumer
goods and world markets became saturated. Economic growth proceeded slowly during
these years, with recessions taking place in 1969, 1974-5, and 1979. In addition, by the
late 19603, decades of booming economic growth combined with high government
spending on both the Vietnam War and Great Society programs triggered inflation. By
1966, the price level had risen by almost 3%. In 1970, prices rose by more than 5%. The
oil embargo of 1973, which caused a steep increase in the cost of oil, had inflationary
reverberations throughout the economy making the situation much worse. Thus, the term
stagflation entered the American vocabulary, referring to the problematic combination of
slow growth and high price levels. By 1971, inflation had so eroded the value of the

American dollar that the Bretton Woods system of fixed exchange rates collapsed as

66

Richard Nixon took the U.S. off the gold standard. Rising interest rates plagued the
economy, caused partly by government deficit spending, but also used by the Federal
Reserve as a tool to control inflation and in a last ditch effort to salvage the Bretton
Woods system. Mortgage rates, at 5% during the mid 19608 climbed to 8.5% by 1970
and to 11% by 1978.68

The U.S. economy underwent a period of profound adjustment to cope with these
changes. The new system that emerged was characterized by a shift in production fiom
manufactured goods to services; the development of a large array of new financial
instruments that created profits without production; a restructuring of labor to provide
greater flexibility, including moving production to regions with lower labor costs; and
enhanced concentration of economic power. Technological innovation also played a
large role in this adjustment. For example, corporations could move facilities to other
regions and even other countries because developing computer technology made it easier
to track and coordinate their activities across vast distances.”

The new conditions, however, posed several problems to savings and loans. First,
rising interest rates made it difficult for them to attract and retain firnds. From 1969
through the 1970s, market interest rates periodically climbed higher than the maximum
rate S&Ls could offer under Regulation Q. When this happened, depositors, often aided

by new technology, moved their funds to investments that paid higher rates. This

 

6' Norman Strunk and Fred Case, 1-2; Martin Lowy, High Rollers: Inside the Savings and Loan Debacle,
(Praeger, 1991), 2-3; Paul Zane Pilzer with Robert Deitz, Other People ’s Money: The Inside Story of the
S&L Mess (Simon and Schuster, 1989) 59-60; David Mason, 188; David Harvey, The Condition of
Postmodernity: An Inquiry into the Origins of Cultural Change (Bais Blackwell, 1990) 126-136; Frederick
E. Balderston, 4-5; Donald D. Hester, 7-8.

”David Harvey, The Condition ofPostmodernity, 157-160; Donald D. Hester, 8-12, Mike Davis, Prisoners
of the American Dream: Politics and Economy in the History of the U.S. Working Class (Verso, 1986) 129-
137; Also see Barry Bluestone and Bennett Harrison, The Deindustrialization of America: Plant Closings,
Community Abandonment, and the Dismantling of Basic Industry (Basic Books, Inc. 1982); Jefferson
Cowie, Capital Moves: RCA ’3 Seventy- Year Quest for Cheap Labor (Cornell University Press, 1999).

67

fluctuation in deposit levels created instability and made it difficult for financial
institutions to plan for the future.70 This problem became especially severe in the early
19703 with the launching of a new investment instrument, the money market mutual
fund. A cash management firm called The Reserve takes credit for creating the first
money market mutual fund in 1970. By 1971, these instruments came under SEC
regulation." Money market funds collected and pooled private savings, and invested in
Treasury bills, high-quality commercial paper, and large denomination certificates of
deposit. Investors had the ability to access their fimds without penalty by writing a
limited number of checks each month, known as negotiable orders. Though these
accounts were not technically backed by the full faith and credit of the U.S. government,
their conservative investment portfolios tended to be safe, and consumers took to them
immediately. These firnds became a major source of competition for consumer savings.
By 1979, money market funds claimed 13.5% of total U.S. savings, with $42.9 billion in
assets; and by 1982, these funds held over $230 billion in assets.72

The banking and thrift industries urged regulators to allow them to compete with
the higher yielding investment options. In 1973 regulators allowed financial institutions
to offer $1,000 four year certificates of deposit (CD) with no rate ceilings. However,
these instruments created chaos as rate wars among institutions arose, and were quickly
banned. In 1974, institutions began to offer a new type of CD with a much shorter term,
but it required a minimum investment of $100,000, thereby discriminating against the

small saver. Finally, in 1977 associations were permitted to offer the money market

 

7" Donald Hester, 9-10.

’1 “About the Reserve: A Tradition of Financial Innovation” hug/www.mservefugscom/histomshtml,
accessed 6/17/2008.

’2 Lawrence J. White, nte S&L Debacle: Public Policy Lessons for Bank and Thrifi Regulation (Oxford
University Press, 1991) 69.

68

certificate. This investment could be bought in $10,000 denominations and the interest
rate rose and fell with the rate of the 6-month Treasury bill. While this instrument did
succeed in attracting funds, it led to a significant increase in the cost of funds. Often
S&L members moved money from ordinary savings accounts to these higher yielding
options. By 1978, 75% of savings for the indusu'y took the form of accounts that paid
market rates of interest. 73

Financial institutions in some states tried to answer the challenge posed by money
market mutual firnds with Negotiable Order of Withdrawal or NOW accounts. NOW
accounts paid interest on savings, yet like money market funds, NOW accounts allowed
depositors to write a limited number of checks per month to access their funds. NOW
accounts pushed the regulatory envelope, since banks had been prohibited fiom paying
interest on demand deposits since the New Deal.74 However, Congress allowed them in
Massachusetts and New Hampshire as an experiment, regulated by the FDIC. In 1973,
Congress authorized federal S&Ls in states that allowed NOW accounts to offer them as
well. By 1976, Congress permitted NOW accounts in all the New England states.75

In this environment of high interest rates, savings and loans also turned to the
secondary market to raise funds. Mortgage originators had the option to sell to Fannie
Mae since its creation in 193 8, and in 1968, the government created the Government
National Mortgage Association (GNMA), typically known as Ginnie Mae. Ginnie Mae

helped institutions bundle pools of FHA and VA mortgages, added their own guarantee,

 

’3 David Mason, 190-191; Frederick E. Balderston, 5-7, 56; R. Dan Brumbaugh, Jr., 14-15; Andrew s.
Carron, The Plight of the my? Institutions (The Brookings Institution, 1982) 8-9.

7‘ David Mason, 194.

7’ House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions
Supervision, Re 'on and Insurance, Hearing, Consumer Financial Services Act of I 97 7 WOW Account
Legislation), 95 Congress, 1" session. September 7, 1977, 40.

69

and sold shares in these packages. The purchaser of Ginniemaes bought a share of the
pool, and collected a corresponding share of the payments made by homeowners. The
profit to investors in the pool depended on factors such as how long homeowners kept
their mortgages before selling or refinancing. Each pool performed slightly differently
and was heavily influenced by the movement of interest rates."5

The Emergency Home Finance Act of 1970, signed into law by President Richard
Nixon, offered another secondary market option with the creation of the Federal Home
Loan Mortgage Corporation or Freddie Mae. Freddie Mac was originated to buy
conventional mortgages, specifically from savings and loan institutions. It tapped into
investment frmds by selling “pass through” mortgage paper or income streams. Income
stream investments allowed the purchaser to buy only segments of a bundle of loans,
depending on specific investor needs. For example, investors could buy principle-only
segments, meaning they would receive payment as homeowners paid on their principle
loan amounts. These payments tended to be delayed since homeowners paid mainly
interest during the early years of a mortgage loan. Interest only segments paid investors
out of homeowner interest payments, and tended to pay earlier. Fluctuations in interest
rates affected these investments as well. For example, a drop in rates would cause
homeowners to refinance and thus pay off principle."

The rise of a national secondary mortgage market, which used investor filnds to
finance mortgages, drastically changed the landscape of the home finance market.

Throughout the 19503, 19605, and 19703, 25-30% of originated mortgages were sold on

 

: Martin Mayer, 38-39; David Mason, 19].
Martin Mayer, 41; David Mason, 191; M. Manfied Fabrituius and William Borges, 59.

70

the secondary market.78 This brought an enormous amount of new capital into the home
mortgage business and brought investment firms into the process. For savings and loans,
this proved to be a mixed blessing. While the secondary market gave thrifis an
alternative method of raising capital for home loans, it also encouraged competition and
challenged their position of privilege. With agencies such as Fannie Mae and Freddie
Mac collecting vast amounts of investor capital and making it available for home
mortgages, savings and loans became a less vital component of the housing finance
market. With the ability to sell mortgages quickly, and with the security of private
mortgage insurance, which became widely available after the 19603 and 1970s,
commercial banks sought to compete directly and “entered the mortgage business with a
vengeance.”79 Saving and loan institutions originated to fill a void in the banking
marketplace. By about 1980, that void was shrinking. As Berkeley economist and
builder, Ned Eichler, explains, “When anyone could originate loans and sell them to the
agencies and other conduits, or even set up his own channel, the ability to acquire
deposits, aided by government insurance, was of little, if any, benefit.”80

The industry also struggled during this era because it became more difficult for
families to afford their homes. With interest rates reaching new heights, monthly
payments often exceeded borrowers’ ability to pay, which prompted the development of
new mortgage products, known as alternative mortgage instruments (AMI). AMIs
lowered initial monthly payments by offering features such as interest only payments for
the first five years or graduated payments that increased at given intervals. While these

loans helped people get into homes, they often produced negative side effects. With

 

7‘ R. Dan Brumbaugh, Jr., 163-166.
’9 Kathleen Day, 58-9.
'° Ned Eichler, 45-49.

71

AMIs, borrowers did not accumulate equity in their properties for the first several years
of ownership, and when payment amounts rose, borrowers sometimes could not afford
the new payment. Other types of AMIs helped deal with changes in interest rates by
offering below market rates at the start of the loan that increased at intervals during the
loan period, or pegged the rate to an index such as the rate for 6-month Treasury bonds.
However, variable rate mortgages proved risky because monthly payments could increase
too rapidly for the buyer to afford. Regulations prohibited federally chartered S&Ls from
using them and California alone allowed its state-chartered institutions to use these
during this era.81
The instability of interest rates made it difficult for S&Ls to maintain their levels
of mortgage lending and squeezed profit margins. During periods of high interest rates,
such as 1969-70, and 1973—4, savings and loans found themselves paying high interest
rates to raise the filnds demanded in the housing market, yet they derived their income
almost solely from a portfolio of mortgages written in the past at lower rates of return.
Institutions could either pay more for funds, or fall short of satisfying mortgage demand.
“Thus, in a period of rapidly rising rates, the thrift institutions faced an earnings squeeze
if they raised offering rates and a liquidity squeeze if they did not.”82 In addition, federal
regulations prohibited savings and loans from diversifying their investment portfolios or

from offering adjustable rate mortgages that transferred all or some of the interest rate

risk to borrowers.83 Federal regulation that privileged social goals over economic

 

" David Mason, [88-189 For more on alternative mortgage instruments, see Walter J. Woerhide, The

Savings and Loan Industry. Current Problems and Possible Solutions (Quorum Books, 1984) chapter 4.
82Memorandum fiorn Robert Carwell to Regulation Q Task Force, October 6, 1978, Council of Economic

Advisors, Regulation Q, Box 74, Charles L. Schultze’ 8 Subject Files, Jimmy Carter Presidential Library.

'3 R. Dan Brumbaugh, Jr.,15-20.

72

rationality threatened to let the industry down and the need for deregulation became
obvious.

In 1966, in response to the industry’s problems, Congress authorized an in-depth
study of the savings and loan industry. The FHLBB commissioned Dr. Irwin Friend of
the Wharton School of Finance and Commerce to conduct the study, along with scholars
from universities across the country. Three years later, the final report, often referred to
as the “Friend Report,” was presented to the F HLBB. Friend claimed that the study,
which included 20 separate scholarly papers, represented “the most comprehensive
analysis of the savings and loan industry which has ever been undertaken?“

The final report recommended significant, but cautious deregulation of the
industry. On the asset side, the study suggested an expansion of powers for S&Ls,
including the right to offer consumer credit and mortgages on multi-family residences.
However, the panel did suggest limiting non-real estate loans to 10% of association
assets. On the liability side, the report suggested that S&Ls be permitted to offer savings
accounts with varying maturities, capital notes or debentures, and limited checking
privileges for its customers. The report also counseled that interest rate ceilings for S&Ls
and their competitors should be gradually eliminated “in a period when credit is easy and
market interest rates are declining appreciably.” Regulating agencies, however, should
have “the standby power” to reinstate the ceilings if necessary.85

In terms of regulations, the study suggested that liquidity requirements be kept

flexible, so that they could be lowered “under appropriate circumstances (particularly to

 

“ Irwin Friend, “Summary and Recommendations: A part of the Study of the Savings and Loan Industry”
in Study of the Saving and Loan Industry, Prepared for the Federal Home Loan Bank Board (U .S.
Government Printing Office, 1969) 1-3. Quote fi'om Letter of Transmittal fiom Irwin Friend to Preston
Martin, July 31, 1969, in Study ofthe Savings andLoan Industry, III.

'5 Irwin Friend, “Summary and Recommendations,” 29-30.

73

meet net withdrawals)” Capital requirements, the experts advocated, should vary with
the potential risk of an association’s investment portfolio. The report also recommended
a loosening of branching restrictions in order to provide for more competition and for
efficiency through economies of scale. Finally, the study recommended that federal
S&Ls be permitted to convert to stock associations, under certain guidelines that would
allocate “conversion profits among parties at interest,” including perhaps having FS LIC
or the federal government receive some of the proceeds. Finally, in terms of supervision
and examination, the study suggested that regulators use statistical data to identify
troubled institutions and thus monitor them more frequently and carefully than other
institutions.“

The study also prescribed that the F HLBB make expansion loans to associations
during “periods of tight money,” or to associations in areas where mortgage demand
clearly exceeds the flmds that can be raised “(except at rates which are clearly excessive
in relation to the cost of financing in the rest of the country).” However, advances should
be offered only to sound institutions, the report warned.87 Though the Friend report
enjoyed the full support of the U.S. League, it did not result in any legislative proposals
or regulatory change during this time.38

In 1969, as the economy and the savings and loan industry continued to deal with
the problems of rising interest rates, inflation, and unemployment, the President’s
Commission on Financial Structure and Regulation, also known as the Hunt Commission,
after its chairman Reed Hunt, began its study of the U.S. frnancial market.

Commissioned by Richard Nixon, the group took a neo-liberal viewpoint that

 

'6 Ibid.
‘7 rbid
” David Mason, 206.

74

government regulation hindered the efficiency of fi'ee markets. In general, the
commission believed that the barriers between various kinds of financial institutions
should be removed on both the liability and asset sides, and that they should become
more alike. Along these lines, the commission advocated phasing out the differential on
interest rate ceilings over a 5 year period. Afler that time, all financial institutions would
be subject to the same rate ceilings. Rate ceilings overall should be phased out, the 1972
report argued, so that financial institutions could compete with money market funds for
deposits. For 10 years, the Fed should retain the authority to use rate ceilings, but only
when a threat of serious disintermediation existed. Furthermore, the report suggested that
all institutions be allowed to offer demand deposits and be subject to the same reserve
requirements and taxation.89
On the asset side, the commission recommended that S&Ls be allowed to
diversify by offering credit cards, holding subordinated debt, and selling mutual fiinds.
Banks, the commission suggested, should continue to enter the mortgage business, with
all financial institutions being taxed similarly. Barriers against branching and interstate
banking should be removed, argued the commission, and the Glass-Steagall wall between
banking and securities should be eased. Finally, the report suggested a partial
consolidation of financial industry regulation, paring down the number of regulatory

agencies to two or three. Separate agencies might exist, the report suggested, for

 

'9 George J. Bentson, “Discussion of the Hrmt Commission Report: Comment” Journal of Money, Credit,
and Banking Vol. 4, No. 4 (November, 1972) 985-989, hgpzllwww.istor.o;g[stable/ 1991238 accessed
11/11/08; Roland 1. Robinson, “The Hunt Commission Report: A Search for Politically Feasible Solutions
to the Problems of Financial Structure” The Journal of Finance Vol 27, No. 4 (September 1972) 765-777,

http://www.jstorgglstable/‘2978662 accessed 1 1/7/07.

75

federally chartered institutions and for state chartered institutions’who the federal
government insrn'ed. Then, a third agency might oversee federal deposit insurance.90
Two pieces of legislation attempted to implement some of these
recommendations. The Financial Institutions Act of 1973 included a phase-out of
Regulation Q, a provision to allow thrifts to offer NOW accounts, and also authorization
for thrifts to invest up to 10% of assets in consumer loans. To encourage S&Ls to
continue their specialization in mortgages, the bill also offered tax credits on real estate
loans. The League however opposed the bill because of the provision phasing out
Regulation Q. Though thrifts strongly opposed interest rate ceilings when they were
implemented in 1966, over time the industry came to support the 1/4% advantage over
commercial banks that they received and they supported its renewal annually even though
it made it virtually impossible for S&Ls to compete with money market funds for
consumer deposits. The lack of League support prevented this bill from passing.91 The
Financial Institutions Act of 1975 proposed similar changes except it allowed S&Ls to
diversify assets even further by holding up to 30% of assets in consumer loans and
commercial stock. Again the League opposed the measure because of its phase-out of
Regulation Q. Though the bill passed the Senate, it failed in the House.92 Economist,
Roland Robinson, has argued that the Hunt Commission tried to recommend politically

feasible reform, but they apparently were not feasible enough, since none of the

suggested changes made their way into legislation for more than 5 years.93

 

9° Lester V. Chandler and Dwight M. Jaffee, “Regulating the Regulators: A Review of the FINE Regulatory
Reforms, Journal of Money, Credit and Banking, Vol. 9, No. 4 (Nov., 1977) 627
mzflwwwjflorgfitable/ 1991535 accessed 9/17/07; Susan Hoffman, 229-230; David Mason, 207-208;

9‘ David Mason, 207-208.

’2 Ibid.

’3 Roland 1. Robinson, 767.

76

In 1975, Representative Ferdinand St. Germain, Chairman of the House
Committee on Banking, Finance, and Urban Affairs took the unusual action of calling for
a new study to be conducted, which came to be known as the Financial Institutions and
the National Economy Study, or Fine. According to FINE study director, James Pierce,
“Most legislation is developed outside of Congress by the administration, by independent
agencies, by special commissions, or by special interest groups. Congress normally
reacts to these legislative proposals, modifies them, and then votes them up or down.”
However, in this case, the Banking Committee was dissatisfied with several years’ worth
of financial reform proposals and thus turned to this procedure instead.94 The report
repeated many of the same recommendations of past studies, such as eliminating
Regulation Q, which Pierce referred to as “without social redeeming value.” The FINE
Discussion Principles also advocated permitting all depository institutions to offer
demand deposit accounts and subjecting them to equal reserve requirements. In order to
encomage investment in housing, reserve requirements would be lowered, based on an
association’s volume of low and moderate income mortgage loans.95

The study also made some suggestions considered radical. For example, it
advised that all the regulatory agencies —the Comptroller of the Currency, the FDIC, the
Fed, the FHLBB, and the NCUA—be combined into a single agency, the Federal
Depository Institutions Commission. Depository institutions had become quite similar,
and were bound to become more similar with future reforms, the study argued. Thus, it

would not make sense to have them regulated and supervised by 5 difiemnt agencies.

 

9‘ James L. Pierce, “The FINE Study,” Journal ofMoney, Credit and Banking Vol. 9, No. 4. (Nov., 1977)
606.

9’ House Committee on Banking, Cin'rency and Housing, Subcommittee on Financial Institutions
Supervision, Regulation and Insurance, Hearings, Financial Institutions and the Nation ’s Economy (FINE)
“Discussion Principles” 94'h Congress, 1‘t and 2" sessions, Part 1, December 2, 1975, 3-8.

77

Furthermore, Pierce explained, the Federal Reserve should be separated from its
supervision of banks and allowed to concentrate on its role of formulating monetary
policy. In that policy formation role, however, the Fed needed to become much more
subject to Congressional scrutiny, since monetary policy was so important:

Monetary policy, on the other hand, is determined in secret by a group of

men who are, not even elected. Furthermore, the Federal Reserve Banks

presidents, who cast 5 out of the 12 votes on the Federal Open Market

Committee, which is the most important policymaking body within the

Fed, do not even receive Presidential appointments. Yet the decisions at

the Fed can undo fiscal policy. Those who decide monetary policy have

the potential of choosing between prosperity and depression; between

inflation and price stability; between financial stability and instability. In

short, they have tremendous power but they are accountable to no one.“5
Not surprisingly, these more radical recommendations of the Fine report such as the
attack on Fed power, became hotly contested and did not make it into the next attempt at
financial reform, The Financial Reform Act of 1976. The main difference between this
bill and the previous two lay in the phase-out of the housing differential in interest rate
ceilings. While the bill called for a 5-year phase-out like the ones before it, it stipulated
that S&Ls holding more than 80% of their assets in home mortgages be allowed to
maintain their ‘/4% differential. The bill, however, never made it out of committee. “It
became abundantly clear in the hearings that the vehement opposition by some influential
groups could not be offset by the support of other groups and that the bill could not be
passed. As a result FIA was allowed a peaceful death,” explains Pierce.”

In the absence of any new legislation, the FHLBB and other regulators took
several actions in the 19705 to try to solve industry problems. In 1972, the Board

adjusted reserve requirements, making it easier for institutions to comply. On the

 

95 .
Ibrd., 8.

’7 David Mason, 208-209; Lester V. Chandler and Dwight M. Jaffee, “Regulating the Regulators,” 627;

Quote from James L. Pierce, “The Fine Study,” 606.

78

liability side, the Board increased the products thrifts could offer savers outside of the
restrictions of Regulation Q rate ceilings, including permitting the creation of money
market certificates in 1978. These certificates, which had a maturity of 26 weeks,
required a minimum investment of $10,000 and pegged interest rates to the 26-week
Treasury bill, giving thrifts a differential over commercial banks. In 1979, regulators
authorized both banks and thrifis to offer a new financial instrument, the Small Saver
Certificate, beginning in January of 1980. These certificates had no minimums, matured
in 30 to 48 months, and indexed their rate ceilings to the average 2 1/2 year rate paid for
U.S. Treasury bills. Again, tlrrifts were awarded a differential.98 The FHLBB in concert
with the Federal Reserve also raised rate ceilings throughout the decade, making savings
accounts at least a bit more competitive with other investment alternatives. On the asset
side, the Board increased the maximum loan to value ratio that S&Ls could offer on
construction loans, and allowed them a larger geographic lending area in which to do
business. These measures proved small, however, and the kind of long term, extensive
reform that the regulatory system so badly needed, did not happen.”9 In fact, by 1975,
Economics professor Edward J. Kane, witness before the House Subcommittee on
Financial Institutions, suggested that actions such as these had hurt more than they
helped:

During the last 15 years, a succession of commissions and study groups

have taken up this issue, but with no palpable benefits. In fact, instead of
developing benefits, things have gotten worse. Financial incentives have

 

9' E. Gerald Corrigan and Evelyn Carroll, “Meeting Challenges of a New Banking Era,” 1981 Annual
Report Essay Federal Reserve Bank of Minneapolis; Senate Committee on Banking, Housing, and Urban
Affairs, Subcommittee on Financial Institutions, Hearing, Depository Institutions Deregulation Act of I 979,
Part 11, 96" Congress, 1't session, June 27, 1979, 92-93.

9’ M. Manfred Fabrituius and William Borges, 59-69.

79

been distorted, and the whole financial system has been made more fiagile
by what I regard as ill-conceived, patchwork adj ustrnents.00

The Comptroller of the Currency made a similar point when testifying before the Senate
Subcommittee on Financial Institutions in June of 1979. Regulatory actions could not
adequately respond to the challenges facing financial institutions, argued Cantwell
Muckenfuss, Senior Deputy Comptroller of the Currency. In fact, he explained that some
institutions feel that jerry-rigged solutions to the deposit rate ceilings “could threaten the
solvency of a number of institutions. These concerns demonstrate the dangers and
problems that the substitution of regulatory judgments, regarding appropriate deposit
rates and deposit conditions, for the decisions of competing financial institutions leads

to 3,101

The question to be explored is “Why?” Based on the studies addressed above,
executive agency regulators such as the F HLBB and the FDIC, key members of Congress
such as the Chairman of the House Banking Committee, industry associations such as the
U.S. Savings and Loan League, and members of the financial industries themselves all
seemed to be aware of an acute need for financial deregulation.102 They could see the
wave of potential problems drifting in towards their industries if something was not done

to change the tides. Yet, no consensus could be reached. Part of the problem, explained

 

'°° House Committee on Banking, Currency and Housing, Subcommittee on Financial Institutions
Supervision, Regulation, and Insurance, Financial Institutions and the Nation’ s Economy (FHVE)
‘Discussion Principles” Hearings 94"l Congress First and Second Sessions, 1975, 112.
"’1 Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Financial Institutions,
Hearing, Depository Institutions Deregulation Act of1979, Part 11,96'll Congress, lat session, June 27,1979
94-95.
102 Testifying before flre House Subcommittee on Financial Institutions, Economics professor, William
Silber even commented, “It is somewhat unique to find economists, politicians and businessmen in general
agreement on anything, much less the need to reform the existing institutional structure. This is, indeed, the
situation with the regulatory environment surrounding the deposit institutions and the markets in which
they operate.” House Committee on Banking, Currency and Housing, Subcommittee on Financial
Institutions Supervision, Regulation and Insurance, Financial Institutions and the Nation’ s Economy
(FHVE) ‘Discussion Principles’ Hearings, 94"I Congress, lst session, 1975,131.

80

FINE study director, James Pierce, involved the belief by each industry group involved,
that deregulation would result in loss of benefits for them. As discussed above, in the
case of S&Ls, the biggest reservation involved losing the advantages bestowed upon
them by the housing differential of Regulation Q. Economics professor Franco
Modigliani, explained to the House Subcommittee on Financial Institutions:

...some in the industry may say that they want to see the ceiling

eliminated eventually, I think it is lip service. I completely agree with you

that when they are absolutely honest they want that protection; they don’t

want any competition . . . You know perfectly well that nobody wants

competition except everybody else. Everybody else should be competing,
but I should be protected. I think that industry feels vegy strongly in that

direction, but should you as legislators approve that?”'

Also, Pierce argued, regulated institutions had become comfortable with their regulators
and felt uncertain about what the future would bring if consolidation of agencies
occurred. Regulating agencies, for their part, tended to be bureaucratic institutions with
an interest in protecting their turf, and therefore had no desire to be consolidated into one
super-agency. '04 Ironically, lobbyists representing the various interest groups faced the
same issue. Consolidation might lead to a loss of work for them.

Another problem involved the lack of a crisis at this point in time. Clearly, S&Ls
and other financial institutions faced hard times and challenges from the economic
troubles of the 19708. However, despite the challenges, the savings and loan industry
managed to increase assets and profits during this time period. In fact, by 1978, net
income as a percentage of net worth, which had declined for the industry from 1955 to

1967, and had fluctuated fi'om 1967 to 1978, retm'ned almost to the 1955 level.”5 While,

 

'°’ Ibid., 209.
‘0‘ James L. Pierce, “The Fine Study,” 616.
"’5 Ned Eichler, 40-41.

81

problems may have been on the horizon, they had not arrived yet, and since legislation
hinged on agreement by multiple groups that had much to lose or gain —commercial
banks, S&Ls, mutual savings banks, credit unions, money market brokers—consensus
was unlikely to occur without a crisis. No crisis existed yet, and unfortunately, no wide-
scale changes would be made to U. S. financial regulation during this era.

Between World War II and the late 19708, the experience of the financial
regulatory structure set up by the New Deal ranged fiom unquestionable success to
struggle. The fate of the industry somewhat mirrored that of the economy overall. The
golden years of the post-war decade gave way to good solid years during the 19508 and
early 19608. But, by the late 19608 and 19708, the economy and the savings and loan
industry experienced great change and the terms of doing business became much more
complicated and difficult. The political system responded attentively to the needs of the
industry during the 19408 and 19508, helping to make it the major source in home
financing that it became. By the late 19608 and 19708, it became less clear how the
government could help S&Ls. Indeed, it became less clear to the industry how it could
help itself. Furthermore, the development of a myriad of new financial instruments to
raise funds for home finance began to call into question the special role the government
had assigned to the savings and loan industry.

The unfortunate part of the story is that the flaws in the New Deal system made
savings and loans extremely vulnerable to interest rate fluctuation. The New Deal did
indeed create “an accident waiting to happen.” Institutions that did everything the federal
government asked of them found they had a problem in the 19708. Even more

unfortrmately, the executive and legislative branches of government and industry leaders

82

proved unable, or perhaps unwilling to solve this problem through regulatory reform
before it reached crisis proportions. This failure calls into question the ability of U.S.

democracy to solve economic problems effectively.

83

CHAPTER 3
DEREGULATION: THE RESTRUCTURING OF THE NEW DEAL REGULATORY

SYSTEM

The legislative process leading to the Depository Institutions Deregulation and
Monetary Control Act (DIDMCA) was long, and the story of how a supportive coalition
was finally built around this deregulatory legislation is complex. Efforts to reform the
banking system had failed for almost a decade. They succeeded in 1980 because of an
exceptional confluence of economic and political circumstances. On the one hand,
technological change that allowed money to move more quickly than ever before, both
within and outside of the country fundamentally challenged the regulatory framework of
U.S. banking. This practically forced Congress to address the issue of financial reform.
At the same time, troubling economic conditions of the late 19708 made it clear that
without remedial action, a banking crisis was imminent. This all happened to take place
while the White House was occupied by a president uncommonly willing to take on
politically difficult legislative issues such as deregulation. Together, these factors created
a rare moment when legislation that asked all interested parties to compromise could
pass.

Jimmy Carter was an unlikely prospect for U.S. President. Not only was he a
Washington outsider, but he lacked all desire to become a Washington insider. He
disliked the special interests that dominated U.S. politics, believing that they interfered
with the government’s obligation to pursue the public interest. He also opposed the pork

barreling, partial solutions, and unsatisfying compromises that represented the usual

84

mode of operation in Congress. However, the public’s disillusionment with government
following the Watergate scandal, and a l6-month recession during Ford’s administration
that caused unemployment to linger at 7.8% at the time of the November, 1976 election,
allowed an outsider like Carter to carve a space for himselfin presidential politics. Thus,
Carter took office in 1977, determined to tackle the kind of difficult and politically
unattractive issues that most politicians preferred to ignore.1

The tasks that lay before Carter were less than glamorous. He assumed the
presidency during diffith times that were not of his making. The economy was still
struggling to recover from the 1973-5 recession, with unemployment above 7%. Slow
growth, however, did not provide much relief from a problematic level of inflation, just
below 6%. At the same time, Carter, a fiscal conservative, inherited a $66 billion budget
deficit.2 Dming his campaign, Carter promised to achieve a balanced budget by the end
of his first term and to make firll employment a top priority. Upon entering office, this
President, who asked the head of his Domestic Policy Staff to compile a list of all
promises he made during the campaign, tried to make good on these commitments. He
pushed a stimulus package through Congress, attempting to speed up recovery from the
recession. It included tax cuts for individuals, tax credits for businesses that hired new
employees, a multi-faceted jobs program, and an increase in counter-cyclical relief for

state and local governments.3

 

‘ Charles 0. Jones, “Carter and Congress: From the Outside In” British Journal ofPolitical Science Vol.
15, No. 3 (July 1985) 270 hgp://www.istor.o_rg[stable/ 193695 accessed 3/25/08; William F. Grover and
Joseph G. Pescheck, “The Rehabilitation of Jimmy Carter and the Limits of Mainstream Analysis”
hm://www.istor.org[stable/3235147 accessed 3/25/08; W. Carl Biven, Jimmy Carter ’s Economy: Policy in
an Age of Limits (The University of North Carolina Press, 2002) 28-9; Norman C. Thomas, “The Carter
Administration Memoirs: A Review Essay” The Western Political Quarterly, V0129, No. 2, (J1me, 1986)
348-360, http://www.jstor.org/stable/448303 accessed 3/‘27/08.

2 w. Carl Biven, 62, 82-83.

3 Ibid., 218, 72-82.

85

Carter and his economic advisors worried less about inflation than about
unemployment. Ruling out anti-inflationary strategies that might negatively affect
employment, such as tight fiscal and monetary policies, the administration used more
subtle, long-term tactics. For example, Carter promised to study government regulations
and alter the ones that needlessly drove up the price of goods. The administration also
sought to restore competition and thereby lower prices through a variety of measures,
including support of free international trade, enforcement of anti-trust regulations, and
deregulation of several industries. Carter had promised in his 1976 campaign to pursue
deregulation, and he made good on that pledge, deregulating airlines, trucking, and
railroads, in addition to financial institutions by the end of his term.4 Carter also pledged
to hold down federal spending in order to control the deficit. Finally, he asked Congress
to expand the authority of the Council on Wage and Price Stability for an additional two
years;

The poor state of the economy and of the government bureaucracy in the late
19708 necessitated reorganization, rationalization, and consolidation of programs already
in effect, not the creation of new and exciting initiatives. Furthermore, Carter’s sense of
fiscal responsibility dictated that programs and staffs be reduced, not expanded in an

effort to cut the deficit.6 This work proved difficult unpopular, and lackluster, especially

 

’ Iwan Morgan, “Jimmy Carter, Bill Clinton, and the New Democratic Economics,” The Historical Journal,
47, 4 (2004) 1023.

m://iournals.cambrigge.ogg,mgl.cl.msu.edu/action/d§p' lavFulltext?tvne=lgfid=265030&1'id=&volume
ld=&issueld=04Laid=265029t3bodyld=&member8hipNumber=&sociegETOCSeflJn accessed 7/10/08.
Morgan explains that the idea of deregulation had become politically popular in 1975 when the Senate
Subcommittee on Administrative Practice and Procedure, chaired by Edward Kennedy, held hearings on
the issue.

5 w. Carl Biven, 127-132.

6 Charles 0. Jones, 281; James L. Sundquist, “Jimmy Carter as Public Administrator: An Appraisal at
Midterm” Public Administration Review, Vol. 39, No. 1 (Jan.- Feb., 1979) 3-11

 

86

for Carter, who did not find macroeconomic policy nearly as compelling as other areas
such as foreign policy.7 However, Carter’s drive to do the right thing, to pursue what was
best for the American public, meant that his administration gave high priority to tackling
these kinds of issues.8

The problems that strained the American economy at large also had negative
consequences for the banking and savings and loan industries. Rising interest rates that
accompanied inflation encouraged the development of higher-yielding investment
instruments not subject to the rate ceilings of Regulation Q. Therefore, banks and S&Ls
suffered disintermediation of funds. S&Ls in particular suffered fiom profit squeeze
because rising interest rates meant that they paid more for deposits than they collected
from their limited portfolios of long-term, fixed-rate mortgages written in the past. These
problems had occurred for most of the decade, and several attempts to solve them had
failed to make it through Congress.9 Jimmy Carter, however, entered oflice determined
to see financial reform accomplished under his watch, and his Domestic Policy Group
used all its resources to make this happen.10

As a Washington outsider and as a president determined to do what was best for
the country regardless of political considerations, Carter often struggled in his

relationship with Congress. He did not bring to office close relationships with

 

7 W. Carl Biven, 55; In his memoirs, Carter admitted that he found domestic policy much more difficult to
enact than foreign policy. In a crisis of foreign affairs, he explained, the public gave its filll support to the
President. However, in matters of domestic policy, “It is almost impossible to arouse such support among a
multiplicity of confirsing and sometimes conflicting domestic issues,” he lamented. See Jimmy Carter,
Keeping the Faith (Bantam Books, 1982) 89.

’ Charles 0. Jones, 297.

9 David Mason, 214.

‘° Charles Schultze has commented on the administration’s philosophical view that deregulation was
desirable. See W. Carl Biven, 219. DPS memos and correspondence discussed below highlight the
numerous actions taken by the department, both early and late in the process, to see to the passage of ‘
financial deregulation.

87

Congressional leaders, nor did he work hard to cultivate them once in office. He had no
desire to bargain or compronrise with Congress over programs. In fact, in Carter’s view,
legislative efforts were best initiated by the President and his staff, who spent much time
carefully studying issues and weighing various policy options. The burden then fell on
the President to offer well-researched solutions and to demonstrate public support to
Congress for the proposed policy changes. Congress’ job, in Carter’s view, was to
support the president in this process once the solutions were offered, thus he rarely
collaborated with members of Congress early in the legislative process.ll

Carter built an apparatus to accommodate his methods for introducing and
guiding legislative initiatives. His Domestic Policy Staff (DPS), headed by Stu Eizenstat,
helped the president formulate policy early in the process, usually providing him with
alternative courses of action, presented in detailed option papers. The DPS helped
educate the president before he introduced issues to Congress. Carter then relied on his
public liaison staff to build public support and to sell his ideas to Congress. Later in the
process, the DPS got involved again, working with Congress directly and even lobbying
on Capitol Hill. “Eizenstat noted that domestic policy advisers virtually live with Hill
staff. ”12

In working with Congress, Carter again suffered, to some degree, from problems
not of his making. During his term, Congress had become less responsive to the
president for a number of reasons. First, the recent Watergate scandal had eroded

Congress’ trust in presidential authority. In addition, a significant number of retirements

brought in new and ambitious members of Congress, who wanted to expand the power of

 

” Charles 0. Jones, 272-275.
'2 Quote from Roger B. Porter, “Advising the President,” PS, Vol. 19, No. 4 (Autumn, 1986), 867-869
http://www.jstor.orgbtable/M9327 accessed 4/2/08. Charles 0. Jones, 277-279.

88

the two houses, and were therefore less inclined to simply follow the president’s lead.l3
Carter himself noticed this trend, reflecting later that “I learned the hard way that there
was no party loyalty or discipline when a complicated or controversial issue was at
stake—none.” This gap in party discipline allowed special interests to exert extra
influence on Congress, “a highly dangerous development,” in Carter’s opinion. Carter
also attributed Congress’ lack of support to a split between conservative and liberal
factions of the Democratic Party that he viewed as “impossible to heal.” Also, his own
narrow election victory left some question as to Carter’s public mandate.l4 Though
Carter clashed with Congress over many of his legislative campaigns, hi8 non-
compromising manner and non-inclusive process may have actually worked well in the
case of banking reform. “This unusual apparatus did contribute to the realization of the
president’s substantive and stylistic goals. It produced a number of victories on issues
that were unpopular on Capitol Hill,” explains presidential scholar Charles J ones.”
Upon entering office, the Carter administration immediately began formulating a
strategy to guide financial reform legislation through Congress. In June of 1977, the
administration’s Economic Policy Group (EPG) sent Carter a detailed options memo,
proposing a plan of action. In light of numerous failed attempts to pass far-reaching
banking reform, the group recommended a more practical approach of pursuing three key
legislative issues for the short term, and studying further, the more complicated and
controversial measures. A memo to Carter fiom chairman of the Economic Policy
Group, Michael Blumenthal, stated “Today. virtually no one favors another omnibus

reform effort. Its prospects of passage would appear to be non-existent. The opposite

 

’3 William F. Grover and Joseph G. Pescheck, 142.
" Jimmy Carter, Keeping the Faith (Bantam Books, 1982) 68-9, 80. Quotes from 80.
'3 Charles 0. Jones, 297.

89

interests of the groups affected, and the difficulty of mobilizing effective support from
the major beneficiaries - consumer/savers—argue for a much more selective approach.”16
The first measure recommended by the EPG was to allow all financial institutions
to offer Negotiable Order of Withdrawal (NOW) accounts. In fact, they argued that
NOW accounts should be the only reform vigorously pursued in 1977. Created in 1972
to compete with the phenomenally popular money market accounts that were attracting
away deposit dollars, NOW accounts paid interest on savings, yet allowed depositors to
write a limited number of checks to access their firnds.l7 Institutions generally charged a
fee for each check. In 1973, Congress formally allowed them in Massachusetts and New
Hampshire as an FDIC-regulated experiment. By 1976, Congress permitted financial
institutions in the other New England states-Maine, Vermont, Rhode Island, and
Connecticut-40 offer them as well. In 1975, the House of Representatives considered
legislation that would permit NOW accounts throughout the nation, but the bill failed.
The issue surfaced again in 1977 in the House Subcommittee on Financial Institutions,
which debated allowing NOW accounts in New Jersey, New York, and Pennsylvania,
again without success. ‘8 Carter’s Economic Policy Group proposed legislation that

would authorize all depository institutions to offer NOW accounts to household

 

l"Memo fi'om Rick Hutcheson to Michael Blumenthal, June 8, 1977, Financial Institutions Reform”
Financial Institution Reform 6/8/77, Box 102, Staff Office Files: Office of Congressional Liaison Lisa
Bordeaux, Jimmy Carter Presidential Library. Note that this memo transmitted Carter’s response to the
memo Michael Blumenthal sent him one day earlier regarding financial institutions reform. A copy of
Blumenthal’s memo is attached, with Carter’s handwritten notes.

'7 David Mason, 194; House Committee on Banking, Finance and Urban Affairs, Subcommittee on
Financial Institutions Supervision, Regulation and Insurance, Hearing, Consumer Checking Account Equity
Act of I 979, 96"I Congress, 1't session, May 15, 1979, 77-80.

"House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions
Supervision, Regulation and Insurance, Hearing, Consumer Financial Services Act of 1977 (NOW Account
Legislation), 95 Congress, 2"" session, September 7, 1977, 40; House Committee on Banking, Finance and
Urban Affairs, Subcommittee on Financial Institutions Supervision, Regulation and Insurance, Hearing,
Consumer Checking Account Equity Act of1979, 96'h Congress, 1't session, May 15, 1979, 80-84.

Lewis J. Spellman, The Depository F inn and Industry: Theory, History, and Regulation (Academic Press,
1982) 38.

90

customers, at a rate set by regulators, with equal reserve requirements for all institutions.
The group justified this recommendation by explaining that the prohibition against
paying interest on demand deposits “has eroded through innovation and eventually will
erode completely.”19
In fact, the EPG argument was convincing. Technological innovations during the
19708, particularly electronic funds transfer, influenced daily transactions in banking and
affected the industry’s future regulatory structure. Over the course of the decade,
technological progress made it possible to conduct more and more business functions
electronically. For example, in 1972, the Federal Reserve Bank of San Francisco
experimented with carrying out internal transactions with its Los Angeles branch
electronically. By 1978 all Federal Reserve Banks had begun to use this system. In 1975
the Social Security Administration and other government retirement systems gave
collectors the option to use direct deposit. Electronic deposit of payroll spread quickly,
both in the public and private realms, as did automatic payroll deductions for retirement
accounts, insurance, and mortgages. In terms of account access, the first automated teller
machines (ATM) came into use in 1971, allowing customers to conduct their banking
activities any time of day, sometimes without going to the bank.20 Furthermore, in 1974,
First Federal Savings and Loan in Lincoln, Nebraska installed the first point-of-service
payment terminals in the local supermarket. Customers need not withdraw cash fi'om an

ATM machine or write checks for their purchases. The terminal automatically deducted

 

'9 Memo from Rick Hutcheson to Michael Blumenthal, June 8, 1977, “Financial Institutions Reform”
Financial Institution Reform 6/8/77, Box 102, Staff Office Files: Office of Congressional Liaison Lisa
Bordeaux, Jimmy Carter Presidential Library.

2° The first ATM machines were located at bank branches. See David Mason 192.

91

the exact amount of the purchase fi'om the customer’s First Federal account.” This
technology spread rapidly during the remainder of the decade. Also in the early 19708,
the Federal Reserve, which acted as a check clearing house for its members, began to
develop the Automated Clearing House (ACH), to process payments without the use of
paper checks. Originally ACH used magnetic tapes to record the information and
delivered the tapes to member institutions, but eventually all information came to be
transmitted electronically.”

Savings and loans utilized electronic frmds transfer beginning in the early 19708,
using the Transmatic System (TMS), created by First Federal Lincoln of Omaha. The
system allowed customers to authorize direct deposits and mortgage payments. By 1974,
TMS remote service units placed in supermarkets allowed customers to authorize checks,
make deposits and withdrawals, pay bills, and use debit cards with participating
merchants.23

Technological developments had significant competitive consequences in the
financial industry. Brokers and individuals gained the ability to follow interest rates on
their investments closely, which presented new competition for S&Ls, who were again
limited by Regulation Q in the amount of interest they could pay on deposits. With easy
and continual access to information, consumers became increasingly savvy.

Furthermore, they could quickly and easily move deposits fiom one institution to another,
from one deposit instrument to another, and even to investments outside of the banking

sector, particularly money market mutual funds, in search of higher rates of return. This

 

2' Jack Weatherford, The History ofMoney (Crown, 1997) 233-236; Frederick E. Balderston, 7.
’2 “Automated Clearing Houses (ACH8)” Federal Reserve Bank of New York,
http://wwwny.fib.om[aboutthefed/fe_dpgint/fed3 l .htrnl, accessed 6-17-2008.

23 David Mason, 192-193.

92

was especially encouraged by the high rate of inflation during the late 19708, which
threatened to erode the value of low-yielding investments considerably.

New electronic banking technology also created the difficult regulatory issues
alluded to by Carter’s Economic Policy Group. For example, some argued that
automated teller machines, which could perform all or most of the functions of a banking
branch, constituted a violation of branching limitations.24 Furthermore, the ability to
access savings through point-of-sale transactions meant that passbook savings accounts
functioned more like checking accounts, which by regulation could only be offered by
commercial banks. Likewise, the ability to electronically transfer funds quickly and
easily fiom savings to checking accounts meant that customers were, in essence, earning
interest on their demand deposits, also a violation of banking legislation. The new access
and payments systems also broke down the barriers separating what had been discrete
segments of banking. Credit unions, savings and loans, and commercial banks could all
now in eflect offer checking-like accounts that paid interest. Each segment of the
financial industry tended to object to regulations that allowed its competitors to utilize
new services. For example, when the Fed proposed that banks be permitted to offer
automatic transfer from savings to checking accounts, the chairman of the F HLBB
vehemently opposed the idea, complaining that it would put savings and loans at a
competitive disadvantage in procuring funds and might deliver “a crippling, debilitating

blow to the supply of mortgage credit.”25 Legislation confirming the legality of interest

 

2‘ In 1985, the U.S. Supreme Court nlled that ATMs were not the same as branches and thus interstate
ATM networks did not violate branching regulations. Fumiko Hayashi, Richard Sullivan, and Stuart B.
Weiner, “A Guide to the ATM and Debit Card Industry,” Federal Reserve Bank of Kansas City,
http://wwwffiec.gov/ffiecinfobase/resomces/retail/fib-gm'de%2010%20the atrn debit gag indgf
accessed 6-19-08.

25 Judith Miller, “Banks’ Automatic Shift of Savings To Checking Accounts Held Illegal,” The New York
Times, April 20, 1977, ProQuest Historical Newspapers The New York Times (1851 - 2005); Judith Miller,

93

9

on demand deposits for all banking segments would make for a “more orderly transition,’
argued the Economic Policy Group. Carter penned “ok” next to this proposal on the
options memo, apparently indicating his approval.26

The EPG’s second proposal, to allow the Federal Reserve to pay interest on
reserves, addressed concerns about membership attrition in the Federal Reserve System.
The Fed required member banks to put aside reserves based on deposit liabilities. It held
those reserves without paying interest, and conducted monetary policy by adjusting
required reserve levels. On the other hand, nonmembers held smaller reserves, and could
earn interest by investing them, which lowered their costs of doing business. “For this
reason, medium-sized and smaller banks-recently have been withdrawing fi'om
membership at a growing rate. As a result, Fed earnings may be weaken ” the memo
stated. Federal Reserve Chairman Arthur Burns worried that a firrther drop in
membership might compromise the Fed’s ability to carry out monetary policy. The issue
became tied to NOW accounts because paying interest on demand accounts would lower
bank earnings, and perhaps entice banks to recoup the difference by withdrawing fi'orn
the Federal Reserve System. The Economic Policy Group thus recommended that “this
legislation include authorization for the Federal Reserve to pay interest on its member
bank reserves, not to exceed $150-$250 million of budget cost.” Again, the president

wrote “ok” next to the proposal.”

 

“Fed Moving to Let Banks Pay Interest On Check Accounts,” The New York Times, February 3, 1978,
ProQuest Historical Newspapers The New York Times (1851 - 2005).

26 Memo from Rick Hutcheson to Michael Blumenthal, June 8, 1977, “Financial Institutions Reform”
Financial Institution Reform 6/8/‘77, Box 102, Staff Office Files: Office of Congressional Liaison Lisa
Bordeaux, Jimmy Carter Presidential Library.

27 Ibid.; The $150-$250 cap on budget cost came from Fed negotiations with the Treasury. The Fed
originally proposed a program of higher interest payments on reserves, but the Treasury would not
recommend to the Office of Management and Budget a plan that cost more than $150-$250 million — the
amount that the EPG estimated would be lost in revenue if membership decline continued at the currentrate.

94

The last measure of immediate importance involved a two-year extension of
interest rate ceilings on deposits through Regulation Q. The EPG proposed the extension
despite the group’s stance that ceilings failed to do what they were intended to do -- keep
funds flowing into the mortgage market. “Regulation Q ceilings are counterproductive —
they actually weaken savings flows and mortgage lending.” However, EPG members
realized that savings and loans and the housing industry perceived Regulation Q ceilings
as helpful to their deposit flows and would not give them up easily. Thus, they
determined, “It is unrealistic, therefore, to seek their elimination without a sound housing
finance alternative. A two-year extension should provide adequate time to prepare one.”
The group further explained that the extension would be opposed by both thrift
institutions, who wanted a longer extension, and commercial banks, who wanted to do
away with the housing differential — the 1/4% extra that savings and loans were permitted
to pay on deposits over commercial banks to encourage fimds to flow into housing. Next
to this proposal, Carter penned, “I have no interest in Reg Q — but do not oppose this
extension.” In an earliersection of the memo dealing with Regulation Q, Carter wrote
“Study phasing out.”28

In reality, interest rate ceilings were already being phased out. Regulators had by
now allowed depository institutions to offer investment instruments that paid rates of
return above the Regulation Q limits, such as high denomination certificates of deposit
and small saver certificates. Pressure to allow these savings options came fiom
competing alternatives such as money market mutual fimds in the late 19708. Depository
institutions suffered from disintermediation as consumers moved their money to higher

paying alternatives. The new savings options helped institutions keep their deposits.

 

28Ibid.

95

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Eu

3
aha»

C0

the

RE

R:

f0:

Also, these instruments helped to level the playing field among depository institutions.
For example, large banks, with operations abroad, had the opportunity to turn to the
Eurodollar market for funds when market rates of interest climbed above Regulation Q
ceilings because dollar deposits abroad were not subject to Regulation Q limits. This
gave them an unfair advantage over smaller banks, S&Ls, credit unions, and mutual
savings banks. This put pressure on regulators to give other institutions a means for
paying higher rates, further weakening rate ceilings. By the late 19708, about 3/4 of the
industry’s savings paid interest rates above the ceiling rate.29

Finally, the EPG finished by highlighting areas for further study, including
redlining, electronic funds transfer, regulations on U.S. bank lending to less developed
countries, and expansion of lending powers for federal savings and loans. Carter again
gave this section of the memo his “ok.”3o Shortly after the memo circulated, the
administration formed an Interagency Task Force on Regulation Q to study interest rate
ceilings and other issues. The Treasury Department chaired the task force, whose
members included the Department of Housing and Urban Development (HUD), the
Council of Economic Advisors (CEA), the Office of Management and Budget (OMB),
the Domestic Policy Staff (DPS), and the President’s Adviser on Consumer Affairs.
Regulatory agencies, including the Comptroller of the Currency (OCC), the Federal
Deposit Insurance Corporation (FDIC), the Federal Home Loan Bank Board, the Federal
Reserve Board, and the National Credit Union Administration, also worked with the task

force.” Thus, by the summer of 1977, the administration had settled on a strategy of

 

:1 Richard N. Cooper and Jane Little, “Competition and Opportmrity;” David Mason, 190-191.

lbid.
3' Memorandum fiom Ernest H. Preeg to Secretary Blumenthal, Jlme 14, 1977, “Follow-on Work to EPG
Memo on Financial Institutions and Bank Regulatory Reform” Banking Reform - Banking, Box 150, Staff

96

heavily pursuing NOW accounts while studying more far-reaching reforms and looking
for ways to build consensus. The approach was Carter-like in that it provided for deep
study as well as input and support fi'om an Inter-Agency Task Group. It perhaps deviated
fiom Carter’s preferred methods of doing business in that it sought a partial solution at
first, with a more complete solution to be achieved later. Carter tended to like whole
solutions and was not generally this patient. However, even if Carter did not pay
attention to politics, many on his staff did. For example, Michael Blumenthal was well
attuned to the fact that Congress had repeatedly turned down efforts at financial reform
and that a complete solution had very low prospects for passage.32

In fact, even the pragmatic approach of taking on a few issues at a time did not
prove successful. By October of 1978, Congress had passed the next piece of financial
reform legislation, the Financial Institutions Interest Rate Control Act of 1978. The law
addressed a smorgasbord of issues fiom insider lending, to interlocking management and
director relations, to consumer protection, to the creation of a Federal Financial
Institutions Examination Council to standardize examination of financial institutions. It
also raised the limit of deposit insurance on IRA and KEOGH retirement accounts fi'om
$40,000 to $100,000. In terms of savings and loans, the act authorized S&Ls to make
loans for land development, construction, and education with up to 5% of assets. As

Carter’s EPG recommended, the act extended the Fed’s authority to set interest rate

 

Office files: Domestic Policy Staff, Eizenstat, Jimmy Carter Presidential Library; Memorandum to Vice
President Mondale, Alfred E. Kahn, Esther Peterson, Charles L. Schultze, Anne Wexler, and Frank Moore
from James T. McIntyre, Jr., May 4, 1979, “Recommendations of the Regulation Q Task Force” Regulation
Q, Box 74, Staff Office Files: Comrcil of Economic Advisors,, Charles L. Schultze, Jimmy Carter
Presidential Library. Note that this memo simply transmitted a copy of the memo prepared by the Treasury
Department regarding “Issues Developed by the Regulation Q Task Force.” McIntyre was collecting
comments on the recommendations before sending them to President Carter.

32 See Memo fiom Rick Hutcheson to Michael Blumenthal, June 8, 1977, “Financial Institutions Reform”
Financial Institution Reform 6/8/77, Box 102, Staff Office Files: Office of Congressional Liaison Lisa
Bordeaux, Jimmy Carter Presidential Library.

97

ceilings on deposits for about two more years until the administration could develop an
alternative program for S&Ls. However, the law did not contain the one provision most
sought after by the Carter administration — nationwide authority to write NOW accounts.
It fell considerably short, adding only New York to the list of states permitted to offer
them.33 Thus, even the focused efforts of the Carter administration to conquer one issue
at a time proved difficult in 1978. The political environment that kept financial reform
from passing in the mid 19708 had not changed much. The various sectors of the banking
industry still opposed deregulation for fear that the changes it wrought would create a
competitive disadvantage. Despite the disappointment, Carter signed the bill on
November 10, 1978, optimistically commenting that “The cooperative spirit which led to
this legislation testifies to the basic soundness and health of our Nation’s depository
institutions.”34

Though NOW accounts did not become widely available, the issue of
checking-like accounts that in effect, paid interest remained controversial and chaotic as
Carter’s EPG had predicted. The chaos came to a head in an April 22, 1979 appellate
circuit court case in the District of Columbia. The decision combined three separate
cases in which competing segments of the financial industry sued each other in an
attempt to keep others fi'om offering interest on checking. The American Bankers
Association sued the National Credit Union Administration over the regulation allowing
share draft accounts; the Independent Bankers Association of America sued the Federal

Home Loan Bank Board over the regulation allowing remote service units; and the

 

’3 The Library of Congress, Thomas, “HR... 14279” hgz/lthomaslocgov/cgi-
bin/bdguery/z?d095:HR14279:@@@L&8umm2=m&> Accessed March, 21, 2008; David Mason, 209.

3" Statement by the President, November 10, 1978, Banking Reform—Banking, Box 150, Staff Oflice Files:
Domestic Policy Staff - Eizenstat, Jimmy Carter Presidential Library.

98

United States League of Savings Associations sued the Federal Reserve Board and the
Federal Deposit Insurance Corporation over regulations permitting the use of automatic
transfer accounts by commercial banks.” Only the credit unions refrained from trying to
stop competitors fi'om offering interest on demand deposits.36 The court overruled a
district court decision which supported institutions’ rights to offer these services. On the
contrary, the court ruled that the use of this “device or technique was not authorized by
the relevant statutes, although permitted by regulations of the respective institutions’
regulatory agencies.” These services violated New Deal legislation that prohibited the
payment of interest on demand deposits and separated the functions of banking into
segments, with commercial banks being the only segment allowed to offer demand
deposits. The court observed that the effect of the new practices was “that three separate
and distinct types of financial institutions created by Congressional enactment to serve
different public needs had now become, or are rapidly becoming three separate but
homogenous types of financial institutions offering virtually identical services to the
public.” The court ruled to set aside the regulations authorizing the new practices, but
stayed the decision until January 1, 1980 “in the expectation that the Congress will
declare its will upon these matters.”37 The court was responding to the delicate condition
at hand. Financial institutions had invested considerable capital in creating the new

services, and consumers had become accustomed to using them.38 Instead of

 

3’ Update on Consumer Checking Account Equity Act of 1979, HR. 3864, 96" Congress, 1" session.
Congressional Record 125 (July 16, 1979): 18836—18837.

3‘ The Success/id Experiment is Extended H.R. 3864, 96“ Congress, 1‘t session, Congressional Record 125
(July 27, 1979): 21048-21049.

37 United States League of Savings Association v. Board of Governors of the Federal Reserve system. et al.
463 F. Supp. 342 1978 (DC: Dist 1978)

http://www.lexisnexis.com.proxyl.cl.msu.edu:2047/us/Inacademic/deli..., accessed 6-19-08
3‘ According to House Subcommittee on Financial Institutions Chairman St. Germain, 1 1/2 million credit

unions offered share draft accounts, and 3000 remote service units existed that accommodated account

99

immediately prohibiting these practices, which would, the court acknowledged “have a
deleterious impact on the financial community as a whole,” the court gave Congress time
to act.39 The decision placed a tremendous obligation on Congress to pass deregulatory
legislation that addressed this trend of homogenization among what had been separate
branches of banking. This pressure to deal with changes in the financial sector surely
aided in the passage of DIDMCA.

In the meantime, economic conditions were worsening. The major problem
involved inflation. While the Carter administration did not view inflation as the most
urgent problem in 1977, it remained stubbornly high, with the Consumer Price Index
measuring 7.7% in 1978, and climbing steeply to 13% during the first 4 months of 1979.
This was partly attributable to rising food costs and to OPEC’s price increase of that year.
By 1979, the administration, which originally tried to convince the Fed not to tighten the
money supply, changed strategies and asked for more constrictive monetary policy.
William Miller, the Chairman of the Fed, hesitated however, fearful of causing a
recession.40

The administration took other steps in light of its increasing concern over the
inflation rate. In April of 1978, Carter announced that he would cap federal wage
increases at 5 1/2% rather than at the typical level of 7%. He urged the private sector to

follow his lead. Carter also introduced voluntary wage price standards in October of

1978, and appointed Alfred Kahn, former head of the Civil Aeronautics Board, as head of

 

balances of over $2.65 billion. See Update on Consumer Checking Account Equity Act of 1979, HR. 3864,
96'll Congress, 1" session, Congressional Record 125 (July 16, 1979): 18836-18837.

39 United States League of Savings Association v. Board of Governors of the Federal Reserve system, et al.
463 F. Supp. 342 1978 (DC: Dist 1978)

ht_tp://www.lexisnexis.com.mryl.cl.msu.edu:2047/us/Inacademic/deli..., accessed 6-19-08.
‘° w. Carl Bevin, 144, 186-190.

100

the Council on Wage and Price Stability and his personal inflation advisor. In
September of 1979, Carter accepted a recommendation from the Tripartite Pay Advisory
Committee, made up of representatives from labor, business, and the general public, to
keep wage increases between 7.5% and 9.5%, though his advisors felt the level to be far
too high.41 These measures, however, proved ineffective in slowing the alarming growth
of inflation, especially given oil price increases in 1979. The private sector simply
disregarded voluntary guidelines, indicating that stronger and more painful action would
have to be taken.42

The pain would be inflicted, not by Carter, but by the new Chairman of the
Federal Reserve, Paul Volcker.43 Carter appointed Volcker against the wishes of his
economic advisors because he felt so strongly about the need to address inflation.
Volcker was willing to make the difficult decisions that he believed were a necessity.
Kahn recalls discussing the administration’s voluntary wage and price controls with
Volcker, “And I remember Paul Volcker saying to me, he said, ‘Fred, that program is
simply not working. I‘m the only one in town who has the weapon that can be used, and
sooner or later I'm going to have to use it.’”44 Volcker’s weapon would be control of the
money supply regardless of the resulting effects on interest rates and economic growth.
This strategy, though painful in the short run, made sense to Volcker, “We'll take the

emphasis off of interest rates and put the emphasis on the growth in the money supply,

 

4‘ Ibid., 134-137, 186,193-196

‘2 Iwan Morgan, 1024.
‘3 The position of Chairman of the Fed became available because Michael Blumenthal, Secretary of the

Treasury resigned as part of the shake-up of staff following Carter’s 10-day Camp David retreat and his
“Malaise” speech. Carter asked the current head of the Fed, William Miller to take over as Secretary of the
Treasury and appointed Volcker despite the candidate’s warning that he would be “fiercely independent.”
See W. Carl Bevin, chapter 2.

4“ Ben Wattenburg, “The Changing Economy: Inflation, Stagflation, and Deregulation” Interview with
Alfred Kahn and Paul Volcker, The First Measured Century,

h ://www bs. fmc/se en se l4.h accessed Julyl,2008.

101

which is at the root cause of inflation; too much money chasing too few goods in the old
proverbial way of putting the inflationary process.”45 Volcker’s policies drove interest
rates to unprecedented heights and created a recession by the second quarter of 1980.46
The federal fimds rate climbed above 13% in 1979 and the prime rate topped out at
15.3% that year.“

Rates of this magnitude began to cause serious problems for S&Ls, and
projections about the future of thrift institutions and the housing market became grim.
For example, FHLBB Chairman Jay Janis complained to Carter’s Chairman of the
Council of Economic Advisors that inflation was causing a loss of earnings for S&Ls.
“Many institutions are believed to be operating in the red right now,” warned Janis. He
went on to estimate that “by the end of 1980, depending on the interest rate scenario,
between 50 and 75 percent of all savings and loan associations will be operating in the
red. For the industry as a whole for 1980, we project that earnings will be in the range of
-0.25 to -O.6O percent.” Under these earnings estimates, many institutions would have
net worth problems as well, explained Janis. The underlying problem, according to the
Bank Board chairman, lay in the high rates that S&Ls had to pay to attract deposit fimds

— a direct result of high inflation. Thus, his suggested solution involved controlling

 

‘5 Ibid.

‘6 w. Carl Bevin, 242-250.

‘7 Federal Reserve, “Federal Funds Rate”
hgpz/lwwwfederalreservegov/releases/h15/data/Monthly/HIS FF O.txt accessed April 7, 2008; Federal
Reserve, “Prime Rate” ht_tp://www.fede[§lreservcnrov/releases/h15/data/Monthly/HIS PRIME NA.txt
accessed April 7, 2008.

 

102

inflation.48 Carter Administration economist, Burke Dillon, found Janis’ estimates to be
“reasonable although perhaps somewhat pessimistic.”49

The Treasury too saw severe problems afflicting the industry, projecting negative
earnings for 1980 and the possibility of closure for “a few particularly poorly managed
mutuals and S&Ls. . .” The Treasury stressed the need for flexible and effective
management of the problem by regulators, warning that “if the regulators cannot deal

with the pathologic cases adequately, a crisis of confidence and financial disruption could

develop.”50

A month before DIDMCA was passed, Tony Frank, the President of a large
California S&L wrote Carter’s Senior Domestic Advisor, alerting him that impending
disaster for the industry was close at hand and that the repercussions could very well
“destroy President Carter’s chances for re-election.” He cautioned that a large banking
run could cause several thrifts and banks to close in the next couple of months, and as “a
staunch supporter, both with thought and money,” he complained, “that considerably
more urgency is attached to the matter of the financial system in this Country than is
publicly exhibited by the White House at the present time?“

The Savings and Loan industry also held pessimistic views about the effects of

Volker’s policies on profitability and on the availability of housing funds. Executive

 

4‘ Memorandum from Jay Janis to Charles L. Schultz, March 5, 1980, “Projected 1980 Earnings of Savings
and Loan Associations,”12/07/ 1976-01/06/ 1981, Box 73, Federal Home Loan Bank Board, Jimmy Carter
Presidential Library.

‘9 Memorandum fiom Burke Dillon to Charlie Schultz, March 10, 1980, “Estimates of S&L Earnings for
1980,” Council of Economic Advisors, Box 74, White House Central Files: Charles L. Schultze’s, Jimmy
Carter Presidential Library.

5° Memorandum fiom Robert Carswell to Economic Policy Group, “Thrift Industry Losses in 1980” March
26, 1980, EPG Steering Group 3/28/80, Box 113, Staff Office Files: Council of Economic Advisors, J irnmy
Carter Presidential Library.

5‘ Letter from Tony Frank to Stuart Eizenstat, February 28, 1980, Depository Institutions Deregulation Act
of 1979, Box 106, Stafl‘ Office Files: Domestic Policy Staff, Eizenstat, Jimmy Carter Presidential Library.

103

Vice President of the U.S. League of Savings Associations, Norman Strunk, issued a
letter to member institutions, predicting sizeable disintermediation, steeply rising costs of
procuring fimds, and perhaps even a drying up of available mortgage finance in some
states. U.S. League economists expected that the rising interest rates would drive more
savers to money market funds and away from passbook savings. “In many cases
associations will find the cost of money to replace that lost through disintermediation to
be such as to make uneconomic anything like the continuation of normal lending,”
warned Strunk. Lending would suffer because the dwindling passbook savings that
provided the industry with capital would have to be replaced by fimds raised through
jumbo certificates and Federal Home Loan Bank advances. However, the interest rates
for these were prohibitively high, indeed higher than state usury ceilings for mortgages in
22 states. Some institutions had already suspended lending by November of 1979. The
hard times, however, did not sway the League’s belief that the industry needed
Regulation Q deposit rate ceilings. League economists complained that “rising interest
rates may intensify pressures to raise Regulation Q ceilings. Costs of such a change
would break the back of some institutions.”52 Clearly, much of the industry still felt it
would be better to lose a hefty portion of their liabilities to higher yielding investments
than it would be to pay market rates of interest. Savings and loan deposits, profits, and
capital all declined in 1979 and by 1980, it looked as though a true crisis might be close

at hand.53

 

’2 “Anti-Inflation Move Spurs Credit Cnmch For Home Lenders,” Savings & Loan News 100, part 2,

(November 1979): 6-7.
3 Memorandum from Robert Carswell to Economic Policy Group, “Thrift Industry Losses in 1980” March
26, 1980, EPG Steering Group 3/28/80, Box 113, Stafl‘ Office Files: Council of Economic Advisors, Jimmy

Carter Presidential Library.

104

A Brookings Institution study of savings and loans also provided a bleak outlook
for the future. Their forecasting model predicted that perhaps as many as one out of
every four thrifts would cease to exist in the future. Most of these disappearances would
occur through mergers, the study predicted, but “up to 625 firms with combined assets of
$83.4B” would require help fiom FSLIC to cover their merger or liquidation. This would
eventually strain the resources of F SLIC, the study explained, and force the agency to
seek more funds fi'orn the U.S. Treasury or the Federal Reserves4

The signals of imminent calarnity--extreme1y high inflation, soaring interest rates,
the movement of consumer deposits out of institutions subject to Regulation Q, the
prospect of loss of public confidence and bank runs-all pressured the various sectors of
the financial industry to compromise. Furthermore, the “philosophy of deregulation had
swept the country,” explains Robert Dagger, who served as Chief Economist of the
Senate Banking Committee and Senior Staff Member of the Financial Institutions
Subcommittee of the House Banking Committee in the 1980s. The combination of these
forces, he agrees, helped to end a decade of squabbling among the various groups
affected by banking deregulation and persuaded them to support the legislation.55

By 1979 Carter had become less patient in his mission for financial reform. A
memo about the “Regulation Q Timetable” discussed “the President’s directive that we
move ‘aggressively’ on structural banking deregulation?”6 The administration also
becarne more creative. Given the difficulties encountered in trying to move financial

reform legislation through Congress, they contemplated circumventing the legislative

 

5‘ Andrew S. Carron, 27-32.

5’ Robert F. Dugger, phone interview by Jill S. Huerta, November 21, 2008.

5‘ Memo from Orin Kramer to Stu Eizenstat, February 28, 1979, “Regulation Q Timetable,” Regulation Q,
Box 74, Staff Office Files: Council of Economic Advisers, Charles L. Schultze’s, Jimmy Carter
Presidential Library.

105

process by executing some reforms through administrative action by regulatory agencies.
For example, a memo explaining the Task Force’s preliminary recommendations,
pondered, “Many of the changes suggested could be implemented by administrative
action of the Federal Reserve Board, the Federal Home Loan Bank Board and the Federal
Deposit Insurance Corporation?” Another memo concluded that perhaps the
administration could persuade regulatory agencies to phase out Regulation Q ceilings.

With respect to changes on Regulation Q ceilings, however, voluntary
administrative action by the regulatory agencies would be preferable to a tough
legislative fight. Administrative changes on Regulation Q ceilings require the
concurrence of the Federal Reserve, the FDIC and the Bank Board . . .None are
likely to want to be perceived as taking the lead for change in this area; if
significant action is possible, they must be led by the Administration.” 8

However, by the time the Regulation Q Task Force made its final recommendations, the

administration seemed resigned to the need for Congressional support, explaining that

Each of the options below could be accomplished through legislation or through
administrative action on the part of the bank regulators. Because of the high
degree of emotion involved, the ability of regulators to act is restricted. As a
practical matter, we believe that only option 2b (more flexible ceilings) coul_(_l_b_e
effectugted bv the re ators without le 'slative actio and even that should have
an element of overgll legislative direction.”

 

In addition to the complex vying for advantage among financial industry interest
groups, the politics within the Interagency Task Force also proved to be divisive, with

banking regulators pulled in various directions by the interests of the sectors they

 

’7 Memo from Robert Carswell to Members of the Regulation Q Task Force, February 9, 1979, Regulation
Q, Box 74, Staff Office Files: Council of Economic Advisers, Charles L. Schultze, Jimmy Carter
Presidential Library.

5' Memo from Orin Kramer to Stu Eizenstat, February 28, 1979, “Regulatirm Q Timetable,” Regulation Q,
Box 74, Staff Oflice Files: Council of Economic Advisers, Charles L. Schultze’s, Jimmy Carter
Presidential Library.

’9 Memorandum to Vice President Mondale, Allied E. Kahn, Esther Peterson, Charles L. Schultze, Anne
Wexler, Frank Moore fi'om James T. McIntyre, Jr., May 4, 1979, Regulation Q, Box 74, Staff Office Files:
Council of Economic Advisors: Charles L. Schultze, J irnmy Carter Presidential Library.

106

regulated. An internal White House memo discussed the pressures affecting each
regulator. For example, the FDIC, which supervised mutual savings banks, expressed
concern that higher interest rates would put undue strain on these institutions, which had
already been hurt by high interest rates. Also, smaller banks, regulated by the FDIC,
strongly supported rate ceilings, though they opposed the housing differential accorded to
thrifts. Likewise, savings and loans had struggled in the high interest rate environment,
making it “politically difficult for McKinney to advocate raising deposit rate ceilings (i.e.
the S & L’s cost of funds) during such a period. ..” Even the Federal Reserve, which had
strongly supported the elimination of deposit rate ceilings all along, hesitated to take the
lead in this action because of the problems experienced by the thrift industry.60 There
was also a significant lack of harmony between the rest of the Task Force and HUD,
which opposed most of the program recommended, fearing that it would have negative
consequences on the supply of mortgage funds.61 In fact, Orin Kramer suggested that
Eizenstat hold a meeting with HUD to give the agency “an opportunity to express its
strong opposition to the thrust of Treasury’s Reg Q recommendations, to evidence your
strong commitment to working closely with HUD on this issue. . 3’62 Like savings and
loans, HUD felt that Regulation Q and the housing differential that gave thrifts an edge
over commercial banks in attracting deposits, protected housing funds. However, Kramer
advised Eizenstat to remind HUD that Regulation Q “cannot protect thrifts against

deposit outflows to other unregulated money market instruments. It is arguable that as

 

5° Memorandum fiom Orin Kramer to Stu Eizenstat, February 28, 1979, “Recommendation of the
Regulation Q Task Force,” Regulation Q - Banking, Box 268, Staff Office Files: Domestic Policy Staff —
Eizenstat, Jimmy Carter Presidential Library.

6' According to Orin Kramer, HUD’s constituency included both S&Ls and builders. Orin Kramer phone
interview by Jill S. Huerta, September 17, 2008.

‘2 Memo fi'om Orin Kramer to Stu Eizenstat “meeting on Regulation Q,” March 2, 1979, Regulation Q—
Banking. Box 268, Staff Office Files: Domestic Policy Staff, Eizenstat, Jimmy Carter Presidential Lrbrary.

107

savers become more sophisticated, and as such instruments proliferate, thrifts will be
required to offer higher deposit rates in order to remain viable and maintain their role as
our major source of mortgage credit.”63 According to Kramer, the internal disputes with
HUD were eventually resolved when Bob McKinney stepped down as the head of the

F HLBB. Jay Janis, the Undersecretary of HUD expressed an interest in the job. When
Kramer asked him how he could want that job when he disagreed with all the
administration’s policies towards thrifts, he replied, “I just became an advocate,” thereby
ending opposition from HUD.64 The difficult political environment inside the Carter
Task Force reflected the difficult political environment outside, with the depository
institutions affected by deregulation, bargaining and negotiating for advantage.

Carter’s Task Force made its final analysis and recommendations about
Regulation Q interest rate ceilings and thrift asset powers in the Spring of 1979.
Reviewing the regulatory system created by the New Deal, the Task Force commented
that, “so long as institutions borrow short-term funds and lend long-term funds, that result
is a constant risk.”65 Interest rate controls on deposits were implemented for thrifts, the
group explained, in the high interest rate environment of the mid 1960s, to prevent S&Ls
from paying excessively high returns on short term fimds, which they could not afford
because of the long-term, lower yielding nature of their mortgage-dominated investment
portfolios. Further, the rate controls sought to channel capital into S&Ls and thus into

housing by setting the ceiling for deposit rates higher for thrifts than for commercial

 

‘3 Ibid.

6‘ Orin Kramer, phone interview by Jill S. Huerta, September 17, 2008.

“Memorandum to Vice President Mondale, Alfied E. Kahn, Esther Peterson, Charles 1.. Schultze, Anne
Wexler, Frank Moore fiom James T. McIntyre, Jr., May 4, 1979, “Recommendations of Regulation Q Task
Force,” Regulation Q, Box 74, Staff Office Files: Council of Economic Advisors: Charles L. Schultze,

J My Carter Presidential Library.

108

banks. The idea behind this was that S&Ls were less able to attract consumer deposits
because by law they could not offer convenient consumer services such as checking
accounts, credit cards, and consumer loans. However, the task force argued that rate
controls had not protected financial institutions as well as planned. Instead, “the
distorting effects of the ceilings have created pressure for exceptions.” In commercial
banking, ceilings had limited the ability of banks to compete for funds, the analysis
explained, causing them to turn to Eurodollars to procure capital. Also during times of
high interest rates, ceilings had led to disintermediation. Increasingly knowledgeable
consumers moved their money to higher yielding investments, causing thrifts to respond
with new deposit instruments such as the money market certificate, with its interest rate
pegged to the six-month Treasury bill. This had squeezed the earnings of S&Ls, but
protected the flow of funds into housing.66 In fact, by 1980, the new deposit instruments
paying market rates of interest, such as jumbo money market certificates, already
accounted for about a third of savings and loan deposits, making liabilities much more
sensitive to market forces than assets, explained a Brookings Institution study on
economic regulation. By the end of 1980, 79.8% of S&L assets were invested in
mortgage loans.” This told an interesting story, pointed out the task force, one that
seriously questioned the validity of using rate ceilings to channel money into housing.
Regulation Q had not protected housing funds. The exceptions to Regulation Q had been
responsible for keeping funds flowing into S&Ls and thus into housing. Housing capital

had been protected, but the tradeoff was falling profitability."8

 

66 Ibid.
‘7 Andrew S. Carron, 9-13.
5‘ Ibid., 5.

109

Another problem with interest rate ceilings lay in their effect on small savers,
argued the task force. Savers with ample funds had several alternatives for earning
higher rates of interest such as $100,000 certificates of deposit, four year certificates of
deposit, and $10,000 money market filnds. However, depositors with less than $10,000
in savings or those who might need immediate access to their funds had no alternative but
to use standard savings accounts, which paid significantly less. While the task force did
not offer one definitive solution to the problem of interest rate ceilings, all members
except HUD favored some form of action towards weakening or abolishing them. The
task force also preferred to link the phase-out of interest rate ceilings to the expansion of
asset powers for savings and loans to allow investment in some higher yielding assets.
Higher earnings on the asset side would better enable thrifts to pay market rate for
deposits without causing a drop in earnings. Likewise, the task force recommended that
S&Ls be allowed to offer interest-bearing checking accounts. While the task force
presented these steps as a “Coordinated Program,” it did not insist that asset powers had
to accompany deregulation of rate ceilings.“9

Finally the task force was split in opinion with regard to variable rate mortgages.
The Treasury, the Council of Economic Advisors, the Federal Home Loan Bank Board,
the Office of the Comptroller of the Currency, and the National Credit Union
Administration all supported authorizing variable rate mortgages nationally, while HUD
and the FDIC opposed the idea.70

On May 22, 1979, Carter sent a message to Congress proposing financial reform

legislation that reflected the recommendations of his Task Force, as well as many of the

 

‘9 Ibid., 6-10.
7° Ibid., 22.

110

suggestions of the Friend, Hunt, and FINE studies. Carter asked Congress to allow
interest rates on deposits to rise to market rates “through an orderly transition period,”
and with the right of regulators to take “emergency action” to protect the soundness of
financial institutions or to conduct monetary policy if necessary. On the liability side,
Carter also asked that all federally insured financial institutions be allowed to offer
interest-bearing transaction accounts for individuals. On the asset side, Carter asked
Congress to allow federal savings institutions to phase in variable rate mortgages to their
portfolios and to invest up to 10% of their assets in consumer loans.“ The next day, The
New York Times reported somewhat pessirnistically, “The endorsement is expected to
touch off a legislative fiee-for-all on Capitol Hill. It will almost surely meet fierce
opposition from savings and loan associations, which have blocked previous efforts to lift
interest rate ceilings”?2

The Times had good reason to be pessimistic, since past efforts at passing very
similar legislation had failed miserably. In introducing the bill in the Senate, Alan
Cranston commented:

. . .the Banking Committee along with the Congress has been

studying and mulling over the issues in this bill since such legislation

evolved from the Hunt Commission study and recommendations in 1971,

on needed improvements in the structure of financial institutions to move

toward freedom and competition in the financial markets. The Senate has

passed two bills on this subject and numerous hearings have been held in
the House and Senate on these issues, however, the issues still remain with

118.73

 

'" Jimmy Carter, “Financial Reform Legislation Message to the Congress Proposing the Legislation,” May
22, 1979, Weekly Compilation of Presidential Documents 15928-930.

’2 Judith Miller, “Carter Bids to Lift Bank-Interest Curb,” The New York Times, May 23, 1979, D12,
ProQuest Historical Newspapers The New York Times (1851 - 2005).

7 3 Depository Institutions Deregulation Act of1979, S. 1347, 96"I Congress, 1" session, Congressional
Record 125, (J1me 14, 1979):14887. Cranston, a Democrat from California, introduced the bill for himself
and for William Proxmire, a Democrat from Wisconsin and Chairman of the Senate Banking Committee.

111

The Senate bill, Sl347, co-sponsored by Alan Cranston and William Proxmire, contained
almost all of Carter’s suggested reforms. Testifying before the Senate Subcommittee on
Financial Institutions, Carter’s Secretary of the Treasury, Michael Blumenthal, expressed
“our appreciation for that initiative, which is very much along the lines of what the
President is suggesting.”74 The bill, which was referred to the Senate banking committee,
proposed authorization of share draft accounts, remote service units and automatic fimds
transfer to address the problems created by the Washington DC. appellate court decision;
permission for all federal institutions to offer NOW accounts; gradual phase-out of
Regulation Q interest rate ceilings over a 10-year period; diversification of thrift
portfolios through consumer lending, commercial paper, and trust services; and variable
rate mortgages. The House bill was sparse compared to the Senate version. Introduced
on July 27, it too formally legalized the regulations set aside by the April 20 Washington
D. C. Appellate Court decision. It also permitted federal institutions nation-wide to offer
NOW accounts. However, it did not address other issues such as interest rate ceilings
and asset powers. Many witnesses who testified before the House Subcommittee on
Financial Institutions recommended such measures, but witnesses such as Irvine Sprague,
Chairman of the FDIC, urged the committee to keep the bill simple so as to ensure
success.75 Orin Kramer suggests that the House bill may have been so bare compared to
the Senate version because the head of the House Banking Committee, Ferdinand St.

Germain, was so heavily supported by the thrift industry, which generally objected to the

 

7‘ Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Financial Institutions
Hearing, Depository Institutions Deregulation Act of1979, 96" Congress, 1" session,, June 21, 1979, 96.
7’ House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions
Supervision, Regulation, and Insurance, Hearing, Consumer Checking Account Equity Act of 1979, 96"
Congress, 1st session, May 15, 1979, 71-73; Update on Consumer Checking Account Equity Act of1979
H.R. 3864, 96'll Congress, 1't session, Congressional Record 125 (July 16, 1979): 18837; Consumer
Checking Account Equity Act of 1979 96'” Congress, 1" session, Congressional Record 125 (September 1 1,

1979): 24026.

112

legislation. On the other hand, William Proxmire, co-chair of the Senate Banking
Committee “thought about larger policy issues — not about special interests.”76 The House
passed its version of the bill, HR 4986, originally called the Consumer Checking Equity
Act, on September 11, 1979, by a margin of 367 to 39.77

During hearings before the Senate Subcommittee on Financial Institutions, all the
major regulators supported the Senate bill, including the National Credit Union
Administration, the Federal Reserve, the Federal Deposit Insurance Corporation, the
Comptroller of the Currency, and the Federal Home Loan Bank Board. However, Anita
Miller of the Federal Home Loan Bank Board seemed the most uneasy about potential
effects of the legislation on savings and loan institutions. She offered a list of concerns
about the reform package, emphasizing that bidding wars might cause savings and loans
“to pay interest rates well above what they could afford.” Earnings in general could
represent a problem, she explained. Savings and loans were indeed granted the right to
offer new income-generating services to help offset the higher rates of interest they
would pay for deposits as the phase-out of interest rate ceilings progressed. However, it
would take time, she worried, for institutions to establish and market these new services,
and S&Ls had already suffered fi'om low earnings and declining net worth during recent
periods of high inflation and interest rates. It was key, She testified that the Bank Board
have some flexibility in phasing out interest rate ceilings: “It is our belief that any

phasing out that mandates rigid precision in terms of timing and does not permit the

 

76 Orin Kramer, interviewed by Jill S. Huerta, September 17, 2008. Though most of the S&L industry
opposed the legislation because of its phaseout of Regulation Q rate ceilings, Kramer notes that a small
number of larger thrifts supported the bill because they were more progressive in their thinking and wanted
to compete for deposit fimds.

77 Consumer Checking Account Equity Act of1979, HR. 3864, 96"I Congress, 1't session, Congressional
Record 125 (September 11, 1979): 24026.

113

regulators wide flexibility, might well create serious problems with respect to financial

solvency.”78

Professional associations for banks, credit unions, mutual savings banks, and
savings and loans supported the bill, though a bit less enthusiastically than the regulators.
All the branches of banking, except for credit unions, seemed concerned about losing
competitive advantage to another segment, and squabbled over the details of who would
be granted what new powers. For example, the American Bankers Association opposed
the timetable called for “which would substantially defer the time when commercial
banks would attain the ability to compete fairly with thrift institutions.” Thrifts that
offered transaction accounts should have to immediately give up the 1/4% housing
differential on rates paid to depositors, the ABA argued, not maintain it over the 10-year
pluse-out period stipulated in the bill. Since the bill provided that interest rate caps be
raised in increments, thrifts should not be permitted new asset powers until the first rise
in interest rates, two years after enactment of the bill, the ABA claimed. Also, they
wanted to see rates begin to rise immediately, rather than in two years.79

Savings and loans, of course, made exactly the opposite argument. Norman

Strunk, Executive Vice President of the United States League of Savings and Loan

Associations, warned of the difficulty thrifts would encounter in raising deposit rates to

 

13 Senate Committee on Banking, Housing, and Urban Affairs, Subcommittee on Financial Institutions,
Hearing, Depository Institutions Deregulation Act of1979, Part 2, 96'II Congress, 1't session, June 27,
1979, 32. Miller’s concerns were also echoed by Charles Partee, Member of Board of Governors of the
Federal Reserve when he testified before the House Subcommittee on Financial Institutions. He argued
that NOW accounts needed interest rate ceilings to keep costs under control and prevent earnings problems,
which would hurt thrifts considerably. House Committee on Banking, Finance, and Urban Affairs,
Subcommittee on Financial Institutions, Consumer Checking Account Equity Act of I979, 96tll Congress, 1"
session, May 15, 1979, 86-91.

79 Senate Committee on Banking, Housing, and Urban Affairs, Subcommittee on Financial Institutions,
Hearing, Depository Institutions Deregulation Act of1979, Part 2, 96" Congress, 1" session, June 27,
1979, 131.

114

market levels. Citing the nationwide mortgage portfolio yield at 8%, with considerably
lower yields in the northeast, Strunk echoed the Federal Home Loan Bank Board’s
concern that paying market rates of interest would squeeze profits too severely. The
industry’s preference was for a bill that allowed rates to be adjusted both upwards and
downwards over the ten year period, “moving to market level deposit rates within a
ceiling fiamework with a rubberband, if you will, instead of a ratchet.” He also lauded
the bill’s “ten-year continuation of Regulation Q,” making the same argument the
industry had made for years: that Regulation Q and the differential were essential to the
savings and loan industry and to the U.S. housing industry. The industry could not do
without Regulation Q, be argued, unless thrifts were given commercial bank powers or
the ability to write renewal rollover mortgages. Strunk credited Regulation Q for the
industry’s continued success in the face of inflation and high interest rates: “Foremost
among the mechanisms for stability in home finance has been the Regulation Q system
and the savings rate differential. Despite our marked inferiority in service powers and
convenience locations, the differential has enabled savings and loan associations to
maintain generally our share of the savings market, though the banks’ passbook share has
grown.” Interestingly, Strunk also pointed out that one fifth of savings in S&Ls were
already earning market rates of interest through money market certificates, though he did
not see MMCS as key to the industry’s success. Regulators, competitors in the banking
industry, and the Carter administration, of course, did not Share this opinion about the

usefulness of interest rate caps and the differential.80

 

'° Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Financial Institutions,
Hearing, Depository Institutions Deregulation Act of1979, Part 2, 96'” Congress, 1" session, June 27,
1979, 177-203. Quotes from 177, 198, 183.

115

James Hagerty, testifying for the National Savings and Loan League, an
alternative professional association, agreed with the need for flexibility in phasing out
Regulation Q. He too emphasized that the industry already paid market rates of interest
on much of its savings and argued that the transition to market rates was proceeding
quickly enough on its own:

The message I want to leave the committee today is that the
process of phasing out regulation Q is already well underway and
is moving very rapidly. The actions of the regulatory agencies to
eliminate the differential on IRA and Keough plans, the
introduction of money market certificates and the recent change in
rates and introduction of money market certificates and the recent
change in rates indicate a lessening of the value of regulation Q.
With marketplace and regulatory actions eroding regulation Q, we
question the need for any legislative stimulus to speed up this
process.8|
Hagerty agreed with Stnmk that the new powers granted to S&Ls by the bill were
inadequate to create equal competition with commercial banks.82
The National Association of Mutual Savings Banks also testified that the Senate
bill did not do nearly enough to level the playing field between mutual savings banks and
commercial banks. Phasing out regulation Q and the differential would put mutual
savings banks at a severe competitive disadvantage to commercial banks. In order to

abolish the differential, argued their president, mutual savings banks should be granted

commercial bank powers.83

On October 25, the banking committee reported the bill to the Senate, which
passed it on November 1, 1979 by a vote of 76 to 9. On November 7, the House agreed

to go to conference with the Senate to reconcile the two versions of the bill, which

 

" Ibid., 249-251.
'2 Ibid., 251.
'3 Ibid., 165-169.

116

differed significantly. They also chose to combine HR. 4986 with another bill, HR. 7,
the Monetary Control Act, arguably because of the two bills’ shared vital importance to
the stability of the financial system. Rousselot, a Republican from California expressed
great frustration that the Senate had “Christmas treed” the House version of the bill.
Reuss a Democrat fiom Wisconsin argued that the conference would alleviate this
problem, “What we do today is a kind of machete to cut off these extraneous Christmas

1

tree limbs that the Senate has unfortunately put on the Consumer Equity Act.” Rousselot,

 

however, did not seem reassured, “What bothers me the most is that we somehow will be . ..
put in the position at the last minute of voting for something that comes out of this h
proposed conference far beyond the scope of these two bills that passed the House.” He

was especially concerned because the Washington DC. appellate court decision made it

vital that legislation be passed before the end of the year to protect the ability to offer

share drafts, remote service units, and automatic funds transfer. “I just felt we should

have this understanding so that we are not put in the position of a last-minute fire sale, as

it were; that we have to take it the way it is because we are up against a deadline?“ AS it

turned out, Rousselot need not worry about the pressure of the deadline. On December

28, 1979, Congress legitimized Share drafts, automated transfer of fimds, and remote

service units until March 31, 1980 to give itself a bit more time to consider the

legislation.
AS the bill went through Congress, the Carter administration continued to work

hard to promote it. They collaborated closely with the American Bankers Association,

reflected in a thank-you letter sent to the organization’s president which expressed that

 

“ Depository Institutions Deregulation Act of I979, HR. 4986, 96" Congress, 1" session, Congressional
Record 125 (November 7, 1979): 31326-31327.

117

“The Association’s Washington staff has been extremely helpful in assisting us in
designing what 1 hope will be perceived as an equitable and rational package. . .we should
work closely together this summer.”85 Larger banks, along with some large S&Ls,
eagerly supported the legislation, hoping for the chance to compete with money market
funds for deposits and to offer variable rate mortgages.86

Much opposition to the bill came from the savings and loan industry, and Carter’s
stafi' engaged in extensive behind-the-scenes work to convince key members of Congress
to support the bill despite pressure from the thrift industry in their states to oppose it. For
example, when the financial reform bill was in the Senate Banking Committee, Orin
Kramer suggested that Stu Eizenstat phone Senator Alan Cranston “who is coming under
pressure fiom California thrifts (the nation’s largest), which seek perpetuation of the
ceilings and the V4 point differential into perpetuity.” Among the talking points provided
to Eizenstat, Kramer suggested that he reassure the Senator that “We understand his
sensitivity to the concerns of the savings and loan industry, and we are willing to
accommodate that concem.”87 The administration was indeed willing to compromise
with the S&L industry if necessary, offering to make the terms of the Regulation Q
phase-out more flexible. However, Eizenstat was instructed to make it clear that “There
are limits to how far we can go to accommodate the thrifts.” The administration had to
walk a fine line between efforts to get S&Ls on board and losing the support of bankers

and others, such as consumer and elderly groups, who had already become impatient with

 

‘5 Letter from Orin s. Kramer to John H. Perkins, June 18, 1979, Box 154, White House Staff Files:
Domestic Policy Staff, Jimmy Carter Presidential Library.

'6 Orin Kramer phone interview by Jill s. Huerta, September 17, 2008.

'7 Memorandum fiom Orin Kramer to Stu Eizenstat, “Telephone Call on Regulation Q,” September 10,
1979, Regulation Q—Banking, Box 268, Staff Office Files: Domestic Policy Staff, Eizenstat Jimmy Carter
Presidential Library; According to Orin Kramer, Senator Cranston was “owned and operated by the savings
and loan indusu'y.” Orin Kramer phone interview by Jill S. Huerta, September 17, 2008.

118

the idea of such a gradual, prolonged phase—out of rate ceilings.88 Kramer also asked
Eizenstat to call Donald Riegle and Paul Sarbanes, two undecided members of the Senate
Banking Committee, to relay to them that “this is one of the few deregulation bills which
can be enacted this year and where the public benefits are readily understandable, we
would hope to be able to work together on this bill.” Eizenstat clearly agreed with this
strategy, noting on the memo that he would call “asap.”89 In October of 1979, after the
Senate Banking Committee had reported almost all the legislation suggested by Carter the
previous May, Kramer and Eizenstat suggested Senate Liason Dan Tate call Senate
Majority Leader Byrd to convince him to schedule time for the bill on the Senate floor,
despite savings and loan opposition expressed by Senator Morgan. Again the talking
points included the fact that “of all the President’s deregulation proposals, this is the only

one which has a chance of passing either house this year,” and that despite thrift

 

Opposition to lifting rate ceilings, the benefits of this to small savers “would be readily
comprehensible to the public.”90

At the end of February 1980, when DIDMCA was in conference, the
administration still involved itself heavily in the legislative effort. As was the
administration’s habit, the final push was made by the Domestic Policy Staff. In a memo
to Eizenstat, Kramer reported “We have reached agreement with Proxmire, Reuss and St.
Germaine on the elements of the bill.” However, “The problem is that over the past day

Senator Cranston has threatened to withdraw his support for the package, which would

 

" In fact, in 197s, consumer groups sued regulators for creating accounts with high minimum deposit
levels that discriminated against small savers. See David Mason 214-215.

'9 Memorandum from Orin Kramer to Stu Eizenstat, “Telephone Call on Regulation Q,” September 10,
1979, Regulation Q—Banking, Box 268, Staff Office Files: Domestic Policy Staff - Eizenstat, Jimmy Carter
Presidential Library.

9° Memorandum for Dan Tate fiom Stu Eizenstat and Orin Kramer, “Senator Byrd and Regulation Q,”
October 19, 1979, Regulan'on Q—Banking, Box 268, Staff Office Files: Domestic Policy Staff - Eizenstat,
Jimmy Carter Presidential Library.

119

splinter our fragile coalition.” Kramer suggested that Eizenstat attend a meeting between
Deputy Secretary of the Treasury Carswell and Cranston, in hopes of winning over the
Senator’s support.91

Stu Eizenstat’s letter replying to Tony Frank, Chairman of a large California
savings and loan, also indicates that the Administration was aware of and perhaps
involved in negotiations taking place while the bill was in conference. Eizenstat’s letter
responded to Frank’s call for “some quick remedial action” to deal with the savings and
loan crisis. Eizenstat’s response assured Frank that “We are expeditiously reviewing a
number of actions, including those you recommend, as well as others (for example,

”92 Carter had never asked for an increase in

increasing the level of Federal insurance).
the limit of deposit insurance. The savings and loan industry wanted this provision, and it
had been recommended by the Board of the U.S. League in May of 1979. However,
neither the House nor the Senate version of DIDMCA incorporated it. The fact that
Eizenstat knew about this compromise that was made during the conference proceedings,
but had not yet been made public, indicates that the administration was still intimately
involved in tailoring and marketing the bill. Such diligent effort from beginning to end
and willingness to compromise obviously helped immensely in finally securing passage
of a financial reform bill.

On March 27, 1980, the conference report on HR 4986, the Depository
Institutions Deregulation and Monetary Control Act, was presented in both the House and

the Senate. The final version of the bill was indeed omnibus legislation, representing the

 

9‘ Memo from Orin Kramer to Stu Eizenstat, February 28, 1980, “Meeting with Senator Cranston”
Regulation Q—Banking, Box 268, Staff Office Files: Domestic Policy Staff-Eizenstat, Jimmy Carter
Presidential Library.

92Letter fi'om Stuart Eizenstat to Tony Frank, March 7, 1980, Banking Deregulation, Box 3, White House
Central Files: Stu Eizenstat, Jimmy Carter Presidential Library.

120

 

 

 

most comprehensive reform of the U.S. financial system since the New Deal. It applied
to federally chartered commercial banks, mutual savings banks, savings and loans, and
credit unions. It addressed liabilities, assets, monetary policy, consumer protection, and
international banking. The product of almost 10 years of effort, the bill embodied the
demands and compromises of all interested parties. On the liability Side, DIDMCA gave
all depository institutions the right to offer transaction accounts, authorizing NOW
accounts nation-wide for individuals. It also addressed the Washington D. C. appellate
court decision by legalizing the use of Share draft accounts by credit unions, remote
service units by savings and loans, and automatic funds transfer by commercial banks.
This gave all segments of banking the right to offer an interest-earning transactions
account. DIDMCA called for the phasing out of Regulation Q interest rate ceilings over
a 6-year period, rather than the ten-year period provided for in the Senate version of the
bill. This made the bill more palatable to consumer groups and to bankers, who wanted a
swift removal of interest rate ceilings and the differential. In a nod to the savings and
loan industry, the differential was to remain intact during the phase-out. Decontrol of
interest rates was to be accomplished by a Depository Institutions Deregulation
Committee (DIDC), consisting of the Board of Governors of the Federal Reserve,
Chairman of the Board of Directors of the FDIC, the Chairman of the FHLBB, and the
Chairman of the National Credit Union Association (N CUA) Board. The Comptroller of
the Currency was to serve on the Committee as well, but as a nonvoting member.
DIDMCA gave the committee the authority to set Regulation Q interest rate ceilings for
six years, with the directive to phase out controls as “rapidly as economic conditions

warrant.” Congress also required the Committee to present it with annual reports

121

 

 

 

regarding the need for an interest rate differential between thrifts and banks, means for
encouraging savings, disintermediation to money market firnds, and legislative and
regulatory suggestions.93

In terms of monetary policy, DIDMCA required that all institutions offering
transaction or non-personal time accounts keep reserves in the Federal Reserve System.
This applied to Fed members and non-members alike. The act also gave the Fed the
authority to require supplemental reserves if necessary to conduct monetary policy and
allowed the Fed to pay interest on these supplemental reserves. Nonmembers of the
Federal Reserve subject to reserve requirements were entitled, under DIDMCA, to the
discount and borrowing benefits offered to Fed members. While the new reserve
requirements expanded the number of institutions required to set aside reserves, they also
lowered compulsory reserve levels, allowing the largest banks to take funds out of

reserve and lend more money.94

On the asset side, DIDMCA expanded investment options available to thrifts. The
final act permitted federal savings and loans to invest up to 20% of assets in consumer
loans, commercial paper, and corporate debt securities. The law also allowed S&Ls to
offer credit cards and to exercise trust and fiduciary powers. The Senate version of the

bill had set the limit at 10% of assets. S&Ls were also freed fi'om previous geographic

 

93 The Library of Congress, Thomas, “HR. 4986” ht_tp://thomas.loc.gov/cgi-

bin/bdgum/D7d096: 1 :Jt+empl~bduwxaz@@@L&summ2=m&|/bss/96search.html| accessed 4/10/08.

9‘ Bank of America, the largest bank at the time gained $1.2 billion for investments because of this
provision, while Citibank and Chase Manhattan each gained $450 million. Charles R. Babcock, “The
Banking ‘Reform’ Bill: Parceling Out the Goodies,” The Washington Post April 15, 1980, A2,
www.1exisnexis.com.prox12.cl.msu.edu:2047/us/Inacademic/deli accessed July 22, 2008; Paul Allen and
William Wilhelm argue that this leveling of reserve requirements changed the relative competitive balance
in banking eliminating “a comparative burden for FRS [Federal Reserve System] banks relative to other
depository institutions.” Paul R. Allen and William J. Wilhehn, “The Impact of the 1980 Depository
Institutions Deregulation and Monetary Control Act on Market Value and Risk: Evidence from the Capital
Markets,” Journal of Money, Credit and Banking, Vol. 20, No.3, Part 1, (Aug, 1988) 367
http://www.iMongtable/ 1992262 accessed .3/27/08.

122

 

and value limits in writing mortgages. Federal mutual savings banks were granted
greater investment latitude as well, with authorization to invest up to 5% of assets in
commercial, corporate, and business loans made within the home state or within 75 miles
of the home office.95
DIDMCA also sought to make loan-writing profitable under the high interest rates

of 1980 by pre-empting state usury laws on first mortgages and on business and
agriculture loans over $25,000. States could override the preemption and re-irnpose
usury limits as long as they did so within 3 years. The legislation also preempted state
usury ceilings on other lending, such as consumer and home equity loans, made by state
chartered federally insured banks, S&Ls, and credit unions. Rates for these loans were
instead set at 1% above the Fed discount rate. National banks already had this privilege.
States could ovenide this preemption at any time by simply passing a law or referendum.
The law also raised the maximum rate that credit unions could charge on loans.96

To improve net worth, DIDMCA allowed thrifts to issue mutual capital
certificates to raise capital towards their net worth. This was a compromise to savings
and loans. It was part of the recommendations made by the U.S. League of Savings
Associations on May 1, 1979, before Carter had sent his reform address to Congress.97

Perhaps the most controversial provision in the final bill was the raising” of the
limit on deposit insurance fi'om $40,000 to $100,000 per account.98 Neither the House

nor the Senate bill contained such a provision. It was agreed to during the conference, as

 

9’ The Library of Congress, Thomas, “HR. 4986” h_t_tp://thomas.loc.gov/cgj-
bin/bdguerv/D‘2d096: l :Jtemp/~bduwxa:@@@_L§summ2=m&|/bss/96search.html| accessed 4/10/08.

96 .

Ibrd.
’7 Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Financial Institutions,
Depository Institutions Deregulation Act of1979, Part 2, 96" Congress, 1“ session, June 27, 1979, 187-

1 s9-
9‘ Ibid.

123

a compromise to savings and loans for loss of the interest rate differential. Like the
mutual capital certificates, it was one of the recommendations of the U.S. League of
Savings Associations when it met on May 1. According to Martin Mayer, the conference
was on the verge of failing when the California savings and loans, assisted by their
Senator, Alan Cranston, agreed to withdraw their objections if the rise in deposit
insurance was included in the legislation.99 Former economist for the Senate banking
committee, Robert Dugger, notes that he was in the room when Cranston brokered this
deal. He backs Mayer’s account that S&Ls agreed to accept the phaseout of Regulation
Q if the limit on deposit insurance was increased. This would allow S&Ls, especially the
large California associations, to take in more brokered deposits and try to “grow out of
their problems.”‘00 Cranston had reason to negotiate on behalf of savings and loans. A
significant number of S&Ls had contributed funds to his 1979-1980 political campaign,
as had the U.S. League of Savings Associations, the National League of Savings
Associations, and the Savings and Loan League of California. Several banks, the
American Bankers Association, and the California Bankers Association had supported
Cranston as well. Thus, he had motive to make sure the legislation passed, since bankers
had supported the elimination of rate ceilings and the differential for some time.“" The
deal was made, and all interested parties gave their approval and support, including the

Community Bankers Division of the American Bankers Association, the United State

 

9’ Martin Mayer, 94. In his memoir, former head of the FDIC, L. William Seidman also credited the
chairmen of the Senate and House Banking Committees, William Proxmire and Henry Reuss, for the
provision. He asserts that, “It was a bipartisan effort, done at a late-night conference committee meeting,
with none of the normal reviews by the press and public. No doubt the members of the committee were
fully aware of the political power of the S&Ls, but the fact is, the legislation was passed with little thought

of what its full effect could be.” See L. William Seidman, Full Faith and Credit: The Great S&L Debacle
and Other Washington Sagas (Times Books, 1993) 179.

‘°° Interview with Robert H. Dugger by Jill S. Huerta, November 21, 2008.

'°‘ Federal Election Commission, 1979-1980 Candidate Index of Supporting Documents — Alan Cramton
printed July 6, 2005.

124

League of Savings Associations, the National Savings & Loan League, the National
Association of Mutual Savings Banks, the Credit Union National Association, and the
National Association of Federal Credit Unions. "’2

Carter signed DIDMCA into law on March 31, 1980, calling it “a landmark
financial reform bill” and “another step in a long but extremely important move toward
deregulation by the Federal Government of the private enterprise system of our
country.”103 The legislation was indeed necessary and long overdue. The inflation and
high interest rates of the late 19603 and 19708 had finally revealed the flaws inherent in
the New Deal regulatory fiamework for banking. Borrowing short and lending long had
steered savings and loans into earnings trouble. Furthermore, technological innovation
had made a balkanized banking industry obsolete and all but impossible to maintain.
American depositors voted with their money against discrete banking segments and
interest rate caps. If the financial industry would not accommodate their demands for
convenience and reasonable rates of interest, they would move their money elsewhere.
This transfer of personal savings out of depository institutions and into the investment
market stood to severely damage the nation’s savings and loans, commercial banks,
mutual savings banks, and credit unions. Perhaps more importantly, it threatened to
change the allocation of credit in the U.S. economy. While money market funds invested

in government securities and a limited range of commercial stock, depository institutions

 

"’7 Conference Report on; HR4 986 Depository Institutions Deregulation and Monetary Control Act of
1980, HR. 4986, 96"I Congress, 2"“ session, Congressional Record 126 (March 27, 1980): 6965-6985.
“’3 Jimmy Carter, “Remarks on Signing HR. 4986 Into Law,” Weekly Compilation of Presidential
Documents Volume 16, Number 14 March 31, 1980, 572-574.

125

tended to invest in housing, agriculture, and small business.104 A credit crunch in those
markets was highly undesirable, especially during a time of slow economic growth.
Some kind of deregulatory effort was needed and DIDMCA was a sound effort.

Unfortunately, the effort came a bit late. By 1980, the Fed’s attack on inflation
had driven up interest rates to unprecedented heights, making it a rather difficult time to
begin the process of eliminating interest rate ceilings. Recall that the Friend Study had
recommended that rate ceilings be gradually phased out “in a period when credit is easy
and market interest rates are declining appreciably.”105 In the high rate environment of
the early 1980s, it would be difficult for depository institutions to pay market rates of
interest. This was especially true for savings and loans because of the nature of their
investment portfolios. While commercial banks had investments of varying maturities,
S&Ls assets were still mainly long term home loans, written at the lower rates of the past.
The interest payments from these loans did not generate enough income to support high
payments of interest on deposits. The potential danger was a further squeeze in earnings.
DIDMCA called for an expansion of S&L asset powers to try to counteract this problem,
but implementing new investment powers took time and money, and posed a significant
challenge during this era of low earnings. Clearly, deregulation of interest rate controls
and expansion of asset powers would have been far easier to achieve over a decade

earlier, when the Friend Study recommended such actions.

 

'°‘ Paul Volcker testified about this difference in credit allocation before the Senate Committee on Banking,
Housing, and Urban Affairs, Subcommittee on Financial Institutions, Depository Institutions Deregulation
Committee, 96'” Congress, 2"" session, August 5, 1980, 8-10.

“’5 Irwin Friend, “Summary and Recommendations: A part of the Study of the Savings and Loan Industry”
in Study of the Savings and Loan Industry, Prepared for the Federal Home Loan Bank Board (U .8.
Government Printing Office, 1969) 29-30.

126

 

 

 

However, as explained above, securing the passage of deregulatory legislation
proved to be a formidable task that took over a decade to achieve. Though large banks
and a number of large S&Ls supported the legislation, it was strongly opposed by most
S&Ls and small banks. Building agreement among the various groups took an enormous
amount of work and compromise since both bankers and S&Ls seemed to have
tremendous political influence. The push and pull of negotiations resulted in the
inclusion of an unfortunate provision in the final legislation. During a time when the
average depositor had $6,000 in their savings account, the increase in the limit on deposit
insurance fi'om $40,000 to $100,000 was both unnecessary and undesirable. It allowed
troubled S&Ls to raise an enormous amount of capital from brokered deposits, which
they could invest in a number of new ways. The risks of these new investments were, of
course, underwritten by U.S. taxpayers. However, without this provision, it is unlikely
that the legislation would have succeeded.

One interesting aspect of this legislative effort is the degree to which negotiations
among competing groups took place outside of the legislative process. Financial
deregulation was contentious legislation, so contentious that it took more than a decade to
accomplish. However, this was not reflected in the votes of the House and Senate, which
were not close. Special interests kept this bill fiom reaching the Senate and House floors
until all the interested parties were satisfied with the product. By the time Congress
voted, most of the major provisions had been agreed upon. The ones that remained were
settled in conference or in private, off the record, as was the case with the increase in the

limit on deposit insurance. The process was decidedly undemocratic.

127

Overall, the legislative effort was clearly a success at its moment of passage. All
the interested parties both benefited and compromised. Depository institutions needed
the ability to offer customers a variety of convenient and interest-paying services in order
to compete with each other. DIDMCA gave them this power. Depository institutions
needed the ability to pay market rates of interest in order to compete with other
investments for private savings. DIDMCA gave them that this ability. S&Ls needed to
begin diversifying their investment portfolios in order to weather periods of high interest
rates. DIDMCA gave them the chance to diversify. DIDMCA also protected the
integrity of the Federal Reserve System, enhanced the ability of depository institutions to
write mortgages in all states, and helped small savers begin to earn a fair return on their
deposits during a time of skyrocketing inflation. After a long struggle, the American
banking system finally began to modernize and rationalize itself to meet the demands that
a changing world economy had placed on it. The question to be answered in the future

was whether this initiative would prove to be too little too late.

128

CHAPTER 4

MORE DEREGULATION

The passage of DIDMCA did not end the jostling for competitive advantage that
had come to characterize the financial industry. On the contrary, attempts to work the
system for benefits continued, and controversy abounded as the newly created Depository
Institutions Deregulation Committee set about its job of phasing out ceilings on deposit
rates. The independent committee, created under DIDMCA, was composed of the
Secretary of the Treasury, the Chairman of the Fed, the Chairman of the FDIC, the
Chairman of the F HLBB, the Chairman of the National Credit Union Administration
Board, and the Comptroller of the Currency, who acted as a non-voting member.
DIDMCA was given the authority to set interest rate ceilings, with a directive to phase
out the ceilings “as rapidly as economic conditions warrant,” though the legislation
stipulated that all interest rate ceilings be eliminated within 6 years of the enactment of
the legislation.1 During a May 28 meeting, less than two months after the passage of
DIDMCA, the committee took decisive action with regard to interest rate ceilings and the
differential for money market and small saver certificates. Though DIDMCA called for a

gradual six-year phase-out of interest rate ceilings and the differential, the committee

took a rather sudden step towards that goal.2

 

' Library of Congress, Thomas, “H. R. 3864” ht_tp://thomas.loc.gov/cgj-

 

3/9/09.
7- Depository Institutions Deregulation Committee Press Release, May 29, 1980, Depository Institutions

Deregulation Committee, Box 74, Council of Economic Advisors, Charles L. Schultze, Jimmy Carter
Presidential Library.

129

With regard to the money market certificate, an instrument created in 1978
carrying a rate that floated with the six-month Treasury bill, DIDC narrowed the
circumstances under which thrifts could pay a %% differential over rates commercial
banks could pay. Before the action, thrifts were permitted to pay a differential of varying
amount anytime Treasury rates fell below 9%. Under the new rules, the differential
would apply only when the Treasury bill rate fell between 7 %% and 8 3/4%. Otherwise,
all depository institutions would pay the same rate of return, which was set at 1/4% higher
than the 6-month Treasury bill rate. The committee also created a minimum ceiling for
money market certificates of 7 374%, meaning that even when the Treasury rate dipped
lower, thrifts and commercial banks had the option of continuing to offer the minimum.
Finally, the committee eliminated the differential on one-time renewals, allowing banks
to roll over existing money market certificates with their depositors at the thrift rates even
when the differential would ordinarily apply.3

DIDC also provided for new rates on small saver certificates. Created in 1979,
small saver certificates carried no minimum denomination requirements, matured in 30
months or more, and offered interest rates that fluctuated with Treasury bills of similar
maturities. DIDC raised rates on small saver certificates by V2%, allowing thrifts to pay
the same rate as the Treasmy paid for 2 1/2 year securities, and permitting commercial
banks to offer '/4% less than thrifts. However, the committee capped the allowable rate at

12% for thrifts and 11 %% for banks. Thus, even when Treasury rates moved above

 

3 Depository Institutions Deregulation Committee Press Release, May 29, 1980, Depository Institutions
Deregulation Committee, Box 74, Council of Economic Advisors, Charles L. Schultze, Jimmy Carter
Presidential Library; Memo to Charlie Schultze fi-om Burke Dillon, May 30, 1980, “New MMC and Small
Saver Deposit Ceilings,” Depository Institutions Deregulation Committee, Box 74, Staff Office Files:
Council of Economic Advisors, Charles L. Schultze” J irnmy Carter Presidential Library; Nancy L. Ross,
“Interest Ceilings Compromise; A Rube Goldberg Compromise on Certificate Rates; Winners, Losers on
Rate Changes” The Washington Post May 30, 1980, www.1exisnexis.com, accessed 1/9/09.

130

those levels, institutions could not pay more on small saver certificates. DIDC also
created a minimum ceiling for small saver certificates of 9.25% for commercial banks
and 9.5% for thrifts. This meant that thrifts and commercial banks had the option, though
not the obligation, of offering 9.25% even when Treasury bill rates dropped below the
point where the pegged rates for these institutions would be 9.25%. DIDC also
increased the penalties assessed for early withdrawal of time deposits such that the
penalty could exceed interest earned and actually reduce principal balances.4

DIDC’s actions proved extremely controversial. By June 17, the U.S. League of
Savings Associations filed suit against the committee in U.S. District Court, hoping the
court would restore the differential. The League claimed that DIDC’s actions would stall
recovery of the housing market by reducing the funds available for mortgage loans. As a
result of the committee’s adjustments, savings and loans would lose more than $17
billion in savings inflows over the next 6 months, the League argued.5 The American
Bankers Association severely criticized the savings and loan industry and the League in
particular for filling newspapers “with new predictions of gloom and doom every day.”
Banks pointed out that they wrote 21% of new mortgages, thus housing funds were not
necessarily jeopardized by the action.6

The decisions of the DIDC also caused serious political problems for the Carter
administration. In June of 1980, the Associate Director of Carter’s Domestic Policy Staff

(DPS), Orin Kramer, sent a memo to Stu Eizenstat, the department director, outlining the

 

4 .
Ibrd., 3-4.

5 Clyde H. Famsworth, “Savings Group Asserts Rate Rules Hurt Housing,” The New York Times, June 5,

1980 ProQuest Historical Newspapers The New York Times (1851 - 2005); Nancy L. Ross, “S&Ls File

Suit To Get Higher Interest Rates,” The Washington Post, June 17, 1980 www.1exisnexis.com accessed

1/24/2009.

" Merrill Brown, “ABA Hits Thrifis’ Criticism of Deregulation Movement,” The Washington Post, July 2,

1980, www.lexisnexis.com.

131

political issues raised by DIDC’s actions and discussing how the administration should
handle them. In responding to thrift complaints, Kramer suggested that the
administration “attempt to walk a fine line between expressing sympathy for the thrifts’
problems and avoiding criticism of Secretary Miller and the DIDC.” In his own
evaluation of the action, Kramer criticized DIDC for its unnecessarily complex scheme,
complaining that, “a system this convoluted could only be devised as a political
compromise by a committee.” However, he called the overall plan a “mixed bag,”
highlighting several benefits, including that the actions would “assure thrifts of
substantial inflows in the coming months.” Another benefit, which “only the most
sophisticated thrifts recognize,” is that interest rate floors set by the committee meant that
when Treasury bill rates fell below 7.75%, thrifts and banks would be more competitive
against money market funds. This was a chance to win the battle with investment banks,
which administered money market mutual funds. Yet thrifts would not see it this way,
according to Kramer. Even though Treasury bill rates did not represent “true market
rates on $10,000 denominations;” Kramer explained, thrifts perceived that they did.
“From the thrift perspective, the regulators have forced the yield above market rates on
an instrument that represents 40% of thrift deposits”,

Continuing to explain thrift misperceptions of their environment, Wer
expressed that, “[t]he underlying difficulty, in my view, is that most thrifts have not come
to grips with the implications of the deregulation act, which stipulates that all rates should
eventually be set by the market.” He was not, however, unsympathetic to the earnings

problems S&Ls would face in paying market rates of interest in the midst of such

 

7 Memo from Orin Kramer to Stu Eizenstat, June 27, 1980, “Depository Institutions Deregulation
Committee” Banking Deregulation, Box 3, Staff Office Files: Domestic Policy Staff-Eizenstat, Jimmy
Carter Presidential Library.

132

difficult economic conditions. “. . .many will be unable to afford to do so, and a
contraction in the number of thrift institutions and reduced profit margins are probably
inevitable unless inflation abates.”8

Kramer’s memo also sheds light on DIDC’s relationship with the administration.
While there was at least some degree of corroboration between the two, the DIDC seems
to have been, for the most part, independent. For example, DIDC apparently
accommodated the administration by retaining the thrift interest rate differential in some
cases. At the same time, Kramer felt that DIDC somewhat betrayed that agreement:

. . .when Secretary Miller agreed with you not to eliminate the differential

below 9%, in my view it somewhat stretched the spirit of that agreement

to retain the differential in the narrow 7 .75-8.75% band for new deposits

only, but to eliminate it under all other conditions. Since thrifts suffered

without the differential above 9% with the clear understanding from the

regulators that they would regain the differential under 9%, their sense of

betrayal is understandable.9
Even though Kramer agreed that “the principle of deregulation is correct and ultimately
beneficial to depository institutions,” he felt, “less than enthusiastic about seeing that
principle implemented so forcefully and rapidly in an election year.” He went on to assert
that “It is critically immrtant that the DIDC avoid controvgy in the coming months.”‘0
While Kramer claimed he would try to get a “controversial action for September” moved
to November, he did not seem sure he could accomplish this and told Eizenstat that he
would “come to you for help if necessary.” While the administration had some ability to
influence DIDC, that ability was apparently limited and DIDC obviously put Carter in a

difficult political position.

 

3 Ibid.
9 Ibid.
'0 Ibid.

133

Both the House and Senate Banking Committees took up the cause as well,
holding hearings to evaluate DIDC’s ruling. Another contentious aspect of the
committee’s actions lay in the nature of its proceedings. Meetings held on this issue on
May 20 and 23 took place in secret and behind closed doors, despite DIDMCA’s
stipulation that they be public, complained the President of the League of Savings
Associations, Edwin Brooks. While the May 28 meeting took place in public, it occurred
after hours and the decisions made were not put to the test of a comment period that
usually accompanied regulatory changes. Furthermore, Brooks argued that the DIDC
gave insufficient notice of the changes which went into effect 3 days before the new rules
became available in the Federal Register. ” The President of the National Association of
State Savings and Loan Supervisors, Walter Madsen, echoed these sentiments, calling the
procedures a violation of the Sunshine Act. '2

During the House hearings, several witnesses testified that DIDC disregarded the
intent of DIDMCA because of a banking bias inherent in the committee, and because of
pressure fiom the American Bankers Association. Not surprising, Edwin Brooks,
president of the U.S. League of Savings Associations was one such witness who
complained that the ABA had pressured the committee. He predicted that mortgage rates
would surely increase as a result of DIDC’s actions and that this would in turn hurt the
homebuilding industry. Walter Madsen, President of the National Association of State
Savings and Loan Supervisors, too felt that the committee was unduly influenced by

bankng interests, since it had two members who were representatives of the banking

 

“ House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions
Supervision, Regulation and Insurance, Hearing, Oversight Hearings on Depository Institutions
Deregulation Committee, 96th Congress, 2nd session, July 2, 1980, 30—3 1.

”mid” August 26, 1980, 359.

134

 

industry. He urged that the Secretary of the Department of Housing and Urban
Development (HUD) be added to the committee to represent housing interests and
suggested that Congress give DIDC more specific guidelines as to how the phasing out of
rate ceilings should proceed. The president of the National Association of Mutual
Savings Banks also called for representation of HUD on the committee and the National
Homebuilders Association supported this, as well as specific directives to the committee
to keep the housing differential in force for the entire 6-year phase-out period.13

These witnesses were heavily supported by Ferdinand St. Germain, Democratic
Chairman of the House banking committee, who argued that “The Congress is entitled to
see that the laws it enacts are followed and that the basic intent of these acts is not
distorted and changed by unseen and unelected bureaucrats hiding behind the pages of
the Federal Register.”14 Frank Annunzio, a Democrat fiem Illinois, was particularly
passionate in his objections to DIDC’s actions, asking, “[b]ut how can the home
mortgage and homebuilding industries be treated fairly when the committee is dominated
by card carrying commercial bank sympathizers.” He introduced a bill to do away with
the committee all together and return the power to set rate ceilings to regulators.ls
Annunzio might have been motivated by his supporters. He received campaign
contributions from various members of the homebuilding industry, such as the

Carpenters’ Legislative Improvement Committee, the Committee of the National

 

‘3 Ibid, July 2 and August 26, 1980.
'4 Ibid., 2.
‘5 Ibid., 4.

135

Association of Home Builders, and the Title Industry Political Action Committee, as well
as from North West Federal Savings and Loan.16

The ABA, of course, sung a different tune at the hearings, supporting both the
committee’s composition and its May 28 decisions. The important issue argued Richard
Rosenthal, ABA banking advisor, was not competition between commercial banks and
thrifts, but competition between depository institutions and unregulated financial
markets. DIDC’s decisions, he explained, made depository institutions more competitive
with investments outside of the banking sector. Furthermore, he argued that the
differential in favor of thrifts did not historically protect housing in tight credit markets
and that many alternative means of housing finance had developed including funding by
commercial banks, the secondary market, and government agencies. DIDC’s decision, he
characterized as a small step toward much needed deregulation that would allow banks to
pay a larger role in housing and allow savings and loans to diversify their assets.‘7

Paul Volcker delivered a similar message in defending DIDC’s decisions before
the Senate banking committee in August. Like the ABA, Volcker claimed that the key
issue lay not in competition among depository institutions, but in competition between
depository institutions and alternate investments such as money market mutual funds.
Thus, DIDC’s actions with regard to raising rate ceilings and eliminating the differential
on some investments should be viewed with regard to the committee’s “central
responsibility under the law as one of managing interest rate ceilings in a manner that

supports the Nation’s economic goals and prepares the way for ultimate

 

'6 Federal Election Commission 1979-I980 Candidate Index of Supporting Documents, Frank Annunzio.
Printed July 6, 2005.

'7 House Committee on Banking, Finance and Urban Affairs, Subcommittee on Financial Institutions
Supervision, Regulation and Insurance, Hearing, Oversight Hearings on Depository Institutions
Deregulation Committee, 96th Congress, 2nd session, July 2, 1980, 98-118.

136

deregulation. . 3’18 Volcker also explained that pairing down the differential needed to be
done to protect the soundness of some small commercial banks. Banks and thrifts had
been paying the same rates for deposits for over a year. As rates dropped and the
differential was about to be reinstated, small commercial banks, who had suffered flour a
drop in profitability under deregulated rates, stood to suffer much disintermediation,
which would have compromised their ability to make important loans. '9 In addition,
Volcker justified DIDC’s establishment of minimum rate ceilings. These helped
depository institutions compete, he argued, because Treasury rates, to which rate ceilings
were keyed, tended to be lower than other available rates in the market and tended to
decline first. Thus, depository institutions needed the ability to pay market rates even
when Treasury rates fell in order to compete with alternative investments.20

Lewis Odom, Deputy Comptroller of the Currency, heavily supported Volcker in
his testimony, pointing out that many factors had to be balanced in managing the phase-
out of Regulation Q. These included giving small savers market interest rates, helping
regulated depository institutions to compete with non-regulated ftmds, ensuring fairness
and soundness among depository institutions, and guaranteeing credit flows to important
markets. DIDC, he believed was doing its job well.”

Jay Janis, Chairman of the FHLBB acknowledged the difficulties faced by DIDC
in interpreting its mandate fiom Congress, instead of merely accusing the committee of
favoritism toward banks. “The question of congressional intent regarding the differential,

as it bears on past DIDC. actions, is a matter of considerable debate, even among

 

'3 Senate Committee on Banking, Housing, and Urban Affairs, Subcommittee on Financial Institutions,

gepository Institutions Deregulation Committee, 96'” Congress, 2'“1 session, August 5, 1980, 8-10.
Ibid., 11.

2° Ibid.

2‘ Ibid., 36-38.

137

Members of the House and Senate, and is the subject of a lawsuit,” he explained. Given
such uncertainty, he supported legislation setting rules on the fate of the differential
during the six-year phase-out period. He did, of course, argue that thrifts needed the
differential while they established the new services in which DIDMCA had permitted
them to engage.22

Senator Allen Cranston was less sympathetic than Janis, stating that DIDC’s
decision had created an “unduly complex interest rate structure imposed without regard
for a needed breaking-in period for the public and for financial institutions.”23 Cranston
had sent Volcker a letter on June 30 criticizing the committee’s May 28 decision and
asking a host of questions about how and why the committee reached that decision. He
urged Volcker “to reconsider the actions you have taken, for they may well be having

unintended consequences.”24

Ultimately, the court ruled that DIDC’s adjustment to rate ceilings was legal. The
court did, however, criticize DIDC’s procedures of failing to give proper notice.” Part
of the committee’s dilemma lay in the fact that interest rates continued rising to new
heights after the passage of DIDMCA. Depository institutions clearly lost deposit funds
to alternative investments such as money market mutual funds as market rates of interest
rose faster than DIDC could remove ceilings. However, savings and loans argued that
they could not afford to pay market interest rates on their deposits because their
profitability was being so squeezed by their low yielding portfolios of mortgages written

in the past. Though DIDMCA gave them new asset powers, those had not yet begun to

 

’2 Ibid., 19-20.

23 Ibid., 21.

2‘ Ibid., 23.

2’ Andrew s. Carron, The Plight ofthe Thrifl Institutions (Washington DC: The Brookings Institution,
1982) 55-60.

138

generate profits. Banks, especially large ones, were more supportive of the DIDC’s
actions because their investment portfolios were more diversified than those of thrifts. At
the same time, they were eager to offer higher rates of return because they were sufl'ering
from disintermediation as investment banks and foreign banks competed with them for
deposits. While profitability proved to be the most pressing problem for S&Ls,
competition was the most pressing problem for banks.26 Perhaps the fallout from
DIDMCA would have been less contentious if interest rates had dropped or even
remained stable after the bill’s passage. However, just the opposite occurred. By the end
of 1980, Paul Volcker’s assault on inflation drove the prime rate up to 20% and the
federal flmds rate reached 19%.27 This strained the U.S. economy and worsened the
financial condition of savings and loans, acting as a catalyst for the passage of more
financial deregulation.28

For example, disintermediation remained a problem after the passage of
DIDMCA. The U.S. League reported that new savings for the first 8 months of 1980
were down 70% from those just a year earlier. The FHLBB also reported a massive drop
in net income on assets in the first half of 1980, from .65% to .17%.29 During the second
half of 1980, 85% of S&Ls reported losses.30 DIDMCA did not seem to forestall the
coming industry crisis. Clearly more action was nwded if the industry was to survive the
high inflation and interest rates that accompanied Volcker’s monetary policy. However,

charting this course would be the job of a new administration.

 

2" Donald D. Hester, “U.S. Banking in the Last Fifty Years,” 12-13.

27 Anthony S. Campagna, The Economy in the Reagan Years: The Economic Consequences of the Reagan
A cbninistrations (Greenwood Press, 1994) 22-23.

2‘ Donald D. Hester, “U.S. Banking in the Last Fifty Years,” 12-14.

29 Nancy L. Ross, “Changes Push Bankers Into 21" Century; Bankers Pushed Unwillingly Into 21“t
Century,” The Washington Post, September 21, 1980 www.1exisnexis.com.

3° M. Manfred Fabrituius and William Borges, 92.

139

By the election of 1980, the Carter administration was burdened by a multitude of
problems: an energy crisis, stagflation, high interest rates, dropping labor productivity,
the Soviet invasion of Afghanistan, and the Iranian hostage crisis. Many of the problems
resulted from long-term global political and economic trends that spanned several of the
previous decades. The post World War H economic system fell into crisis. The U.S. had
gradually lost its position of economic dominance. It faced competition as post World
War 11 Japan and Western Europe rebuilt their economies and Third World countries
developed their manufacturing capacity. The rise in labor productivity abroad and the
drop of labor productivity at home encouraged capital flight to other countries. This
drained the domestic economy of much-needed investment capital, exacerbating the
productivity problem. In addition, oil-producing countries in the Middle East asserted
new independence and power over other countries that clamored for their resources and
poured funds into their investments. The world had become more integrated and
interdependent, and in the process, the U.S. global position had eroded. These broad
developments came together in 1980 to create significant and decisive political change.3 1
Jimmy Carter lost the presidential election by 10 percentage points, and Republicans won
33 new seats in the House and took control of the Senate for the first time in 25 years.
1980 proved to be nothing short of a landslide election.32

Political scientists Thomas Ferguson and Joel Rogers have argued that 1980

represented a realignment election, the culmination of a process in which business

 

3' Thomas Ferguson and Joel Rogers, “The Reagan Victory: Corporate Coalitions in the 1980 Campaign”
in Thomas Ferguson and Joel Rogers, editors The Hidden Election: Politics and Economics in the I 980
Presidential Campaign (Pantheon Books, 1981) 9-26;Thomas Ferguson and Joel Rogers, Right Turn: The
Decline of the Democrats and the Future of American Politics (Hill & Wang, 1986) 78-8 8.

32 Barbara Sinclair, “Agenda Control and Policy Success: Ronald Reagan and the 97‘” House,” Legislative
Studies Quarterly, X, 3 (August 1985), 292; Anthony S. Campagna, 23-27; Immanuel Wallerstein, “Friends
as F 065,” in Thomas Ferguson and Joel Rogers, editors, The Political Economy: Readings in the Politics
and Economics of American Public Policy (M .E. Sharpe, Inc., 1984) 329-331.

140

interests reevaluated their positions and formed new political coalitions and party
loyalties. Such realignments occur, they argue, “when cumulative long-run changes in
industrial structures (commonly interacting with a variety of short-rim factors, notably
steep economic downturns) polarize the business community thus bringing together a
new and powerful bloc of investors with durable interests?” Ferguson and Rogers use
the term “investors” to refer to those who contribute to or invest in political campaigns of
parties and candidates who they believe will serve their interests once in office. Thus,
they buy control of the political agenda and the environment in which they do business.
Individuals, they argue, lack the information and resources to exert this kind of control
over the U.S. political process and therefore, rarely get the chance to maximize their
benefits. In Ferguson and Rogers’ view, politics are controlled mainly by business
interests.34

David Harvey expresses a similar view of this political watershed. He argues that
the U.S. and the world faced a crisis in the mid 19705 as the economic and political
systems that dominated the world after World War II fell apart both intemationally and
within countries. The economic crisis, which included high unemployment, high
inflation, stagflation, increased demand for social spending, and the collapse of the
Bretton Woods system challenged the political system in many countries. The old
methods of controlling the economy—Keynesian spending, close government regulation
of many industries, free trade, and fixed exchange rates—no longer appeared to work,
and those to the left of the political spectrum failed to devise new and effective solutions,

explains Harvey. Politics became more polarized with social democrats who believed in

 

33 Thomas Ferguson, Golden Rule: The Investment Theory of Party Competition and the Logic of Money-
Driven Political systems (The Unviersity of Chicago Press, 1995) 22-25.
3" Ibid.

141

government planning on one side and neo-liberals, who believed in “liberating individual
entrepreneurial freedoms” on the other side. The neo-liberals won, and that victory,
Harvey argues, was part of a political project to restore wealth and power to the elite
class.”

By 1980, almost all segments of U.S. business turned away fiorn the Democratic
Party, convinced that Republicans would more effectively pursue their interests. This
meant that Reagan’s supporting coalition was a diverse group, with sometimes
conflicting goals and preferences. For example, those with operations or investments
abroad supported Reagan for his promise to strengthen the U.S. military and enhance
U.S. power and prestige. They saw this promotion of stability as necessary protection for
their investments.36 Large banks, which had made loans to developing countries and
collected deposits fiem wealthy oil-producing countries, fell into this group. Capitalists
who depended on multi-national markets also desired stable and free trade and they too
supported Reagan’s stance on increased military might and presence in foreign affairs.
Corporate interests tied to military spending of course supported Reagan, as did the
Sunbelt in general, which could only benefit from the infusion of federal military
spending into their region. Ironically, domestic producers, with protectionist tendencies

also joined the Republican coalition, attracted to the anti-labor, anti-regulatory platforms.

 

3’ David Harvey, A Brieinstory ofNeo-liberalism (Oxford, 2005) 2-23.
36 Jimmy Carter had bitterly disappointed capitalists with investments in Iran by proving unable to stabilize
the Khomeni regime and protect U.S. interests there. Over the course of Reagan’s term, investment banks
and insurance companies opposed his high deficit spending, which created expectations of inflation and
hurt investor confidence in the bond market. See Ferguson and Rogers, The Hidden Election, 28-29, 154.

142

Domestic oil producers supported Reagan as well, looking for relief from government
controls.37 This coalition was indeed a broad one.

Political scientist Barbara Sinclair has argued that Reagan’s early economic
program reflected the fact that he had gained almost complete control of the national and
Congressional political agendas through the Republican landslide election win. In 1981,
she argues, Congress was so convinced of Reagan’s public mandate for change,
economic change in particular, that his administration could successfully secure passage
of almost their entire program. In fact, their control of political alternatives proved so
complete that even the Democrats, in an effort to win back the business investors they
had lost in 1980, turned to the right, calling for similar initiatives.38

Ferguson and Rogers argue that the varied interests and demands of Reagan’s
supporting coalition provided the context and limits for his policy decisions once in
office. To balance many opposing interests, the administration pursued policies that
either benefited all of Reagan’s supporters, or helped some while acting neutrally towards
others. Naomi Klein has recently argued that Reagan’s election in 1980 represented a
democratic implementation of neo-liberal policies. These policies are usually adopted in
times of natural, military, or economic disaster, she explains. At such times of chaos and
confusion, corporate interests, especially multinational corporate interests, seize the
opportunity to quickly implement their vision, which they call fi’ee market capitalism.
What they truly seek is “economic shock therapy,” argues Klein, a sudden and complete

adoption of “business fiiendly policy demands,” such as privatization, deregulation, and

 

37 Ferguson and Rogers, Right Turn, 88-93; Thomas Ferguson, Golden Rule, 243-245; Ferguson and
Rogers, The Hidden Election, 18, 28-29; Mike Davis, Prisoners of the American Dream: Politics and
Economy in the History of the U.S. Working Class (Verso, 1986) 171.

3' Barbara Sinclair, “Agenda Control and Policy Success: Ronald Reagan and the 97‘h House” 291-314;
Ferguson and Rogers, Right Turn, 138.

143

social spending cuts. They seek a pure form of capitalism. Corporate interests, backed
by the Chicago School of Economics scholars who articulate their ideology, have been
able to come close to full implementation in other countries. However, they did not have
complete success in 1980 because they lacked a true disaster. In the case of democratic
implementation of business fiiendly policies, resistance to economic shock therapy, to the
complete transformation of the U.S. capitalist system, forced Reagan and his supporters
to accept “piecemeal changes rather than a total conversion.”39 Nonetheless, whether
Reagan’s administration was trying to appease a large and varied set of business investors
or attempting to transform the U.S. economy into a purer form of capitalism, they were
very successful in pursuing business fiiendly policies.

Reagan’s initial program included a mix of fiscal policies designed to cut
government spending on social programs while increasing defense spending, supply-side
tax cuts, tight monetary policy to lower inflation, and decentralization of the economy
through deregulation and the transfer of functions fi'orn the federal to state government.
Led by David Stockman, the new Director of the Office of Budget Management,
Reagan’s administration immediately launched cuts to social spending. The new budget
lowered eligibility standards for programs such as student social security benefits and
food stamm. It reduced welfare programs such as Medicaid, Aid to families with
Dependent Children, and school lunch programs by $5.5 billion. Subsidies to industries

such as agriculture and energy were likewise reduced. Congress accepted most of these

 

39 Naomi Klein, The Shock Doctrine: The Rise of Disaster Capitalism (New York: Henry Holt and
Company, 2007) 6-12. Klein argues that the terrorist attack of September 11, 2001 later gave corporate
interests a better opportlmity to pursue their vision. The Bush administration immediately began waging a
“war on terror,” in Iraq in which it vastly privatized firnctions formerly performed by the government such
as health care and food services for soldier and prisoner interrogation. A huge international “disaster
capitalism complex” formed, explains Klein. Those companies in the complex, providing private services,
have profited enormously and seek to make the practice permanent.

144

proposed cuts, but strongly rejected Reagan’s proposal to reduce Social Security benefits.
The following September, the administration pushed for even more domestic spending
cutbacks, but with less success.4O These spending cuts, while clearly painful for poor
Americans, did not affect most of Reagan’s supporters.

The administration then guided the passage of the Economic Recovery and Tax
Act of 1981, designed to stimulate economic growth through adjustments on the supply
side. The act called for a three year program of comprehensive income tax cuts — 5% the
first year, and 10% the second and third years. The bill also reduced the highest tax
bracket from 70% to 50%, indexed tax rates to adjust for inflation, allowed charitable
contributions to be deducted even if taxpayers did not itemize their returns, and deferred
capital gains on the sale of primary residences if a new residence was purchased within
two years. To encourage investment, the law also allowed for faster depreciation of
capital assets. The most ardent supply-siders argued that these tax cuts would bring
about such strong incentives to work and invest that they might finance themselves with
quick results.41 However, that clearly proved to be an overstatement. What the tax
modifications did accomplish was to contribute markedly to the grth of tax shelters for
the wealthy. In fact, the overall program heaped the most benefits on the wealthiest 1%
of the U.S. population. The ideology behind these supply-side adjustments was that the
wealthy recipients of additional funds would either spend their windfall or invest it in

useful ventures, creating stimuli for economic growth. In what became an infamous

 

4° Michael J. Boskin, Reagan and the Economy: The Successes, Failures, and Unfinished Agenda (ICS
Press, 1989) 52-62; Thomas Ferguson, Right Turn, 127-130; Robert Heilbroner and Aaron Singer, 323;
Barbara Sinclair, 297.

‘" In his memoirs, OMB Director, David Stockman, explains that Jude Wanniski and Art Laffer, “the two
high priests of supply side, sometimes argued that the tax cuts would pay for themselves. ..1 never bought
that literally and didn’t think they did, either. I put it down to salesmanship.” See David A. Stockman, The
Triumph of Politics: How the Reagan Revolution Failed (Harper & Row, 1986) 53.

145

phrase, the Reagan administration claimed that the benefits of this spending and
investment would “trickle down” to lower income groups.42

Reagan’s early monetary policy supported the Federal Reserve initiative to fight
inflation by restricting the money supply that began under Carter. This meant that the
recession and high interest rates would continue, making it difficult for the supply-side
stimuli to work effectively. It also meant that unemployment rates would continue to be
high for the rest of 1981 and 1982, hurting labor but perhaps helping Reagan’ supporters
in labor-intensive domestic manufacturing industries.43

Reagan’s deregulatory policy was, to some extent, a continuation of Carter’s
efforts to cut unnecessary administrative costs and to revise inefficient rules that
burdened industry and exacerbated inflation by raising prices. However, deregulation
also had great ideological appeal to Reagan and his fiee market conservative
constituency, who believed that government should play a much smaller role in private
affairs. In addition, it allowed him to help some members of his coalition who sought
relief from antitrust, environmental, labor, and other regulations. Once in office, Reagan
created a Task Force on Regulatory Reform, chaired by Vice President George Bush, to
study deregulatory issues. In the meantime, the administration found ways to cut
regulation without legislative efforts. For example, he gave OMB the power to review
and oversee regulatory changes, requiring the individual agencies to prepare a Regulatory
Impact Analysis for each new regulation. The OMB, with its clear bias towards lowering
spending, then performed its version of cost-benefit analysis on the proposed changes.

Reagan also tended to appoint agency heads who shared his deregulatory philosophies,

 

42 -
Ibrd.
‘3 Anthony Campagna, 33-34; Michael J. Boskin, 63-64.

146

people who would certainly avoid establishing new regulations, and in some cases,
people who were somewhat unsupportive of the agencies they led. For example, his
appointments to the Department of Labor, OSHA, and the National Labor Relations
Board were all somewhat unsupportive of unions. He likewise tended to dismiss those
staff members who proved unsympathetic to his deregulatory cause.44 Besides helping
domestic producers through deregulation, the Reagan administration tended to meet their
needs and demands through individual actions and favors on a per industry basis that
allowed for the provision of aid while maintaining an open trade policy.45

The recession and high interest rates that accompanied Reagan’s early economic
program caused continuing problems for the savings and loan industry. Even though
DIDMCA had taken steps to help the industry, those solutions had not yet had a chance
to work. In fact, in the short run, these changes may have hurt more than they helped
because deregulation of interest rates meant that S&Ls now had to pay more for their
funds. From 1980-1982, the average cost of fimd for thrifts was rising faster than the
return on assets.46 Furthermore, even as depository institutions increased rates on
deposits, unregulated money market funds continued to drain money away fi'om them,
offering rates as high as 16% in March of 1981." In many cases, consumers could earn
up to 10% more on their savings in money market funds.48 On the lending side, thrifts did

not immediately take advantage of the powers granted by DIDMCA because it took a

 

“ Anthony s. Campagna, 98-100, Michael J. Boskin, 63-4; Thomas Ferguson Right Turn, 130-133.

‘5 Thomas Ferguson, Golden Rule, 246.

‘6 R. Dan Brumbaugh, Jr., Thrifls Under Siege: Restoring Order to American Banking (Ballinger
Publishing Company, 1988) 30—35; The economy contracted 1.5% in 1982. See David Stockman 98-99.

‘7 “Clyde H. Famsworth, “Aid Studied for Savings Industry” The New York Times, March 6, 1981 Late
City Final Addition, p.1 ProQuest Historical Newspapers The New York Times (1851 - 2005).

‘3 Thomas P. Vartanian, “Remarks Regarding the Depository Institutions Act of 1982” November 17, 1982
in Harold E. Mortimer, Chairman, and L. Richard Fischer and Russell A. Freeman, Co-Chairmen, The
Depository Institutions Act of 1982 (Practicing Law Institute, 1983) 16-17.

147

while to research, plan for, and execute these programs. New lending on mortgages
dropped, as unemployment and high interest rates made it more diffith for Americans to
buy homes. Problems faced by the industry proved numerous and challenging.49
The Reagan administration’s handling of the industry’s problems was deeply
influenced by three factors: the need to balance the interests of Reagan’s broad political
coalition, the determination to keep any potential solutions off the federal budget, and a
deep commitment to minimize government interference with business. Ideologically,
Reagan’s administration had little interest in helping the thrift industry. The stance that
government should not interfere in most industries dictated that ailing institutions should
either merge with stronger institutions, or be allowed to die. Furthermore, Reagan’s goal
to cut non-military domestic spending became an obstacle to the implementation of sound
solutions that would have ultimately minimized taxpayer liability. The administration,
however, could not be guided solely by its anti-spending and small government
preferences because many savings and loan executives were important investors in
Reagan’s political coalition. When he took office, 9 of the nation’s 10 largest S&Ls were
located in Reagan’s home state of California and were headed by Republican executives,
many of whom contributed to the 1980 campaign. Reagan’s reliance on political
contributions and support fi'orn this group limited the spectrum of options available to

him and his administration.”

\

4
5: David Mason, 218.
W een Day, S&L Hell: The People and Politics Behind the $1 Trillion Savings and Loan Scandal (W.
‘ 1\Iorton & Company, 1993) 76-90; Campaign contributions are very diffith to trace. According to
any Glynn, savings and loans contributed approximately $11 million to politicians during the 19805.
S & y Glynn, “Who Really Made the S&L Mess” in Robert Emmet Long, editor, Banking Scandals: The
Ls andBCCI (The H.W. Wilson Company, 1993).

148

The crafting of savings and loan policy proved complex during the early 19803
and was shaped by multiple opposing forces and participants including Congress,
regulators, the industry, and the Reagan administration. The S&L industry, of course,
wanted government aid. In their view, they suffered from a problem not of their own
making. They had done what the government had asked of them since the New Deal —
provided fixed-rate, long term, and reasonably priced home loans. Yet, high interest rates
and inflation threatened net worth, profitability, and in some cases solvency. Among
other things, the industry wanted access to cheaper capital in order to shrink the spread
between rates they paid for funds and interest they collected fiom past loans. Some in the
industry also wanted relief from the particularly challenging business environment,
perhaps through a government purchase of old, low-yielding mortgages. The largest of
the S&Ls, represented mainly by the National Savings and Loan League, strongly
favored deregulation, and understood that their institutions needed to change radically if
they were to survive. The S&L industry engaged in an enormous amount of lobbying and
had many fiiends in Congress, including the head of the House banking committee,
Democrat, Ferdinand St. Germain, and Senate banking committee member, Democrat,

Alan Cranston. While many members of Congress supported the industry because they
were the recipients of S&L largesse, others did so because they truly understood the
seriousness of the industry’s condition and found the cause of home financing popular
With their constituents. In addition, Chairman of the Senate banking committee,
Republican, Jake Garn has been described by journalist Kathleen Day as “a darling of the

Reagan-Bush White House,” though Day also depicts him as a fiiend of the S&L

149

industry. Like the Reagan administration, Jake Garn claimed to believe in free market
solutions.5 '

Despite the campaign support many S&L executives provided to Ronald Reagan,
the administration opposed any kind of bailout or government assistance to the industry
that would appear on the budget. This was especially true of Secretary of the Treasury
Donald Regan,52 and Assistant Treasury Secretary Roger Mehle. Reagan had put Mehle
in charge of S&L policy. In addition, David Stockman, director of the OMB opposed
government aid to any industry that would interfere with spending cuts to which he was
deeply committed. This trio initially opposed most solutions to provide aid to the
industry and Regan and Mehle, in particular, were viewed as enemies of the industry.
However, they had to tread carefully since alienating part of Reagan’s supportive
coalition would have been problematic.”

Richard Pratt, a Republican nominated by Reagan as Chairman of the Federal
Home Loan Bank Board in March of 1981, became somewhat of a bridge, joining
together the various disparate interests. A University of Utah business professor, Pratt
had extensive experience in the savings and loan industry. He had worked as chief

economist for the U.S. League during the late 1960s and had also been a consultant for
the California S&L League. From 1970-1979, he was director of the Seattle Federal

Home Loan Bank. Pratt was clearly an industry insider, chosen by the U.S. League,

\

5' Rudolph A. Pyatt, Jr., “S&Ls, Facing Greater Competition, Score Regulatory Agency; Thrift Leaders
Assail Regan on S&L Regulation” The Washington Post, October 19, 1981 www.1exisnexis.com. Robert
- I(arisen “Behind the Saving of America’s Savings and Loans; Political Chronicle of the Salvation of
1 el‘ica’s Savings and Loans; High Interest Rates Are the Villain for S&Ls” The Washington Post, July 5,
5298 1 , p. Al www.1exisnexis.com; Kathleen Day, 76-90.
Regan was a former Meryl Lynch chief executive who strongly believed that S&Ls needed freedom from
grgulation, especially regulations regarding brokered deposits. See L William Seidman, Full Faith and
53 edit: the Great S&L Debacle and Other Washington Sagas (Times Books, 1993) 181-182.
thleen Day, 76-90.

150

which had considerable influence over the filling of this position.54 However, Pratt’s
connections did not end there. Pratt was also a protege of the aforementioned chair of the
Senate Banking committee, J ake Garn, which connected Pratt to the Reagan
administration as well. Both Pratt and Garn were Republicans fi'om Utah, and both were
Mormons. Richard Pratt would be the architect, charged with drafting all aspects of the
intricate S&L solution. Pratt hired Thomas Vartanian as head counsel of the Federal
Home Loan Bank Board and Brent Beesley, a fellow Mormon from Utah, as the head of
the Federal Savings and Loan Insurance Corporation.55 This team of men, connected to
each other, the S&L industry, and the White House became the tight-rope walkers in
charge of devising a plan that would please Reagan’s supporters in the industry, avoid
alienating other groups in the Reagan coalition, remain consistent with Reagan
administration spending targets, and meet with Congressional approval — a complex
balancing act to say the least.
Those working on a course of action for S&Ls understood the critical nature of
the industry’s condition. At the beginning of 1981, Alan Greenspan argued that 9 out of
10 thrifls were losing money. By the end of that year, Pratt informed Federal Reserve
Chair Paul Volcker, that the magnitude of the industry’s problems amounted to about ‘
$100 billion. Pratt knew he had to act decisively, but he also knew that the White House
and the industry wanted him to avoid publicizing the miserable financial condition of
many S&IS- 56 He was to devise a quiet solution that avoided the costly alternative of

Sb - . . .
Hag down institutions. For Pratt, and the Reagan administration, who already
5M
gatofiueen Day, 83-85; “Home Loan Bank Choice” New York Times Mar 20, 198] p.D8 ProQuest
Kath 1:“ NewSpapers The New York Times (1851 - 2005).
fame»? 3’. 83-86; 1.. William Seidman, Full Faith and Credit: the Great S&L Debacle and Other
Kathleeon Sbgas (Times Books, 1993) 181-182.
n Day, 74, 93.

 

151

 

believed in reducing government hindrance or interference with business, deregulation
emerged as the obvious answer.” Deregulation would provide benefits to the industry
without costing the government anything or clashing with the administration’s ideology.
Speaking to a group of attorneys in 1982, Thomas Vartanian recalled that
there were only a limited number of practical actions that could be taken
to ease the strain: increased deregulation of regulated financial
institutions, a new system of regulation imposed upon non-depository
institutions such as money market mutual fimds, and/or immediate
strengthening of the financial regulators to ensure that the weak
competitors which would not be able to survive would be allowed to fail
in a non-disruptive fashion with as little cost to the FSLIC and the FDIC
as possible. A new trend was now clearly visible on the horizon.58
Clearly absent from Vartanian’s list of options were viable alternatives such as shutting
down troubled institutions before they created greater exposure to the insmance fund.
Also not considered was a mortgage warehousing plan proposed by Senator Moynihan of
New York in which the government would purchase and hold mortgages owned by banks
and S&Ls that paid less than a given interest rate. When short term rates dropped down
to a certain level, the institutions would be allowed to buy them back. Thus, the
government would take the loss associated with the interest rate differential and the
depository institutions, freed from their poorly performing past assets, could write new
Profitable mortgages. At the time, the program would have cost about $10 billion.
Though the U.S. Savings League gave its heavy support, the Treasury department
Violently opposed the proposition, because of the cost it would put on the budget,

"815% g to it as a “hidden subsidy.”59 The Bank Board obviously never pushed for this

 

Wy, High Rollers: Inside the Savings and Loan Debacle (Praeger, 1991) 21.

152

or other options that would put expenses on the budget. Vartanian recalled the clear

decision to deregulate as much as possible:

Regulated institutions would need the freedom to choose the type of
business they wanted, given their own abilities, competitive environments
and economic motivations. Therefore, the F HLBB decided to remove

itself from managerial, decision-making processes to the extent legally
permissible.60

While some of the deregulatory program would require Congressional approval,
as chief S&L regulator, Pratt and his bank board could accomplish much of it on their
own. For example, the first action Pratt took was to issue a regulation allowing S&Ls
throughout the nation to write adjustable rate mortgages (ARMS) in April of 1981. Prior
to this time, S&Ls could only offer ARMS in states that allowed their state institutions to
write such loans. This was probably much needed as it served as the only means for
institutions to protect themselves from interest rate volatility. Furthermore, Pratt’s board
permitted S&Ls to engage in futures and options markets. Also in 1981, Pratt changed
the rules regarding S&L ownership and deposit insurance. Up until that time, in order to

qualify for deposit insurance, a stockholder-owned S&L had to have at least 400
shareholders, 125 of them from the community served. Regulations also prohibited any
one person from owning more than 10% of the S&L’s stock and any control group from
Owning more than 25% of the stock. Pratt’s board eliminated these requirements,
allowing a thrift owned by just one person to obtain deposit insurance. In addition, that
one oWner could receive 100% financing for the purchase fiom the Federal Home Loan
bank, putting up real estate as security. Thus, the owner would have very little of his or

be:-
Owh capital invested in the thrift. Pratt also changed restrictions on the brokered

epo -
w” collected. Before 1931, S&Ls could collect only 5% of their total
Ibid., 1 9-

 

153

 

 

deposits from brokers. The rest came fiom individual consumers. Brokered funds were
traditionally viewed as supplementary because they were more expensive than consumer
deposits, and they tended to move rapidly fi-om institution to institution in search of the
highest going interest rate. S&Ls tended to turn to brokered funds only periodically
when mortgage demand exceeded available capital. Pratt eliminated the restriction
completely, allowing S&Ls to obtain as much as they pleased in brokered depositsf’l
Perhaps the biggest regulatory change during Pratt’s tenure occurred in January of
1 982 when the FHLBB allowed thrifts to switch accounting methods for financial
statements to regulators from Generally Accepted Accounting Procedures (GAAP) to
Regulatory Accounting Procedures (RAP). As the industry sank into deeper financial
distress, RAP helped S&Ls to appear healthier than they really were in a number of ways.
In terms of assets, under RAP thrifts could revalue properties they owned fiom
foreclosures, direct investments, or their own office buildings at market value when
calculating net worth. Of course, appraisers determined market values in a subjective
process that ofien resulted in inflated values, which caused assets to seem larger than they
really were. RAP also allowed thrifts to spread losses over ten years, while under GAAP
losses had to be taken immediately in the year incurred. Finally, RAP treated Goodwill
generated from mergers differently from GAAP. While GAAP allowed Goodwill to
remain as an asset on the balance sheet for 10 years, RAP lengthened that period to 40
y ears. Although Goodwill often represented a legitimate asset — a certain intangible

v -
all“? den Ved from the merger- the 40 year rule seemed to exceed reasonable limits. For

6M
R.
[mic-91:?“ Bmmmugh, Jr., Thrifis Under Siege, 42,150; R. Dan Brumbaugh, Jr., The Collapse of Federally

Mayer, 663 epsos itories: The Savings and Loans as Precursor, (Garland Publishing, Inc., 1993) 3440; Martin
[381‘] - ‘6

0 - David Mason 220-221; Thomas P. Vartanian, “Remarks Regarding the Depository
“3 Act of 1982,” 19-24.

 

154

example, the Securities and Exchange Commission ruled that publicly traded savings and
loans could only claim goodwill as an asset for 25 years.62 Using the change in Goodwill
accounting rules as an incentive, the FHLBB encouraged and sometimes even arranged

for mergers of weak institutions. This enabled them to quietly solve the problem without

burdening F SLIC or the federal government with any costs. Thus, the FHLBB saw the
merger of 516 S&Ls between 1980 and 1982.63

The new rules about losses dramatically affected the S&L industry. Beginning in
September 1981 and expanding in May 1982, the FHLBB encouraged troubled thrifts to
sell their low-yielding mortgages, written at lower rates of the past. Then, for tax
purposes, they were permitted to write off the entire loss during one year, resulting in a
tax credit. Of course, for regulatory accounting purposes, institutions spread that same
loss over the life of the loan.64 Again, this policy served as a way to funnel some money
into thrifts in the form of a tax credit, without having to put new expenses on the federal

budget or drain money from F SLIC. At the same time, it made troubled S&Ls appear
healthier than they were.

While some of these regulatory reforms made legitimately needed changes, most
merely placed a band-aid on a wound that demanded more serious treatment. Worse yet,
some of the changes, like the switch to RAP, covered the wound so that nobody could see
the bleeding. But Pratt’s options were limited by political considerations. The Reagan
Administration would never have supported the appropriation of billions of dollars

a
ceded to make a legitimate attempt at solving the problem.

 

62
63 David

64 Via ason, 220-223; Martin Mayer 70; R. Dan Brumbaugh, Jr., Thrifts Under Siege, 60-62.
in 1 Ulas<>tn 221-223; Martin Mayer, 65-8.
1 " laYer, 70—71.

155

rm

(3’

ll

In the meantime, Richard Pratt also pursued deregulation and aid for the industry

through legislative channels. Pratt and his staff ultimately designed and wrote the Gam-

St. Germain Act of 1982, with full support and participation from the Reagan
Administration. Early drafts of the bill were even referred to as “the Pratt bill.”
However, Pratt had to balance many interests in accomplishing this legislative feat, not
the least of which was an apparent lack of support fi'orn Treasury officials Regan and
Mehle early in the process. In the spring of 1981, Pratt, as Chairman of the FHLBB,
along with regulators from the FDIC, the Fed, and the NCUA approached F emand St.
Germain, the Chairman of the House banking committee, asking him, “to consider
statutory changes to broaden their merger and acquisition authorities, and to expand the
resources of the Federal deposit insurance funds.”65 St. Germain, reported receiving a fair
amount of support and cooperation from the House and Senate for a bill that would
accomplish such changes, but “inflammatory statements by high-ranking administration
officials culminated in a Treasury Department veto.”66 It would seem that Pratt had not
yet secured Regan and Mehle’s support for his legislative agenda.
A few months later, at a House banking committee hearing, Pratt and Mehle both
testified as to the condition of the savings and loan industry, the need for emergency ‘
Killer; and the best path to pursue in helping the industry. The testimony of the two men
difified significantly with respect to the immediate condition of the industry and the need
for elliergency measures to improve the situation. Pratt, who came across as highly
Sml’athetic to the plight of thrifts argued that “the industry is structurally unsuited to

Sill-vi
Ve under the present set of economic circumstances and competitive interfaces.”
6M
0
£111! ":4: [committee on Banking, Finance, and Urban Affairs, Conduct of Monetwy Policy (Pursuant to the
Ibid.‘ 2 0.1V": em and Balanced Growth Act of I 978), 97" Congress, 1" session, July 14, 1981, 1.

 

156

Furthermore, he claimed, Congress created the untenable environment for thrifts by
expecting them to pay market rates of interest on liabilities, while restricting their ability
to earn competitive rates of return on assets. Such inequality among depository
institutions, he complained, “will guarantee the lack of thrift survivability and the lack of
home finance money in this country.“7 Besides calling for structural change, Pratt
insisted that FSLIC needed additional flexibility in handling troubled thrifts. He, and the
other regulators of depository institutions, also emphasized the urgent and immediate
need for his program. “. . .as a means of crisis management,” he argued, “we believe it is
vital that the Congress provide the F SLIC with certain tools.” He also warned that “If
Congress does not act in the short run to address this matter, there will be no long run for
a very substantial segment of the thrift industry.”68

The testimony of Assistant Secretary of the Treasury Roger Mehle proved far less
alarmist. Mehle clearly acknowledged the difficulties and challenges that inflation, high
interest rates, and competition from money market mutual funds inflicted on thrifts.
These problems required attention, he admitted. However, he felt that the best solution
involved long-term reform, in particular deregulation of restrictions on assets, and the
improvement of economic conditions. “What the industry needs at the moment, along
with the entire economy, is less inflation and lower short-term interest rates,” Mehle told
the House banking committee. This would be accomplished, he argued, through
Reagan’s newly implemented economic program. He did not believe that the problem
called for emergent action or legislation. To the contrary, be communicated that “[w]e

believe the Federal deposit insurance agencies and other regulators with whom we have

 

‘7 Ibid., 35.
" Ibid., 36.

157

(11.

“I

[hr

di

Te

C0

\shn

been in close contact can deal adequately with any seriously troubled depository
institutions that need special assistance before short term interest rates decline.” Thus,
Mehle was no more supportive of what had come to be known as the “regulators’ bill”
than he had been the previous spring when the Treasury Department vetoed the effort.69

Some members of the House banking committee seemed to take offense to
Mehle’s nonchalant attitude about the condition of thrifts. For example, during the
question session, Representative Stanton, a fellow Republican from Ohio, asked Mehle,
“Does the administration plan to abandon the financial savings and loan industry, or will
they help them? They [the savings and loan industry] are convinced that they have a
problem. Moreover, they are convinced that you don’t think they have a problem. That
would be underscored by your statement here this morning.”70 Representative LaFalce, a
Democrat from New York, certainly noticed the discrepancy between Mehle’s testimony
and that of Pratt and other regulators:

We’re getting dire reports fi'om the regulators, and you’re coming before

us as a representative of the administration; and you are painting the other

side of the coin. You’re saying, well, the glass is half full; the others have

said it’s half empty. As a matter of fact, they have said more than, it’s half

empty; they have said it’s like about 90-percent empty. So we’ve got not

only a difference in nuance or perspective, but perhaps in factual

interpretation.7|

Weeks later, this difference of opinion between Pratt and Mehle was still sparking
discussion among banking committee members. Henry Gonzalez, a Democrat from
Texas, sent a letter to St. Germain, expressing that at the hearing “a strange,

contradictory, and ominous, series of events occurred. Mehle’s testimony flatly

contradicted the previous testimony presented by Chairman Pratt and two other

 

‘9 Ibid., 439.
7° Ibid., 450.
7' Ibid., 458.

158

regulators.” Gonzalez went on to explain that “Mehle categorically denied any
emergency and made, what to me, are astounding dogmatic prenunciamentos of ‘no
crisis.’ Both of these men cannot be correct.”72 St. Germain responded to Gonzalez
affirming that “I share your concerns that this divergence of views have great
implications for public policy and for our financial markets.” He told Gonzalez that he
introduced the Regulators’ bill again on July 30, explaining that “Clearly the
Administration precluded action on the bill before the recess and again clouds the outlook
for such legislation?”
However, the two men may have been exaggerating the differences between Pratt
and Mehle. While the tone of Pratt’s testimony differed markedly fi'om Mehle’s, the
substance did not diverge quite as much as Gonzalez and St. Germain claimed. Pratt
argued that the crisis suffered by thrifts called for three different policy initiatives. First,
he contended, “the efforts of the administration and of the Federal Reserve to bring
inflation under control must be allowed to work.” Next, he highlighted the need for
Congress to grant regulators the power to use additional tools “as a means of crisis
management.” Third, Congress needed to deregulate the asset side of thrift balance
sheets, allowing them to diversify their portfolios and rely less heavily on the mortgage
market.74 While Mehle clearly disagreed with Pratt’s assertion that regulators needed
special tools to deal with the current crisis, he did not disagree with Pratt’s other two

premises. Furthermore, with regard to the special tools that Pratt asked for, otherwise

known as the “Regulators’ bill,” Mehle claimed that “Two of the parts, the administration

 

72 Depository Insurance Flexibility, Act 97'” Congress, 1" session, Congressional Record 127 (October 27,
1981): 25410.

’3 Ibid., 25411.

74House Committee on Banking, Finance, and Urban Affairs, Conduct of Monetary Policy (Pursuant to the
Full Employment and Balanced Growth Act of1978), 97til Congress, 1" session, July 14, I981, 36.

159

did not favor; one of the parts the administration was unopposed to—was sympathetic to
in fact.” Mehle and the administration opposed increasing the regulators’ borrowing
lines with the Treasury and the expansion of capital assistance powers. However, he and
the administration were supportive of a provision that would give regulators the power to
set up interstate and inter-industry mergers for ailing thrifts and said that they had already
communicated that support to the House and Senate banking committees.75 This is
consistent with letters sent to St. Germain by Secretary Treasury Regan, stating that:

the Administration believes the President’s economic program is the best

remedy for the current ills of mutual savings banks and savings and loan

associations . . .Over the longer term, I will be urging the regulatory

agencies and Congress to liberalize the asset powers of thrift institutions to

make these organizations more competitive in every type of economic

envrronment.
In a later letter, he said “The Administration has no objection to the regulators’ proposals
for interstate and inter-industry mergers and consolidations. We are sympathetic to what
appears to be a competitive fiee market means of dealing with a failing depository
institution?” Therefore, in reality, Pratt and the Treasury only strongly disagreed about
how to handle the immediate, short-term thrift crisis, not over the proper long-term
course of action. The Treasury Department seemingly objected to any resolution of thrift
industry problems that would appear as an expense on the budget. Solutions that would
not cost anything, such as deregulation and mergers got full administration support.

Despite the Treasury’s objections, the House banking committee reported the

“Regulators’ bill” on October 7, 1981 to the House. Gonzalez had urged St. Germain to

 

75 -

Ibid., 450.
7’ Deposit Insurance Flexibility Act, HR. 4603, 97" Congress, 1" session, Congressional Record 127
(October 27, 1981): 25407-25423.

Ibid.

160

move ahead on the bill notwithstanding the administration’s opposition, “I believe that
Congress has to respond and take action immediately otherwise, once again, we will be
the patsy for the Reagan Administration ploys against the Democrats.”78 On the same
date, Republican, William Stanton introduced the Thrift Institutions Restructming Act,
which proposed giving savings and loans greatly expanded asset powers. In introducing
the bill, Stanton gave his firll support to passage of the Regulators’ bill, but emphasized
that a more long-term solution was necessary as well. Stanton said he was introducing
the bill “at the request of Chairman Richard T. Pratt, of the Federal Home Loan Bank
Board, [and] on behalf of the administration, which has endorsed it.”79 Also on the same
date, Jake Garn, Republican Chairman of the Senate banking committee introduced S.
1720, a more far-reaching bill that not only expanded asset powers of thrifts, but also
increased deposit insurance to $250,000 for IRA and Keough retirement accounts,
allowed credit unions to offer a broader range of real-estate loans, permitted commercial
banks to underwrite municipal revenue bonds, allowed all depository institutions to
manage and sell mutual fund investments, and preempted state usury ceilings on
consumer loans. Garn commented that much of the bill had been drafted by the
regulators themselves, such as Pratt. 80

The House, which enjoyed a Democratic majority, passed the Regulators’ bill on
October 28, 1981, but the Republican-dominated Senate did not act on it. On February
23, 1982, St. Germain tried again, introducing a bill that would create the Home

Mortgage Capital Stability Fund. This law would appropriate a $7.5 billion fund that

 

73 .
Ibrd.

’9 The Plight of Thrift Institutions, HR. 4603, 97" Congress, 1” session, Congressional Record 127

(October 7, 198]): 23726-23728.

8° S. I 720, 97"I Congress, 1’’ session, Congressional Record 127 (October 7, 1981): 23616.

161

regulators from the FHLBB, FDIC, and NCUA could draw on to assist troubled
mortgage-lending institutions whose net worth dropped below 2% of assets. The aided
institutions would have to pay back the funds with interest and would be required to
earmark 50% of new deposits for mortgage loans on 1-4 family residences.81

On May 4, after committee hearings, St. Germain introduced a revised version of
the bill. The revisions, he explained, responded to “concerns raised by the witnesses and
to concerns over the budget impact of the original bill.” Instead of directly loaning funds
to ailing thrifts with net worth problems, the federal government would guarantee the net
worth of federally or state-insured institutions. The guarantee would be backed by an
$8.5 billion account in the Treasury, but the government would only have to pay out cash
if the guaranteed institution failed and was liquidated.82 St. Germain seemed to finally
accept that the Reagan administration would only go along with a plan that refi-ained
from placing expenses on the budget. The House passed the revised bill on May 20,
1982, with St. Germain claiming it was supported by the U.S. League, the Independent
Bankers Association, the National Associations of Mutual Savings Banks, and the
Consumer Coalition. The ranking Republican member of the banking committee,
Chalmers Wylie offered a substitute amendment that differed from St. Germain’s bill in
two ways. First, it did not offer net worth assistance to banks along with thrifts. The bill
need not contain “anything for commercial banks because commercial banking is not a
troubled industry at the present time,” argued Wylie. Secondly, it addressed net worth

shortages by having troubled thrifts issue income capital certificates in exchange for

 

8' Home Mortgage Capital Stability Fund, 97‘” Congress, 2ml session, Congressional
Record 128 (February 23, 1982).

’2 Net Worth Guarantee Act, 97'“ Congress, 2ml session, Congressional Record 128 (May 4, 1982): 8655-
56..

162

promissory notes, which he claimed would by accounting standards, actually boost net
worth. Wylie claimed that accounting authorities did not believe that St. Germain’s net
worth guarantee by the Federal government would technically boost net worth. He also
argued that St. Germain’s method would take longer since an appropriation would have
to be made for the Treasury fund backing the guarantee.83 St. Germain’s version passed
in the House that day, but the key work on this bill was done in the Republican-
dominated Senate.

The House bill, which contained only short-term relief provisions for the industry
proved to be a skeleton compared to the Senate version, which its banking committee
worked on for 18 months. Like the House bill, the Senate version provided regulators
with expanded powers to help troubled thrifts and credit unions, all of which were subject
to sunset in three years. In addition to permitting the assumption of liabilities,
contributions, and the purchase of securities by regulatory agencies, the bill formally
allowed regulators to arrange mergers for ailing institutions. This was already taking
place,84 but the bill sought to control the process by providing a hierarchy of preferences,
privileging in-state mergers over interstate ones and mergers of similar institutions over
dissimilar ones. It also provided that regulators give priority to institutions in adjacent
states over ones farther away. As Alan Cranston commented during debate on the bill,
“the restraints in this section are meant to discourage the use of involuntary mergers as

the primary solution to the thrift crisis. Indeed it is the intent of the Congress that all

 

’3 Providing For consideration of HR 6267, Net Worth Guarantee Act, HR. 6267, 97"I Congress, 2"“
session, Congressional Record 128 (May 20, 1982): 10760-10766.

" Traditionally the F HLBB followed laws that applied to commercial banks even though they were not
obligated to do so, and federal law did not permit commercial banks to branch across state lines without the
permission of the state into which they were crossing. Pratt chose to stop following that guideline when it
came to troubled savings and loans and thus made it easier to arrange mergers. He also chose to stop
following the federal law that forbade non banking corporations from owning banks for the same reason.
See Kathleen Day, 95.

163

other options and alternatives be considered and that a true emergency exist before this
section is used.” Some in Congress feared that use of interstate, inter-industry mergers to
solve the problems of distressed institutions would erode interstate branching restrictions
set up by the McFadden Act in 1927. Regional competition and concentration of power
lay at the heart of this debate. As James Exon, a Democrat from Nebraska argued,
“Through the proliferation of our financial institutions we have been contributing to
taking the money out of the communities and transferring that money to large financial
centers and, with it, considerable economic power.” The bill provided for other
emergency relief provisions, including allowing the FDIC to facilitate an institution’s
conversion to a stock association in order to raise funds and allowing the FHLBB to
appoint FSLIC sole conservator of a state institution under emergency conditions even if
prohibited by state law.85

The Senate bill also created a capital assistance program for thrifts with net worth
problems, permitting the FDIC and FSLIC to purchase capital certificates from troubled
institutions, thereby raising net worth. To qualify for the program, institutions had to
have a net worth of 3% of assets or less, have suffered a lost during the last two
consecutive quarters, have the ability to remain solvent for at least 6 more months, and
have at least 20% of assets invested in mortgages or mortgage-backed securities. The
bill also greatly expanded the lending options available to thrifts, pre-empted state
restrictions on the enforcement of due-on-sale clauses, provided that within 60 days of
the law’s passage, DIDC create an account equivalent to and competitive with money

market mutual funds. The minimum deposit for such accounts was to be no more than

 

’5 Depository Institutions Amendments of1982, S. 2879, 97'” Congress, 2'“1 session, Congressional Record
128 (September 24, 1982): 25123-25163.

164

$5,000 and there were to be no interest rate ceilings. Furthermore, the law instructed
DIDC that all accounts were to be freed of rate ceilings and the differential by January 1,
1984.86
As the Senate discussed the bill and as various Senators proposed amendments,
Jake Garn spoke to the difficulties encountered in reaching a consensus among all
interested parties:
A year and a half of working on this bill has produced a very fragile coalition of
those who would agree on it. In fact, we reached a point a lot of people thought
was never possible, as controversial as some of the issues were, such as due on
sale, new powers for the thrifts, and many other issues. At this point, the ice is so
thin, I believe that unless we can keep the bill as reported by the committee intact
we would probably lose it and not be able to enact it this year. . . I will oppose any
and all amendments today for the same reason. 87
The bill passed the Senate on September 24, 1982 without any major amendments.
Ultimately, it went to conference to reconcile the vastly different House and Senate
versions. Why were the two bills so different? Both houses of Congress exhibited a
desire to help thrifts weather the crisis and retool for the firture. However, the
Republican-dominated Senate proved much more willing to push through Pratt’s entire
reform agenda quickly. The Democratic-controlled House was far more hesitant. Part of
the answer may involve Pratt’s and the Reagan administration’s close relationship with
Senate banking committee chairman Jake Garn. Garn could facilitate the process for
Pratt in the Senate. The House effort was a bit messier, as Democrats fought back against
the administration’s program. As detailed above, St. Germain tried fiuitlessly to
appropriate on-budget funds to the industry, which the Reagan administration simply

refused to support. The House also attempted to split short-term thrift aid from long-term

 

'6 Ibid.
‘7 Ibid., 25132.

165

deregulatory issues, which the administration also opposed.88 In fact, when the bills were
formally separated, Donald Regan withdrew the Treasury’s request to testify before the
House banking committee, stating “The Department would prefer not to address this bill
in isolation of the other issues affecting the thrift industry. Therefore, we would like to
refrain fiorn testifying until your committee begins comprehensive hearings on financial
institutions. . 3’89 In the end, Pratt and the administration got all they wanted. Virtually all
the provisions agreed upon in the Senate were approved in conference.90

As one might imagine, not everyone in the House was pleased with the resulting
bill or with the process by which it was pushed through. The conference report was
presented to the House dming the closing hours of the end of the session, under a rule
that prohibited separate voting on the individual provisions. Representatives were faced
with a take-it-all or leave-it-all decision, so in order to provide emergency relief to the
industry, they also had to agree to deregulation. On the other hand, Republican Trent
Lott was correct in pointing out that “these are not new issues. They have been debated
before Congress for decades. The difference is that now there is a need as there has never
been before.” Also, supporters argued that the bill had widespread support from most of
the interested parties. Stanton claimed that of the 40,000 financial institutions in the

country, about 38,500 supported the legislation. St. Germain claimed it was supported by

the Fed, the FDIC, the F HLBB, the Comptroller of the Currency, the Department of the

 

8’ Richard Pratt and the administration clearly wanted their entire program to become law during the 97m
session of Congress. As mentioned above, upon introducing the Thrift Institutions Restructuring Act,
which dealt with longer-term regulatory change, House Republican William Stanton said he did so on
behalf of Richard Pratt and the administration.

”Providing for the consideration of HR 4603, Deposit Insurance Flexibility Act, HR. 4603. 97'” Congress,
1'“t session, Congressional Record 127 (October 27, 1981): 25407-25411.

9° Corference Report on HR. 6267 Net Worth Guarantee Act, HR. 6267, 97"I Congress, 2'“1 session,
Congressional Record 128 (September 30, 1984) 26426.

166

Treasury, the NCUA, and “every trade group affected except the Independent Bankers
Association.”

The independent bankers objected to the new lending powers the bill bestowed
upon thrifts and to the deposit instrument created to compete with unregulated money
market mutual funds. In fact, small independent banks, designed to service only their
local communities, had suffered for quite some time under the increased competition
created by money market mutual funds and by DIDMCA’s deregulation, which allowed
thrifts to enjoy some of the same asset powers as banks. At the 1981 Annual Convention
of the American Bankers Association, the president of a small Arkansas bank told the
audience that small banks “feel like a country dog that’s brought to the city. We don’t
know who our fiiends are and we’re getting kicked from both sides.”91

Money market funds hurt small banks just as they hurt S&Ls: by causing
disintermediation. Depositors increasingly moved their savings to the funds, which
ofl‘ered as much as 10% more interest than banks or S&Ls could offer under Regulation
Q limits. However, deregulation of rate limits also hurt bank profitability as it created the
same kind of interest rate squeeze experienced by thrifts. It became difficult for small
banks to be profitable when they had to pay such high rates on their funds. Banks of all
sizes responded to the new conditions by raising their fees for deposit services, reducing
branch operating costs, and shifting to assets that produced higher earnings.

Notwithstanding these attempts to boost earnings and cut costs, profit rates for banks did

 

9' Robert A. Bennett, “Bankers Dance to a Somber Song,” New York Times, October 11, 1981, F4,
ProQuest Historical Newspapers The New York Times (1851 - 2005). The ABA, mainly served the
interests of large banks, but part of the reason for holding an annual convention was to sell the smaller
banks on their legislative program.

167

not return to their previous levels until the 19903. 92 Large banks were in a better position
to weather this kind of storm. Perhaps, they were also sophisticated enough to see that in
order to survive, they simply had to compete with investment banks for funds. Large
banks even challenged previous restrictions on intra and interstate banking, arguing that
money market funds were able to draw capital from across the nation and they should be
allowed to do the same. Deregulation simply was more burdensome for smaller banks.
In an environment of interstate banking, they would surely be swallowed up by large
national banks if they were to survive at all. Thus, small banks objected to provisions in
the new bill that allowed interstate and inter-industry mergers, seeing it as a direct
challenge to the restrictions on branching that allowed them to exist in the marketplace.
Furthermore, the greater asset powers granted to thrifts represented increased
competition, while granting small banks very little. Larger banks, which were more
eager to draw capital from a larger geographic area, tended to support the legislation.93
Another way to measure the effects of deregulation on various depository
institutions, argue business finance professors Comett and Tehranian, is to examine how
stock prices of stockholder-owned institutions reacted to announcements indicating
imminent deregulation. They found that “both President Reagan’s Housing
Commission’s call for a sweeping expansion of the powers of thrift institutions and
banks” and “the Senate passage of the Garn-St. Germain bill” resulted in an increase in
value of the stock for large banks and large S&Ls, and a decrease in stock price for small

banks and small S&Ls. Likewise, when the bill faltered temporarily in the Senate, the

 

92 David B. Humphrey and Lawrence B. Pulley, “Banks' Responses to Deregulation: Profits, Technology,
and Efficiency” Journal of Money, Credit and Banking, Vol. 29, No. 1 (F eb., 1997) 73-93
mgizl/wwwistonorg/sta‘ble/2953687 accessed 6/29/09.

93 Robert A. Bennett, “Bankers Dance to a Somber Song,” New York Times, October 11, 1981, F4.

168

stock prices of large banks and S&Ls dropped, while the stock values for small banks and
S&Ls rose. Thus, investors agreed with bank and S&L interest groups about the effect
that deregulation might have on their institutions.94
Despite small bank objections, and opposition by some in the House, the
conference report was accepted. The newly titled Garn-St. Germain Depository
Institutions Act of 1982, named for the Chairmen of the Senate and House Banking
Committees, was sent to President Reagan’s desk. Reagan signed the bill two weeks
later, commenting on the law’s ability to help the small saver by providing higher returns
on savings and enhanced access to loans. Reagan also identified the bill as merely the
first step in “cm administration’s comprehensive program of financial deregulation.”95
Indicating his desire for additional financial deregulation, Reagan commented that
“[u]nfortunately, this legislation does not deal with the important question of delivery of
other financial services, including securities activities by banks and other depository
institutions.”96
The final law contained several provisions that affected savings and loans. First,
the law provided for emergency assistance to distressed banks and savings and loans. It
allowed federal insurers to help troubled institutions through contributions or through the
purchase of non-voting stock. The law also allowed the F HLBB to convert state-

chartered mutual associations into federally chartered stock associations regardless of

state law. Regulators were permitted to arrange for mergers of distressed institutions,

 

9’ Marcia Milton Comett and Hassan Tehranian, “An Examination of the Impact of the Garn-St. Germain
Depository Institutions Act of 1982 on Commercial Banks and Savings and Loans” The Journal of
Finance, Vol. 45, No. 1 (Man, 1990), 95-111 ht_tp ://www.jstor.org[stable/23288l1 accessed 6/29/09.

9’ Ronald Reagan “Remarks on signing HR 6267 into law — Garn-St. Germain Depository Institutions Act
of 1982” October 15, 1982 Weekly Compilation of Presidential Documents, Volume 18, number 41, 1319-
1320.

9‘ Ibid.

169

with a hierarchy of preferences put in place privileging intrastate over interstate mergers
and intra-industry over inter-industry mergers. These emergency provisions were to
sunset three years after the date of passage.97
The law also addressed net worth problems among savings and loans by

implementing an income capital certificate program. To qualify for the program, the
institution had to have a net worth of 3% of assets or less, suffer losses for two
consecutive quarters, and have at least 20% of its total loans invested in residential
mortgages or mortgage-backed securities. FSLIC and the FDIC then could purchase net
worth certificates from the institutions, issuing negotiable notes in return.98 This
maneuver amounted to a slight-of-hand trick to boost net worth without changing the
federal budget or requiring cash expenditures from F SLIC. In explaining this provision
to a group of lawyers, head FHLBB counsel, Thomas Vartanian said:

In mid-1981, the legal staff of the FHLBB set about the task of devising a means of

enhancing the rapidly diminishing net worth of thrift institutions. Limited on the one

side by the absence of statutory language providing explicit authority for the FSLIC

to purchase equity securities, and on the other by the Administration’s concerns that
assistance be of a nature that would have a minimal effect on the federal budget, the

F HLBB’s lawyers designed and implemented the unprecedented income capital
certificate (“ICC”) program.
Though the S&Ls taking part in the program enjoyed a boost to their net worth on paper,
nothing material had changed regarding the financial condition of these institutions.99
In terms of liabilities, the law made two important changes. First, it called for the

phasing out of all interest rate limits and differentials on all accounts by January 1, 1984.

 

97 Library of Congress, Thomas, “HR. 6267” http://thomas.loc.gov/cgi-
gin/bdquery/D?d097: l :Jtemp/~bdviuj :@@@L&summ2=m&|/bss/d097query.htmll.

Ibid.
99 Thomas P. Vartanian, “Remarks Regarding the Deposiotry Institutions Act of 1982” 27; However,
journalist Kathleen Day points out that the net worth certificates personally helped thrift executives in
stock-owned S&Ls by boosting the stock value. Executives often used their stock as collateral for other
investments, she explains, and as their institutions got into net worth trouble, stock prices dropped, and
many executives faced calls for more money or collateral. See Kathleen Day, 91.

170

Secondly, it required DIDC to create, within 60 days of the law’s passage, a new account
to be offered by depository institutions, competitive with money market mutual funds.
The account was to be free of interest rate limits.100

On the asset side, Garn-St. Germain greatly expanded the investment options
available to savings and loans. First, the law eliminated all loan-to-value ratio limitations
on residential mortgages, which had previously been set at 80%. Then, the law allowed
thrifts to diversify their portfolios into commercial investments. Thomas Vartanian told
lawyers “the Act provides the federal thrift with the ability to place up to 90 percent of its
assets in commercial-type investments.” It allowed S&Ls to invest up to 40% of assets in
loans secured by commercial real estate. Also, under the new law, up to 11% of assets
could be invested in commercial loans. Institutions could also invest up to 3% of assets
in direct equity investments in businesses.'°'

Finally, the law pre-empted state laws that prohibited mortgage lenders from
enforcing due-on-sale clauses in mortgages. While several states had such statutes, this
heated issue was perhaps most controversial in California. Sellers in that state, and
others, had argued that mortgages were tied to the property, not the individual and thus
could be transferred to a new individual when the property was sold. This hurt the
lending institutions considerably because it tied them into interest rates of the past, rather
than allowing them to initiate a new loan at the going rate when the property was sold. It
also deprived institutions of new origination fees. Furthermore, the lack of an

enforceable due-on-sale clause in the mortgage contract, made the loan less acceptable

for sale on the secondary market. Finally, the statutes against enforcement created a lack

 

"’0 Library of Congress, Thomas, “HR. 6267” http://thomas.loc.gov/cgi-
girl/bdquery/D?d097 : 1 :Jtemp/~bdviuj :@@@L&summ2=m&|/bss/d097query.htmll.
Ibid.

171

of parity among institutions, since federal savings and loans were given blanket
permission to enforce due—on-sale clauses in 1976.102 This dilemma had been argued
back and forth in California state courts throughout the 1970s, and as the courts tended to
rule in favor of sellers, California mortgage lenders had suffered great losses of potential
income. The fact that the question was definitively settled in the Garn-St. Germain Act
probably speaks to both the extent of hardship faced by California S&Ls and the
considerable political influence they obviously wielded.103

Garn-St. Germain, passed during a time of severe hardship for the savings and
loan industry, brought about profound changes for S&Ls. On the one hand, the
legislation offered temporary fixes for severe problems that helped keep institutions
afloat until lower inflation and interest rates could come to the rescue. On the other hand,
the legislation changed the entire structure of the industry. Many savings and loans
would no longer look like savings and loans after instituting the new powers accorded
them by the law. With the stroke of a pen, the law deregulated a government-insured
industry that had operated under highly restrictive conditions for over 50 years.
Combined with the deregulation implemented unilaterally by Pratt and the Bank Board, it
represented a drastic and sudden change. In his memoirs, William Seidman, Chairman of
the FDIC at the time, laments that Garn-St. Germain allowed S&Ls to invest in

practically anything regardless of the risk. “It was another license to gamble with the full

 

102 Eric J. Murdock, “The Due-on-Sale Controversy: Beneficial Effects of the Garn-St. Germain Depository
Institution Act of 1982” Duke Law Journal, Vol. 1984, No. 1 (Feb., 1984), 121-140,
hgp://www.jstor.o_r:g[stable/1372346 accessed 6/29/09.

"’3 Martin Mayer, 47-51; Thomas P. Vartanian, “Remarks Regarding the Deposiotry Institutions Act of
1982” 32.

172

faith and credit of the U.S. government, supplied through insured deposits,” he
complained.104

Furthermore, deregulation did not stop at the federal level. States such as
Arizona, California, Texas, Florida, Ohio, and Maryland, fearing that their state-chartered
institutions would convert to federal charters to enjoy the benefits of deregulation, passed
similar deregulatory legislation, in some cases even before the Garn-St. Germain Act was
passed. Some sate laws surpassed the federal one in terms of leniency.105

The Reagan administration cannot be judged for the ailing condition of S&Ls
when it took office. The problem was not of their making. However, one can evaluate
how the administration dealt with the situation it inherited. This is especially true
because the Reagan administration’s strong agenda control and considerable political
power rendered it largely able to implement the policies it supported and equally able to
close down options it opposed. Therefore, sudden and drastic deregulation was not so
much a compromise struck, but a path chosen that was completely consistent with the
administration’s ideology, interests, goals, and support groups. The S&L industry had
considerable influence with both parties, and Pratt and his team rode the wave of
deregulation that allowed them to throw enough bones to appease this important
constituency. During the 1980s, fervor for deregulation and faith in the market, already
strong during the 19703, skyrocketed. Reagan’s inaugural pronouncement that

“government is not the solution to our problem; government is the problem,”'°6 became

 

'°‘ L. William Seidman, 181.

'05 Lenny Glynn, “Who Really Made the S&L Mess?”; Norman Strunk & Fred Case

Where Deregulation Went Wrong: A Look at the Causes Behind Savings and Loan Failures in the 1980s
(U .8. League of Savings Institutions, 1988) 58-9.

‘°° June 20, 1981, Ronald Reagan’s Inaugural Address, available from
hgpz/lwwwxeaganlibgry.com/re_agan/sxeches/first.asp

173

the guiding principle in several policy areas, including financial reform. However, as the
adage goes, perhaps Richard Pratt should have been more careful what he wished for. He
did indeed get it. Deregulating to the extreme was perhaps too drastic, for an industry

that had been protected, micro-managed, and insured by the federal government since the

New Deal.

174

CHAPTER 5

THE COLLAPSE AND ITS MEANING

Ironically, the Garn-St. Germain Act, with its badly needed emergency relief
provisions, became law just as conditions were on the verge of improving for savings and
loans. During the second half of 1982, the economy began to recover, and interest rates
dropped slightly. In addition, the launching of the money market account authorized by
Garn-St. Germain, brought in a huge influx of capital. In its annual publication of
statistics, the U.S. League noted that, “In only two and one-half weeks between its
authorization and year-end, the money market account attracted nearly $34 billion, 6% of
total deposits.”1 From 1982-1985, funds continued to pour into these accounts, with
record growth in deposit levels during 1983 and 1984, notwithstanding a drop in the U.S.
personal savings rate.2 F urtherrnore, mortgage lending reached unprecedented heights
from 1983-1985. This was fireled partly by the drop in mortgage interest rates, which
encouraged consumers, who may have delayed purchasing in the high rate environment,
to buy homes again. Private housing starts in 1983 outnumbered the previous year by
almost 3 million, and the sale of existing homes was about 36% higher than in 1982.3
The better rates also encouraged borrowers to refinance high interest rate loans made
during the credit crunch years of 1979-1982.4 At the same time, investors displayed a
renewed interest in mortgage-backed securities, as the yields for corporate bonds and

utilities moved closer to the rate of return on conventional mortgages. S&Ls sold a

 

' ’83 Savings and Loan Sourcebook (United States League of Savings Associations, 1982) 6.

i 1984 Savings Institutions Sourcebook (United States League of Savings Associations, 1934) 5-7, 22.
Ibid., 39.

‘ I985 Savings Institutions Sourcebook (United States League of Savings Institutions, 1935) 9-10.

175

record number of loans from their portfolios. All this primary and secondary market
activity made for record mortgage portfolio turnover ratios—25% in 1983,5 26% in
1984,6 and 34% in 1985. Portfolio tlu'nover helped to improve earnings, as new loans
took the place of old, poorly performing ones. New loans also produced income through
loan origination fees.7

There were also many signs in the 19803 that the S&L business was changing.
S&Ls were not the small self-help institutions fiom which they originated,and they were
not the simple collectors of savings and writers of mortgages that the New Deal had
called for either. They were becoming integrated into the U.S. capital market. For
example, in its 1985 publication of statistical data, the League advised that institutions
might want to use futures contracts to hedge their interest rate risk.8 Also, associations
were selling an increasing number of their loans on the secondary market, largely to
federal agencies such as Fannie Mae, Gimrie Mae, and Freddie Mac, in exchange for
mortgage backed securities. This trend became particularly pronounced in 1986 with the
creation of the real estate mortgage investment conduit (Remic), which provided a tax-
exempt means to pool mortgage backed securities. The number of loans sold by
associations increased 76.7% between 1985 and 1986. This changed the way S&Ls
operated. As noted by the U.S. League in 1987, “Recently, savings institutions also have
become more interested in originating mortgage loans for subsequent sale to investors

such as pension funds and insurance companies.”9 S&L borrowers were no longer

 

5 I984 Savings Institution Sourcebook., 9. This was the highest seen by the industry since 1950.

6 I 985 Savings Institutions Sourcebook, 9-10.

7 I984 Savings Institutions Sourcebook, 9.

8 I985 Savings Institutions Sourcebook, ll, 15. The League credit Ginnie Mae with creating the first
financial futures contract.

9 I987 Savings Institutions Sourcebook (United States League of Savings Institutions, 1987) 10.

176

financed mainly by personal savings from their fellow citizens. The money for their
loans came from a variety of sources.

The industry looked remarkably healthy fi'om 1982-1985. It appeared to have
survived the hard times of 1979-1982 and remodeled itself for success. In 1984, industry
profits came in at over $1 trillion and 1985 profits were record-breaking. However, there
were indications that all was not well. For example, the alarming rate of growth of some
institutions worried regulators, as did the new investments made by a number of
associations using the expanded powers that the Garn-St. Germain Act granted them.
This prompted the F HLBB to change reserve requirements for F SLIC-insured savings
institutions, effective March 31, 1985. New reserve requirements were to be calculated
quarterly, based on each institution’s growth and the percentage of high risk assets on its
books. The F HLBB seemed to be concerned about the growth rates and investments of
some institutions, and though the industry as a whole earned record earnings in 1985, the
League’s publication noted that “about 90% of savings institutions made a profit in
1985.” Little explanation was provided for the unprofitable 10%.10 News about the
FSLIC insurance fund also proved worrisome:

The F SLIC faces many new pressures caused by such forces as financial

deregulation, which has increased competition for savings and greatly

expanded investment options for all insured institutions. As a result,

Congress is increasingly concerned about the viability of deposit

insurance... ”

The Board also restricted direct investments to 10% of association assets or twice an

institution’s net worth. Finally, the Board imposed quarterly premium assessments of

 

'° Ibid., 14.
" Ibid., 17.

177

1/32 of 1% on all FSLIC-insured institutions to add about $1 billion to the insurance
fund. ‘2

This disconnect between the idea of record profits and the phenomenon of
worried regulators can be explained partly by a lag in the numbers. New, risky
investments, such as acquisition, deveIOpment and construction loans, can originally look
quite profitable because they are loaded with up-front fees that associations report as
income. In addition, often the first few years of payments are built into the loan, almost
guaranteeing that it will perform well early. Losses from unwise decisions can take years
to work their way into annual profit figures. In addition, institutions grew dangerously
quickly because they could raise an immense amount of brokered funds. DIDMCA
facilitated this by increasing the limit on deposit insurance, and Dick Pratt encouraged it
by removing the restrictions on the amount of brokered flmds an institution could raise.
Thus, in no time at all, an institution could raise enormous funds, invest those funds in
unsound loans, and appear to be incredibly financially healthy, when it reality, it was
extremely vulnerable.l3

Profits in 1986 proved much lower than in the previous year. In its annual
statistical report, the League tried to justify the industry’s performance:

Although profitable institutions had an exceptionally good year, about 2%

of the institutions that did not make a profit caused a severe drag on the

business’ overall earnings. These institutions, which are administered by

the F HLBB through its Management Consignment Program, lost about $3

billion last year. Without counting the performance of the MCP

institutions, the business’ return on assets would have been 0.35% and

after-tar: net income would have come close to equaling the record $3.92
billion.

 

‘2 Ibid
‘3 Martin Mayer,
‘4 Ibid., 15.

178

While this addressed the 2% of institutions that caused the largest losses, it did little to
explain the other 18% that failed to earn a profit. Obviously something was going wrong
in the industry. The report again discussed the strain on F SLIC resources and expressed
that “By the spring of 1987, Congress was close to taking final action on legislation to
recapitalize the FSLIC.”15
By the end of 1987 record earnings had turned into record losses, caused by poor

investment decisions, plunging oil prices, the bursting of the real-estate bubble in many
regions, and gambling, fraud and mismanagement encouraged by deregulation. The
industry lost $6.8 billion that year, with about 1/3 of all savings institutions suffering
losses. The U.S. League tried to argue that even after restructuring, the S&L industry
was “by and large still hostage to the uncertainties of interest rate movements.” They
claimed the increase in rates in 1987 hurt the industry’s profitability by lowering loan
originations, thereby lowering loan fee income and profits from the sale of assets.
However, this failed to explain why 1/3 of the industry remained unprofitable. Even the
League had to attribute much of the loss to problems associated with deregulation:

Eventually, however, economic forces began to turn against a number of

institutions causing large losses in their loan portfolios. Victimized by a

plunging oil economy, institutions in Texas bore a substantial share of these

losses. In some cases, mismanagement or fiaud accounted for severe

financial difficulties or failures.‘6

Another problem thrifts faced during this time was continuing competition from

commercial banks in the mortgage market. As discussed earlier, banks suffered from

increasing competition in all areas. AS restrictions on interstate banking were relaxed,

banks which had always enjoyed strong positions in their communities faced competition

 

'5 Ibid, 20.
‘5 Ibid. 14-15.

179

from outside their region. U.S. commercial banks also faced competition fiom
international banks and investment banks. Bank profitability buckled under the strain of
this intense rivalry, and the 19803 saw the highest bank failure rate since the Great
Depression. The number of government insured commercial banks fell fi'om 14,512 at
the end of 1984 to 10,514 by the end of 1994. The drop in numbers reflected institutions
taken over by the government, voluntary closures, and mergers with or acquisitions by
other banks. The number of remaining banks also included S&Ls and mutual savings
banks that had converted to commercial bank charters. Given the vulnerable condition of
many commercial banks, competing with S&Ls, which were themselves vulnerable,
represented one of the best options. In fact, several factors gave banks a competitive
edge over S&Ls. For example, banks were not burdened by a portfolio of fixed-rate,
low-yielding loans from the past the way that S&Ls were. Therefore, they could afford
to offer lower loan rates. Furthermore, banks had the benefit of hindsight. They
understood how S&Ls got into earnings trouble and could protect themselves fi'om such
problems by using the newly available adjustable rate mortgages and by selling loans on
the secondary market. Commercial banks represented formidable competition.17

The mounting S&L industry losses continued to take their toll on FSLIC
resources. Despite the $3 billion raised from special premium assessments, F SLIC’s
reserve fimd proved grossly insufficient to handle the rapidly growing number and size of
troubled institutions. In August of 1987, Congress passed the Competitive Equality
Banking Act of 1987, which authorized F SLIC to borrow up to $10.8 billion from the

U.S. Treasury. '8 Initiated by the efforts of Undersecretary of the Treasury George Gould,

 

1: Donald D. Hester. “U.S. Banking in the Last Fifty Years: Growth and Adaptation,” 16-17.
Ibid., 18-19.

180

this plan was intended as a bail-out for S&Ls that would supply F SLIC with extra finds
and provide for the closure of insolvent associations. It represented an earnest effort to
solve the industry’s problems. The S&L industry, however, strongly opposed this deal,
and called on Speaker of the House, Jim Wright (D, TX) to support their case. The
League opposed bailout funds in general and insisted that the approximately $10 billion
of recapitalization being considered was more than enough. Most of the industry
remained healthy, the League argued. The final bill provided $10.8 billion to FSLIC, and
called for 3 years of supervisory forbearance for well-managed S&Ls with weak capital
levels. It also mandated that regulators supervising thrifts in depressed areas use more
lenient guidelines.19 To a large degree, the industry got its way. While the additional
funds were supposed to be used to take action towards troubled thrifts, the regulatory
forbearance stood in the way of accomplishing this. As savings and loan historian David
Mason has argued, “regulatory forbearance was interpreted as a signal for regulators to
‘back of’f.’ It “had the affect of allowing poorly run S&Ls to engage in riskier lending
and grow larger. The result was that when these institutions did finally fail, the cost to
the F SLIC was significantly higher.”20 Another genuine attempt at solving the industry’s
problems had been thwarted by the industry itself, and in fact, the limits placed on
regulators exacerbated the problem and raised the costs of the final resolution.

By 1987, 11% of the S&L industry had fallen into insolvency. The worst
problems occurred in Texas, where 109 institutions were insolvent and accounted for

more than half of the nationwide losses for S&Ls that year. Texas was hit exceptionally

 

'9 L. William Seidman, Full faith and credit : the great S & L debacle and other Washington Sagas (Times
Books, 1993) 194; Glyn Davies, A History of Money: From Ancient Times to the Present Day (University
of Wales Press, 2002); David Mason, 232-233.

2° David Mason, 233-234.

181

hard for a number of reasons. First, the state’s economy was built around the oil industry
and as oil prices plummeted, the whole state economy fell apart. This eventually led to a
collapse of the real estate market, which hurt thrifts directly. In addition, Texas
institutions had engaged in some of the riskiest investments. The state had deregulated
its depository institutions well before the passage of DIDMCA. Texas S&Ls could invest
in just about any venture and they did. Thus, when the local economy collapsed, many
S&Ls became insolvent. In 1988, facing insufficient F SLIC resources and growing
insolvencies, the Board implemented “the Southwest Plan,” an attempt to sell or merge
troubled Texas S&Ls to investors who might return them to profitability by consolidating
costs. However, since liabilities for these troubled institutions were greater than assets, to
convince acquirers to participate, the Board had to throw in huge incentives, such as
loans and guarantees to compensate buyers for losses. The enticement for buying these
thrifts also lay in tax benefits, since buyers could write ofl’ the acquired institutions losses
if the purchase became final before January 1, 1989. This led to a chaotic barrage of
mergers during the final days of 1988. Purchasers played it smart, waiting until the last
minute to get incredibly good deals. For example, Ronald Perleman, the chairman of
Revlon, organized a group that spent $315 million buying 5 thrifts, and received $897
million in tax benefits. The Board arranged for the purchase of 181 S&Ls under the
Southwest Plan, at a cost of $32 billion. The excessive costs of this program gained the
attention of many in Congress and convinced them of the need for a true industry

bailout.21

 

2' David Mason, 234-236; Michael Waldrnan and Staff of Public Citizens’ Congress Watch, Who Robbed
America? A Citizen ’s Guide to the Savings and Loan Scandal (Random House, 1990) 85-90; Paul Zane
Pilzer, Other People ’S Money: The Inside Story of the S&L Mess (Simon and Schuster, 1989) 204-205.

182

By the end of 1988, even though 205 S&Ls had been resolved, about 250
institutions were still insolvent and the largest ones were losing $1 billion per month.
Also, FSLIC’S net worth fell to negative $75 billion by the end of the year.22 By 1989,
the Chairman of FSLIC estimated that 340 S&Ls were insolvent and that 800 institutions
possessed assets worth $400 billion that needed to be sold, merged or liquidated. 23 The
full effects of extremely rapid growth and risky investments were being felt. The
collapse had come, but the Reagan administration had managed to avoid dealing with it.
That would be a task for incoming President George Bush.

In August of 1989, Congress passed the Financial Institution Reform, Recovery
and Enforcement Act of 1989 (F IRREA). The law created the Resolution Trust
Corporation. Funded with $50 billion, the organization was charged with the task of
selling off the assets of insolvent thrifts. The $50 billion was financed off the budget,
through the sale of long term bonds and higher premiums and taxes fi'om the S&L
industry. F IRREA also did away with the FHLBB and F SLIC. The Board was replaced
by the Office of Thrift Supervision, a new agency within the Treasury Department.
Deposit insurance for S&Ls became the responsibility of the FDIC, which created a new
fund called SAIF, the Savings Association Insurance Fund, to administer it. The law also
called for stricter capital requirements for institutions by June of 1991, and more stringent
accounting rules, such as the elimination of goodwill as equity. F IRREA sought to return
S&Ls to their housing focus, and thus required institutions to devote at least 70% of
assets to investments related to residential housing in order to be considered a qualified

thrift lender. The law also created stronger regulations about other investments, calling

 

22 David Mason, 241-243.
23 Glynn Davies, 535-540..

183

for institutions to divest themselves of junk bond holdings and to reduce commercial real
estate investments. State-chartered S&Ls had to limit their activities to those permitted
for federally chartered thrifts, regardless of how lenient state regulations might be.24 The
legislation represented a complete change of philosophy about savings institution
regulation. The faith in free market outcomes had temporarily faltered.

David Mason has described the interesting politics behind this legislation. The
League, he argues, lost most of its power to influence the legislation because the industry,
which had suffered from internal divisions since the mid 19505, became radically divided
in opinion. Weak S&Ls opposed the strict provisions of the bill, while healthy
associations “were tired of opposing efforts to improve the industry,” explains Mason.
The rift between the two was so large that the three largest California institutions even
hired their own lobbyists to help them fight for strict capital and accounting standards.25
The significant power of the League had been nullified by its own implosion.

The conditions for S&Ls had been very harsh for 20 years. Savings and loans had
suffered from flawed and inflexible regulation, high inflation, unfavorable interest rate
fluctuations, mounting competition, and structural economic change that called into
question their reason for existence. Deregulation also proved to be a strain, as it
compelled thrifts to pay market rates of interest, and stretched the skill set of the
industry’s executives by requiring them to invest in areas with which they had little
experience. Even the industry bailout stressed S&Ls by instituting stricter capital
requirements on already unhealthy associations. Survival represented a difficult task.

Many thrifts merged with larger ones or converted to commercial bank charters. One

 

2‘ David Mason, 241-247.
2’ Ibid

184

strategy for survival, described by bank CEO, Anat Bird in 1993, was to become highly
efficient at originating, servicing, and selling mortgage loans. This favored larger
institutions. By the late 19803, the U.S. had developed a national mortgage market, with
Fannie Mae, Ginnie Mae, and Freddie Mac playing the role of financial intermediary
previously carried out by S&Ls. The deposit market too had been nationalized. The
need for a separate and unique S&L industry simply no longer existed. Many S&Ls
chose to convert to bank charters or to merge with larger institutions. Of the 4000 S&Ls
and mutual savings banks that existed in 1985, only 2300 remained in 1993 .26 By March
of 2009, only 301 remained.27

To understand why the S&L industry experienced a collapse of such epic
proportions instead of a gradual phaseout, one must understand the flaws inherent in the
deregulatory program pursued by the Reagan administration. Reagan inherited a sick and
troubled thrifi industry in 1981, ailing fi'om regulations that prohibited healthy investment
diversification and subjected S&Ls to interest rate risk. The high-inflation, high-interest
rate environment of the late 1970s and early 19803 acted as a catalyst, exposing all the
flaws and vulnerabilities created by previous regulation. Something had to be done.
However, the steps taken by the Reagan administration focused more on avoiding a
solution than on crafting one. The emergency relief provisions pursued by the Reagan
administration and the Bank Board during the early 19805 made sense. Their purpose
was to help thrifis through a time of difficult economic conditions. Some of the

regulations issued also made sense, such as allowing S&Ls to write adjustable rate

 

2° Anat Bird, Can S&Ls Survive? The Emerging Recovery, Restructuring & Repositioning of America ’s
S&Ls (Bankers Publishing Company and Probus Publishing Company, 1993).

27 Industry Aggregate Report, March 2009, Office of Thrift Supervision,
ht_tp://files.ots.treas.gov/32110900.flf accessed 6/25/09.

185

mortgages to protect themselves from interest rate fluctuation, and permitting a certain
amormt of careful investment diversification so that a Slump in the housing market did
not cause severe strain for the industry. However, the steps taken by the Reagan
administration went far beyond those ends and ultimately worsened the magnitude of the
industry’s problems exponentially.

The most obvious problem with the legislative and regulatory reform program
was that it allowed distressed S&Ls to continue doing business. The capital assistance
program contained in the Garn-St. Germain Act, and Bank Board regulations lowering
net worth requirements permitted F SLIC to delay taking action on insolvent institutions.
While this might have been good for the budget numbers in the Short run, it created larger
losses in the long run.28 Furthermore, ignoring the problem of troubled institutions had
negative effects on the whole financial industry, argues former FDIC chairman, Bill
Seidman. Insolvent thrifts tended to do economically irrational things to stay alive,
including offering unreasonably high rates of return to attract deposits. Depositors did
not need to worry about how an S&L could afford to pay such high returns because their
money was insured by the federal government. Since the Bank Board removed the limit
on brokered funds and DIDMCA raised deposit insurance to $100,000, attracting huge
capital inflows proved easy to any institution willing to offer higher rates than

competitors. “They posed unfair, and recklessly irresponsible, competition to banks,”

 

2‘ Frederick E. Balderston, Thrifis in Crisis: Structural Transformation of the Savings and Loan Industry
(Ballinger Publishing Company, 1985) 106.

186

Seidman complains. “. . .they helped debase credit standards and destabilized the system
to the point of threatening the collapse of some of its strongest players.”29

Another problem with abrupt and sudden deregulation lay in thrift executives’
lack of experience and savvy in the field of investing. While executives at the largest
thrifts might have had a good command of investment instruments and markets, most
thrift executives did not. They had spent their careers conducting the kind of simple
business mandated by the New Deal regulatory framework: they collected deposits and
wrote home loans. Even before the Garn-St. Germain Act freed S&Ls to invest directly
in almost any business, Pratt’s regulations encouraged thrifts to sell poorly performing
loans by permitting them to spread losses over the life of the loans. For tax purposes,
however, institutions could claim and deduct all of the loss at once, entitling them to
recover tax revenues from previous years.30 This led thrift executives directly to Wall
Street to sell their loans.

Salomon Brothers was the first investment firm to securitize mortgages in 1977.
In their opening mortgage deal, Salomon bought loans fi'om Bank of America and sold
them to regular Salomon investors, such as insurance companies. From this beginning,
the firm created a small mortgage trading department. The department head, Bob Dall,
believed that securitizing mortgage could be an effective means of moving money from
the Rust Belt, where deposits exceeded mortgage demand, to the Sunbelt, where demand

exceeded deposits. The undertaking, however, proved unsuccessfirl at first. In his

memoirs, former Salomon bond trader, Michael Lewis, described the initial lack of

 

29 L. William Seidman, 176. Fabritius and Borges add that stressed S&Ls hurt the reputation of all S&Ls,
which meant consumers demanded higher returns on their deposits. See Fabrituius and Borges, chapter 6.
3° R. Dan Brumbaugh, Jr., Thrifts Under Siege: Restoring Order to American Banking (Ballinger
Publishing Company, 1988) 62.

I87

interest in mortgage securities. “The mortgage market was the financial equivalent of a
ghost town: Nothing moved, nothing traded” In fact, by 1980 many at Salomon Brothers
wanted to close down the unprofitable department.31

All that changed in 1981 when S&Ls were permitted to deduct loan losses to
recover past tax dollars. Suddenly, Salomon Brothers, the only investment firm on Wall
Street to have a mortgage trading department, was buzzing with S&L activity, buying
loans from thrifts and selling them mortgage bonds in return. However, S&L managers
and owners were in way over their heads when it came to conducting business on Wall
Street. They sold their loans for too little and bought bonds for too much. In addition,
many managed institutions on the brink of failure and were thus willing to try gambling
with investments such as junk bonds that they did not fully understand. “Thrift
presidents were desperate.” Lewis explained. “They didn’t know the mentality of the
people they were up against. They didn’t know the value of what they were selling. . .The
only thing the thrift managers knew was how much they wanted to sell.” From 1977-
1986, savings and loans portfolio of mortgage bonds grew from $12.6 billion to $150
billion. “The S&L manager had become America’s biggest bond trader,” argued Lewis.
“He was also America’s worst bond trader. He was the market’s fool.”32 Journalist
Martin Mayer echoes Lewis’ sentiments about the vulnerability of thrift executives when
dealing with Wall Street:

The debilitation of the industry is in large part the result of its contact with a
more intelligent, more sophisticated, more amnesiac, more mechanical, more

 

3' Michael Lewis, Liar ’3 Poker: Rising Through the Wreckage on Wall Street (W .W. Norton & Company,
1989) 86-100.

32 Ibid., 101-114. This point is also made in Steven K. Wilmsen, Silverado: Neil Bush and the Savings &
Loan Scandal, (National Press Books, 1991) 52.

188

predatory form of life. It was like the Indian tribes when white settlers
brought them measles.33
Likewise, when Gam-St.Germain granted S&Ls the power to invest directly,
some thrift managers stretched into fields about which they knew little. They invested in
wild plans that had been prohibited before deregulation, and promised to pay large
returns, including windmill farms, race horses, and pornographic libraries}4 They also
invested in commercial real estate projects, which seemed like a reasonable alternative
since thrifts had experience in real estate. However, the acquisition, development and
construction (ADC) loans S&Ls wrote carried much risk. Institutions often financed
100% of the construction project, allowing the borrower to pay interest only until
completion of construction. At times, the institution financed more than 100% of the
appraised value of the project because they built the first several years of payments into
the loans. On the balance sheets, S&Ls counted these payments as income, even though
they were made directly from loan proceeds. S&Ls carried all the risk, since the
borrower, who was frequently a close fiiend or business associate of the S&L owner,
could walk away hour the project at any time and lose nothing.35
Unfortunately, deposit insurance encouraged these strategies. The government’s
guarantee of deposits allowed troubled, even insolvent institutions, to continue to attract
funds. S&Ls had a blank check when it came to raising capital, and the ability to gamble

with billions of dollars. This was especially true because supervision of institutions

 

33 Martin Mayer, 74.

3‘ L. William Seidman, Full Faith and Credit, 191.

35 Norman Strunk and Fred Case, Where Deregulation Went Wrong: A Look at the Causes Behind Savings
and Loan Failures in the I980s (U .S. League of Savings Institutions, 1988) 75-77. Martin Mayer, 12-13,
277; Michael Waldman 35-40; R. Dan Brumbaugh, Jr., Thrifls Under Siege: Restoring Order to American
Banking (Ballinger Publishing Company, 1988) 153.

189

proved lax. If the S&L lost its bets, it was no worse off, because it had been insolvent
and on the brink of failure anyway. If the S&L won its bets, it might survive. AS former
FHLBB economist R. Dan Brurnbaugh has noted, “An adage that developed in the 19803
was that ‘heads the savings and loans won, tails the FSLIC lost.’”'7“S Former U.S. League
President, Norman Strunk, and former California Savings League economist, Fred Case,
have argued that “excessive growth has long been recognized as one of the best
predictors of financial institution failures. In the long term, it resulted in an “explosion of
problem assets.”37 Growth facilitated by deposit insurance significantly increased the
magnitude of the S&L collapse.

The new industry environment, brought about by radical deregulation and
gambling for resurrection, attracted a different kind of person to the S&L business. He
was no Jimmy Stewart.38 These were gamblers who, under the new capital and net worth
rules, could buy an S&L with a very small cash investment. With little money of their
own on the line, they could then gamble with what amounted to taxpayer funds. This
created even more reckless speculation, and there is convincing evidence that it
contributed heavily to the S&L disaster. For example, of the 72 associations placed in
management consignment between March of 1985 and July of 1987, more than half were
either managed or owned by people who had entered the business during or after 1980.39

The new cast of S&L owners also frequently included builders, land developers, and real-

 

” R. Dan Brumbaugh, Jr., The Collapse of Federally Insured Depositories: The Savings and Loans as
Precursor (Garland Publishing, Inc., 1993) 10.

37 Norman Strunk & Fred Case, 71.

3' In the famous movie, “It’s a Wonderful Life,” actor Jimmy Stewart played George Bailey, the honest,
hard-working owner of Bailey Building and Loan. His thrift was a small, simple one that existed to serve
his local community. It did not make him rich.

’9 Norman Strunk and Fred Case, 89; L. William Seidman, 179; a Dan Brumbaugh, Where Deregulation
Went Wrong 153.

190

estate entrepreneurs, who bought associations in order to make loans to themselves.40
The limitless amount of available funds and lack of restrictions on what could be done
with the money drew in gamblers, speculators, and the dishonest like a bright light
attracts mosquitoes. Former FDIC chairman, William Seidman commented that “As a
lawyer as well as an accountant, if I had been asked to defend these gamblers in court, I
might well have used the defense of entrapment.”41

How much of the industry collapse Should be attributed to fraud or other illegal
activities remains controversial. A small group of criminologists has argued that
“systematic political collusion-mot just policy error- was a critical ingredient in this
unprecedented series of frauds.”42 The combination of increasing deposit insurance and
deregulation opened the door to white-collar crime of an unusual nature. Whereas most
corporate crime victimizes a company’s workers or consumers, S&L crime victimized the
criminals’ own institutions and industry, they have asserted. William Black has referred
to these corrupt S&Ls as control hands. “A control fraud,” he explains, “is a company
run by a criminal who uses it as a weapon and shield to defiaud others and makes it
diflicult to detect and punish the fraud.” He contends that the savings and loan scandal
consisted of a compilation of control frauds that proved severe enough to threaten the
health of the overall economy.‘13 Calavita, Pontell, and Tillman go so far as to argue that
S&L crime fit the definition of organized crime, in that it was “premeditated, organized,

continuous, and facilitated by relationships between its perpetrators and public

 

’0 Norman Strunk and Fred Case, 90.

“ L. William Seidman, 179.

’2 Kitty Calavita, Henry N. Pontell, Robert H. Tillman, Big Money Crime: Fraud and Politics in the
Savings and Loan Crisis (University of California Press, 1997) l.

‘3 William K. Black, The Best Way to Rob a Bank is to Own One (University of Texas Press, 2005) 1.

191

officials.”44 Journalists Stephen Pizzo, Mary Fricker, and Paul Muolo too have argued
that fiaud explained a significant number of S&L failures and that the FBI failed to see
this because they treated each institution separately, instead of looking across thrift
failures for commonalities. “We never once examined a thrift—no matter how random
the choice—— without finding someone there whom we already knew from another failed
S&L,” they explain. Through the course of their examinations they claim to have
uncovered, “mobsters, arms dealers, drug money launderers, and the most amazing and
unlikely cast of wheeler-dealers that ever prowled the halls of financial institutions.”45
In some cases, it proved difficult to differentiate between a desperate thrift
gambling for resurrection and criminal activity. This line became blurred because
regulators allowed such questionable investment practices and accounting standards in
order to avoid pursuing genuine solutions. Furthermore, esteemed professionals, outside
the industry, facilitated and put their stamps of approval on both the speculation and the
fraud. They did so, because they were paid well. Appraisers overvalued property values.
Brokers earned high commissions by sending deposits to unsound institutions and by
selling S&Ls risky, overpriced assets such as junk bonds. Lawyers stopped regulators
from doing what needed to be done. Regulators, who planned to return to the industry
after their stint in regulation, became beholden to the industry and failed to crack down

on institutions when they should have.46 Accountants certified financial records that

 

‘4 Ibid, 83.

‘5 Stephen Pizzo, Mary F ricker, Paul Muolo, The Looting of America 's Savings and Loans (McGraw Hill
Publishers, 1989) 6-10.

‘6 L. William Seidman, 192-3, Lenny Glynn, “Who Really Made the S&L Mess?” in Robert Emmet Long,
editor, Banking Scandals: The S&Ls and BCCI, (The H.W. Wilson Company, 1993) 18.

192

were seething with unacceptable accounting practices.47 Finally, some members of
Congress, as the recipients of S&L largesse, interfered when regulators attempted to do
their jobs. The most famous and obvious example of this was the “Keating 5.”48

The massive sums of money paid by S&Ls to outside professionals and public
officials created a contingency of powerful interests who stood to benefit hour the flawed
system. These people all had a financial stake in preventing the resolution of the thrift
crisis and maintaining the system that attracted gambling and fraud. In discussing
accounting problems at the famous Silverado Savings and Loan in Texas, Steven
Wilmsen commented that “for some reason, delight for objective accounting flew out the
window in the 1980s, to be replaced by delight for money. It was greed, pure and simple.
But the greed didn’t appear out of thin air. It was produced and nurtured by the Reagan
administration’s deregulation.”49

Problems in the industry were also exacerbated by Reagan administration budget
cuts. Just as the S&L industry was suddenly and radically deregulated, and just as an
increasing number of thrifts approached or reached insolvency, budget cuts significantly
reduced bank examination staff and salaries. The Reagan administration, which was
eager to reduce nonmilitary spending, believed that part of deregulation involved cutting

supervision. Between 1980 and 1985, the number of bank examiners per troubled thrift

 

’7 By 1990, the FDIC and RTC had begun lawsuits against 21 accounting firms for fraud and negligence in
an attempt to recover $1.5 billion. See Steven K. Wilmsen, Silverado: Neil Bush and the Savings & Loan
Scandal, (National Press Books, 1991) 173.

48 The Keating 5 was a group of five senators, 4 of them Democrats and 1 Republican: Alan Cranston
(D,CA), Dennis Deconcini (D,AZ), John Glenn (D,CH), John McCain (R,AZ), and Donald Riegle (D,MI).
They all received political contributions fi'om Lincoln Savings and Loan owner, Charles Keating, and were
accused of intervening when the FHLBB attempted to take regulatory action against the S&L. Ultimately, a
Senate Ethics Committee determined that John McCain and John Glenn had only shown poor judgment,
but Cranston, Deconcini, and Riegle had improperly interfered with regulators. The committee officially
reprimanded only Alan Cranston.

’9 Steven K. Wilmsen, 173.

193

fell by 50%. FHLBB chairman, Ed Gray, tried to warn the administration about the
problem, but former FDIC chairman William Seidman recalls that “Stockman had no
patience with warnings that the Federal Home Loan bank Board needed more
supervisors. No matter how many requests were made to him to focus on the troubles of
the S&Ls, he passed the problem down the chain of command, and, as far as I know
never took any interest in it.” Treasury Secretary Donald Regan too balked at Gray’s
pleas for more supervisorss0 In 1984, the average S&L examiner earned $24,775 per
year, while even his or her public sector counterparts in bank examination earned
$30,750-$37,900. These salaries were so low that the government struggled to fill even
the senior positions. Fewer than 700 examiners were charged with supervising about
3500 S&Ls. This proved grossly inadequate. Given the enormous expansion of S&L
investment powers, the development of creative accounting tricks, and the number of
S&Ls in distressed financial condition, the examination staff needed to grow, not shrink.
Furthermore, the system needed sophisticated, well-trained examiners. The paltry
compensation offered would never attract such people, who could earn much more in the
private sector. Many institutions went unexarnined for years, giving S&L owners the
idea that they were immune to regulations, and could get away with anything.’ 1
Ironically, one of the worst problems with the deregulatory campaign of the 19803
was that it did not go far enough. If the Reagan administration and the Bank Board were
determined to radically and abruptly deregulate the S&L indusuy, they could have
finished the job by eliminating or changing the terms of deposit insurance. As Dan

Brumbaugh argues, deposit insurance creates the need for regulation because it eliminates

 

5° L. William Seidman, 181-2; Paul Zane Pilzer, 163.
5' Martin Mayer, 143-145.

194

all forms of market discipline. Savers and brokers do not tend to investigate the
soundness or past results of the institutions in which they deposit their funds when those
funds are backed by the full faith and credit of the U.S. government.52 Thus, institutions
could and did act recklessly with depositors’ funds, without hurting their chances of
attracting new capital in the filture. This appreciably increased the eventual resolution
costs. Another problem with deposit insurance was that the rate charged was equal for all
institutions, whether they invested conservatively or speculatively. This had always been
a problem with deposit insurance and was the reason some people opposed the idea
before its implementation in the 19303. In particular, more conservative eastern bankers
feared that their premiums would have to pay for the excesses of wildcat western
bankers. To a large degree, however, close regulation of financial institutions kept this
from happening.53 After deregulation, sound institutions did indeed find themselves
paying the same as troubled gambling institutions that posed a much greater threat to the
FSLIC firnd.

These fundamentals of deposit insurance were far fi'om abstruse, and clearly the
Reagan administration and the FHLBB were aware of the perverse incentives they
created with the combination of deregulation and deposit insurance. In fact, the Garn-St.
Germain Act required the FHLBB to study deposit insurance and present Congress with a
report of the Board’s recommendations. Eight months later, as Richard Pratt was leaving
his post, he and the Board submitted their Agenda for Reform. It called for reform in six

areas of the deposit insurance system “in order to bring that system into equilibrium and

 

’2 Dan Brumbaugh, Where Deregulation Went Wrong, 6—8; James K. Glassman, “The Great Banks Robbery
in Robert Emmet Long, editor, Banking Scandals: The S&Ls and BCCI, (The H.W. Wilson Company,
1993) 24-26; Ned Eichler, The Thrifl Debacle (Berkeley: University of California Press, 1989) viii.

’3 Paul Zane Pilzer, 3740.

195

control the risk exposure of the Federal Savings and Loan Insurance Corporation (FSLIC)
while maintaining the benefits of deregulation to the public.”54 The suggestions included
a switch to insurance premiums based on risks taken by each institution, rather than the
use of flat premiums based on deposit volumes. Complaining that the deposit insurance
system “bears no rational relationship to risk imposed on the FSLIC by the insured
institution,” the Board explained that risk-based premiums would attempt to reflect
interest rate risk, default risk, and net worth levels. The Board also suggested that some
of the responsibility for insuring deposits be transferred to the private commercial
insurance sector. This would be beneficial, the Board argued, because it would impose
market discipline on S&Ls. Depositors might not concern themselves with their
institution’s soundness, but a private insurer surely would, the Board argued. “Private
insurance Should provide incentives to manage risk through premium pricing and other
forms of competitive pressure.”55
The Pratt Bank Board suggested other reforms to shore up deposit insurance.
They recommended better accounting standards, such as requiring current value
information, so that “depositors, investors, and managers are fully informed about the
financial condition of associations.” This was ironic, coming from Pratt, since just two
years earlier; he had authorized the shift from Generally Accepted Accounting Principles
to Regulatory Accounting Principles. The Board also suggested holding directors and
managers more responsible for “prudent stewardship of the deposits insured by the
FSLIC,” and encouraging institutions to build adequate capital reserves, perhaps through

conversion from mutual to stock organizations. The final area for reform discussed by

 

5’ Agenda for Reform: A report on deposit insurance to the Congress fiom the Federal Home Loan Bank
Board (Federal Home Loan Bank Board, March, 1983) 6.
’5 Ibid., 6-7, 21.

196

the Board involved consolidation of the three deposit insurance funds (FDIC, FSLIC, and
NCUSIF, National Credit Union Share Insurance Fund) into one organization.56

Eight months after the passage of Garn-St. Germain, Pratt and his Bank Board
seemed to be acutely aware of the mismatch between expanded powers of depository
institutions and the deposit insurance system. Furthermore, they spoke of the serious
consequences of such a mismatch. It is difficult to imagine that they were not aware of
this problem when they wrote and lobbied for the legislation. Why then, did they not try
to pass a more comprehensive law that would have broadened S&L powers, while at the
same time adjusting the deposit insurance system? The answer obviously lay in politics.
Congress was unlikely to pass such a profound undoing of New Deal banking regulation.
However, this issue might shed light on the process by which the Garn-St. Germain bill
moved through Congress.

As discussed in chapter 4, the House and Senate versions of the bill differed
Significantly. The Democratic-dominated House sought only to pass emergency
provisions to prevent the collapse of numerous institutions. Though, the House
leadership did want to consider long-term changes such as expanded powers for S&Ls
and further deregulation of interest rate caps, they wanted to take more time, analyzing
these important issues in a separate bill. Once the House leadership chose to separate the
bills, they lost support fi'om the Reagan administration. Recall that Donald Regan
withdrew his willingness to testify before the House banking committee once the two
bills were separated. Why was the bundling of these bills so important to the
administration? The Republican-dominated Senate, on the other hand, chose to bundle

together the emergency provisions with long-term deregulatory change. In the Senate,

 

“mas7

197

Dick Pratt and the Reagan administration had more power to guide the bill’s provisions
because Jake Garn, an administration insider and good fiiend to Dick Pratt, served as
chairman of the banking committee. The Senate passed the full bill, went to conference
with the House, and saw the inclusion of virtually all the Senate bill’s provisions in the
final draft. The House was all but forced to accept the conference report because it was
voted on during the final horns of the session, under a rule that prohibited separate voting
on individual provisions. If the House wanted troubled S&Ls to receive emergency
assistance, it had to also agree to radical deregulation of the industry. Many in the House
favored some sort of deregulation initiative anyway. However, pushing the bill through
in such a hurried manner meant that all the consequences of profound deregulation would
not be considered. One of those consequences was the problem with deposit insurance
discussed by Pratt and the Bank Board eight months later. Once deregulation became a
fate accompli, Pratt could argue that the Situation necessitated privatization and alteration
of the deposit insurance system.

This is not to contend that Pratt and the administration planned this process as a
means to force a specific change in deposit insurance. However, the bundling of
deregulation with emergency provisions, and the timing of the vote, probably made it
Significantly easier to pass a deregulatory bill. It may also have resulted in a greater
degree of deregulation than would have occurred had the bills been considered separately
and in a less hurried manner. In a more thoughtful legislative process, skeptics might
have brought to light some of the logical consequences of an extreme deregulatory bill
and built enough opposition to force a compromise. In the end, if the Reagan

administration was trying to bring about risk-based premiums and privatization of deposit

198

insurance, they did not get what they wanted. Risk-based premiums for deposit insurance
were not implemented until 1992, and insurance privatization still has not occurred.

The deregulatory strategy pursued in the 1980s had other repercussions, such as
economic downturns in specific localities, and perhaps to the U.S. economy overall.
S&Ls encouraged to gamble, lent so much capital to building projects that overbuilding
resulted, especially in commercial real estate. The corresponding drop in real estate
value hurt local and regional economies. Some have argued that the real estate bubble
and burst of the 19803 even contributed to the recession of 1990.57

S&L policy of the 1980s also had implications on the regional balance of
economic and political power in the late 20th century U.S. Because of the dual system
that allowed states to charter savings and loans as well as the federal government, there
had always been differences in S&L regulations. These differences led to meaningful
variations in S&L liabilities and assets that reflected the specific economic conditions in
individual states. For example, as discussed in chapter 2, California S&Ls did business
differently from the rest of the industry because of the huge population influx following
World War H, and the corresponding excessive demand for housing. Texas S&Ls also
operated differently from the rest of the nation because of the unique demands and
outcomes of its oil-based economy. Likewise, the enormous, growth and development of
the Sunbelt states, based largely on post World War 11 federal defense spending, caused

the region’s S&Ls to fare differently from those in the rest of the nation.

 

57 R. Dan Brumbaugh, The Collapse of Federally Insured Depositories,10-11, James K. Glassman, “The
Great Banks Robbery in Robert Emmet Long, editor, Banking Scandals: The S&Ls and BCCI, (The H.W.
Wilson Company, 1993) 32.

199

For example, Texas and California had always regulated their savings and loans
rather liberally. Long before the deregulation of the 1980s, Texas S&Ls could invest in
commercial real estate and consumer loans. California too deregulated before the rest of
the industry. Both states were among the first to allow stock ownership of thrift
institutions, and California was the first state in which both state and federal institutions
could write adjustable rate mortgages. Thus, the deregulation of the 19808, to a large
degree, extended the policies of California and Texas to the rest of the nation?8

After passage of the Garn-St. Germain Act, many states followed suit by
deregulating their state-chartered institutions. This was done out of fear that institutions
desiring expanded asset powers would convert fi'om state to federal charters. Arizona,
Texas, Florida, Ohio, and Maryland were among the states that reacted to federal
deregulation with their own state deregulation. However, no state proved quite as
proactive as California. State law in California permitted state corporations to give
political contributions to candidates running for state office only, not federal office.

Thus, the threat of charter conversion carried more weight in that state. When some of
California’s S&Ls began to convert to federal charters during the late 19708, the state’s
legislature responded with the Nolan Act. Passed in the fall of 1982, this law gave

S&Ls the power to invest in any assets they pleased. When Congress passed the? Garn-St.
Germain Act, state institutions had no incentive to change charters. The dynamics of the
dual charter system created a strange kind of competition between the federal government

and the states as to who could offer more lenient regulation.59

 

5’ Norman Strunk and Fred Case, 46, 56-66.
’9 Norman Strunk and Fred Case, 58-59; Martin Lowy, 52-3.

200

A high percentage of the so-called, “high-flying” S&Ls, those institutions that
grew at an amazing rate and gambled in speculative ventures, were located in the
Southwest, both because of the more lenient state regulations and because of
opportunities offered by the enormous growth of that region. Among the famous ones
were Silverado, a Denver association with Neil Bush serving on its Board, Empire in
Texas, Charles Keating’s Lincoln Savings and Loan in Arizona, and American
Diversified in California. For a while, the fast-growing high flyers looked like models of
excellence. For example, Texas institutions, which had diversified their investments
before others, looked much more profitable than other S&Ls during the hard years of
1979-1982. However, these practices eventually led to the disaster of the late 19805 and
Texas, which appeared to have healthy institutions earlier in the decade, led the nation in
insolvencies by 1988.60

Just as regulations varied by state, so did the degree of financial stress
experienced by S&Ls and the cost of resolving troubled institutions. In 1987, chief Bank
Board economist J arnes Barth, commented that when it came to losses, “Clearly, the
many are being pulled by the few.” In 1987, 20 institutions created a loss to F SLIC of
$2.1 billion. These institutions were all located in Texas and other southwestern states.
They were responsible for 67% of the industry’s losses that year.61 Barth later calculated
that 50% of the cost for the total bailout was attributable to institutions in Texas, while
California, Florida, and Illinois were together responsible for 25%.62 Another analysis of
bailout costs by economist Edward Hill, estimated that the bailout would cost a total of

$150 billion plus interest. Thirteen states, located mainly in the south and southwest,

 

6° M. Manfred Fabrituis and William Borges, 114-120.
6' Ibid., 144.
62 James Barth, 33.

201

emerged net winners, he argued, while 37 states became net losers. While Connecticut
would lose $882 per capita on the bailout, Texas would gain $3510 per capita, he
explained.63 Another study conducted by The Northeast-Midwest Congressional
Coalition, analyzed costs in a slightly different way. The 1988 study compared tax rates
to responsibility for FSLIC losses. Texas paid 6.6% of the nation’s tax bill, yet accounted
for 65% of the S&L bailout costs that year, the study revealed. On the other hand, the 18
states of the northeast and Midwest paid 47% of the country’s taxes and incurred only
10% of FSLIC costs that year. The study’s authors argued that the S&L bailout
represented a transfer of wealth fiom one region to another.‘54 In an entertaining analogy,
they compared the S&L debacle with going to a fancy restaurant with your Texas cousin.
While you order conservatively, he spends extravagantly, and then comes up short when
the bill arrives. Everyone else, of course, gets “stuck with the tab?“ In 1993, another
calculation revealed that half of the failed assets held by the Resolution Trust Corporation
(RTC) were located in Texas and Oklahoma.66

The movement of billions of dollars from the rest of the country to the southwest,
in order to rescue or liquidate failed institutions, transferred income and wealth to the
Sunbelt. J oumalist Martin Mayer, disagrees, calling this assertion “nonsense? States
receiving large bailout funds did not benefit, he argues. They suffered from problems

67

such as real estate market collapse. He is, in fact, correct. However, if one looks

beyond the late 19805 and into the future, the Southwest region clearly reaped great

 

‘3 Lenny Glynn, “Who Really Made the S&L Mess?” in Long, 19.

6’ Keith Laughlin, Mary Weaver, Bob Kelley, Stuck With the Tab: The Regional Implications of the

gavings and Loan Bail-Out (Northeast-Midwest Institute The Center for Regional Policy, 1989) 1.
Ibid.

6”Lenny Glynn inLong, ll.

67 Martin Mayer, 311.

202

rewards from the fate of the S&Ls in its states. In an effort to grow quickly and gamble
for resurrection, many institutions in the southwest offered outrageously high interest
rates and attracted capital from states across the nation. In essence, as Paul Zane Pilzer
has stated, the rest of the country loaned money to the Sunbelt states.68 Institutions
invested this money in all kinds of projects within their region, fi'om malls to windmill
farms. Executives at these associations paid themselves outrageously high salaries. They
spent much of this money in the regional economy. The resulting overbuilding of
commercial and residential real estate did indeed create a real estate bubble that
eventually burst painfully. This, combined with terrible management and fiaud, took
down many of the region’s thrift institutions. However, bailout money paid the tab for
the problem and the effects of the ensuing real estate slump, though serious in the short
term, did not last forever. The positive effect of the infilsion of billions of dollars of
capital into the region would far outlast the negative effects. As Edward Hill argued, “A
more relevant point is that the ‘distressed’ office buildings, malls, and condos the feds are
now trying to sell in the ‘winning’ Sunbelt states will serve for years to come as lures for
companies in other regions to relocate in what amounts to financial fi'ee-fire zones.”69
The argument that a region benefited from growth so rapid that it resulted in a real-estate
bubble that eventually burst is a contentious one. However, it does seem to hold true for
the Sunbelt in the late 19805. For example, Texas, which experienced severe economic
problems in the late 19805, including collapse of its real estate market, bounced back

fairly quickly. The 1989-2001 job growth rate in TX (2.7%) exceeded that of the U.S. as

a whole (1.5%) as did the population growth rate. (2.0% for TX, 1.2% for the U.S. as a

 

6’ Paul Zane Pilzer, 82-83.
6’ Lenny Glyn, 19.

203

whole). This supports Hill’s argument that the Sunbelt emerged fiom the S&L disaster as
an attractive location for businesses.70
In addition, the billions of dollars that moved into the Sunbelt from the end of
World War 11 through the end of the 19805 resulted in millions of dollars in political
contributions just as the New Right began its ascent to political dominance. Savings and
loans indirectly contributed to the ascent through political contributions and regional
economic stimulation. Eastern investors, who enthusiastically sent their funds to high-
flying southwestern S&Ls, and profited enormously from above-market interest rates,
may have unknowingly financed the very region and political party against which they
competed.7l
It is no coincidence that the S&L crisis was particularly severe in the home states
of former Presidents Reagan, Bush, Sr., and Bush, Jr. In the field of banking, economics
and politics are intimately intertwined; banking is, by definition, political. Political
scientist, Susan Hoffman, perhaps puts this best:
What the textbooks do not convey, indeed what they obscure is how
political the banking process is. In their central process of taking in
deposits and making loans, these institutions create and allocate
money. They decide where credit will flow throughout society and

thus what human initiatives will flourish and which will whither.
People, ventures, regions, win and lose."2

 

7° Robert W. Gilmore, “The Face of Texas: Jobs, People, Business, Change” October 2005, Federal
Reserve Bank of Dallas hgp://www.dallasfed.ogglresearch/pubs/fotexas/fotexas gjlmerhtml accessed
6/15/09.

7' In her case study of Orange Cormty, California, Lisa McGirr studied the flourishing of conservative
grass roots political activism that occurred beginning in the 19605. Deregulatory sentiment was strong
there, she explains. Celebration of the free market came easy in Orange County, where the economy
thrived from government military and defense spending. Conservative cultures grew rapidly in other
Sunbelt areas, she argues, that “shared an older regional identity defining itself against northeastern
power.” These areas also tended to have wealthy and skilled populations, and economies benefiting from
defense and military spending. See Lisa McGirr, Suburban Warriors: The Origins of the New American
Right (Princeton University Press, 2001), quote from page 14.

72Susan Hoffman, Politics and Banking: Ideas, Public Policy, and the Creation of Financial Institutions
(The Johns Hopkins University Press, Baltimore, 2001) 2.

204

Political ideology about the relationship between government and business played a
central role in the S&L story. Lenny Glynn emphasizes the need to put the S&L collapse
into the context of “Sunbelt ideology,” which he defines as “pseudo-laissez—faire,
shamelessly combining a drive to get government ‘off the backs’ of business with a huge
appetite for government spending and guarantees. . . It’s party-time ideology, bereft of
accountability.”73 Sunbelt ideology originated in the Goldwater campaign, Glynn
explains, as a purely conservative ideology. However, by the time Reagan became
president, it had been transformed into a program of retaining New Deal programs
officially, while doing away with New Deal restrictions through deregulation. The goal
was to provide business with a “’free market’ with risks guaranteed or underwritten by

the state.”74

That is just what the thrift deregulatory program achieved. It was
appropriate, Glynn argues, that the worst of the crisis occurred in the Southwest, given its
love-hate relationship with the federal government. The region’s political rhetoric
claimed a preference for smaller government, yet, it also clamored for federal spending.”
Thrift deregulation became yet another case of heads private individuals win, tails the
federal government and the taxpayers lose.

The famous story of Charles Keating, owner of Lincoln Savings and Loan,
illustrates almost all of these problems. Charles Keating bought Lincoln Savings and
Loan in 1983, in a deal that never should have been approved by regulators. Keating was
one of the many land developers attracted to the industry because of the ease with which

an S&L owner could raise and invest cash after the deregulatory campaign of 1982. Like

many of the new S&L owners and executives, Keating had a past. In 1979, in connection

 

73 Lenny Glynn in Long, 12.
7“ Ibid.
7‘ Ibid.

205

with his role as officer of American Financial Corporation, the SEC charged Keating and
his law firm with granting improper loans to insiders and failure to report a pattern of
loans to purchasers of assets. The Lincoln pm'chase was approved nonetheless. Keating
promised regulators at the Federal Home Loan Bank Board that he would keep Lincoln’s
top management staff intact and that he would continue the S&L’s tradition of writing
mortgages in poorly served black and Hispanic neighborhoods. However, once the
purchase was approved and complete, Keating immediately broke both these promises.
He then began an enormous expansion of the institution, collecting a vast sum of
brokered deposits by paying extremely high rates of return. He invested these funds, not
in mortgages, but in risky ventures, including his own dabbling in hotels and planned
communities. When many of these investments proved unprofitable, Keating used
various tricks to beef up his income figures, including trading bad loans and properties
with other associations in a scheme commonly referred to as a “daisy chain,” and making
loans to “straw borrowers,” people who never intended to repay the loans.76

Keating was a generous contributor to elected officials of both parties and when
Lincoln came under investigation by the San Francisco Home Loan Bank Board, he
called in his political favors, asking regulators and senators to help him stop the
investigation. In a story that became infamous, five senators, Alan Cranston (D,CA),
Dennis Deconcini (D,AZ), John Glenn (D,Ol-I), John McCain (R,AZ), and Donald Riegle
(D,MI) worked on his behalf. Donald Riegle asked Federal Home Loan Bank Board
Chairman Ed Gray to attend a meeting in Senator DeConcini’s oflice without any staff

accompanying him. At the meeting, the other four senators accused regulators of

 

7‘ Martin Mayer, 165-186. Howard Rudnitsky, “Good Timing, Charlie,” in Robert Emmet Long, editor,
Banking Scandals: The S&Ls and BCCI (The H.W. Wilson Company, 1993) 36. Also see Michael
Binstein and Charles Bowden, Trust Me: Charles Keating and the Missing Billions (Random House, 1993).

206

harassing Charles Keating and asked Gray to suspend the investigation. Keating had
contributed generously to the campaigns of all five senators. Eventually Lincoln Savings
and Loan was resolved by regulators; Charles Keating served 4 ‘/2 years in prison for
fraud, racketeering, and conspiracy before an appeals court overturned his conviction;
and a Senate Ethics Committee determined that McCain and Glenn had shown poor
judgment, and Cranston, Deconcini, and Riegle had improperly interfered with
regulators. The committee officially reprimanded only Alan Cranston.77

The Lincoln case is an extreme example, but it embodied many trends and
practices that occurred in other thrifts: the use of brokered funds to create rapid growth,
creative and even illegal accounting practices, and perhaps most important, the
implication of highly respected professionals. Lincoln’s business practices relied on the
support of appraisers, accountants, lawyers, regulators, senators, and even soon-to-be
Federal Reserve Chairman Alan Greenspan, who wrote a letter to the Federal Home Loan
Bank Board on Keating’s behalf, arguing that Lincoln should be exempt from the board’s
10% limit on direct investments.78 Furthermore, Keating gave generously to the
campaigns of Congressmen in both parties with the single goal of buying political
influence. This is most obvious in the case of Senator Alan Cranston. Keating donated
$850,000 to Cranston’s campaign, mainly through voter registration groups. However, as
political scientist, Dennis Thompson has argued, the policy views of Keating and
Cranston could not have been more dissimilar, “an arch conservative Arizona
businessman devoted to the fiee market and opposed to pornography and abortion teamed

up with one of the leading liberals in the Senate, a former candidate for president who

 

’7 Ibid., 187-203.
7‘ Ibid., 324-325.

207

had called for a nuclear fieeze and higher social spending.”79 The donations were clearly
meant to buy the kind of help that Cranston provided when Lincoln Savings and Loan
came under investigation.

There is no shortage of blame to go around in the S&L story. The New Deal
restructuring of banking created a flawed system that was too rigid to adjust for its flaws
as changing conditions made them obvious and problematic. Thrifts are not to blame for
the trouble they got into while doing exactly what this system asked of them. Once
inflation and rising interest rates made the regulatory flaws obvious, it took entirely too
long to solve the problem. Interest groups representing S&Ls, banks, builders, and
realtors spent years and millions of dollars protecting the status quo because they feared
that change would hurt them. Long after multiple studies had identified the problems;
long after anyone with an elementary understanding of the industry saw the crisis
coming; long after thrifts themselves knew that change was inevitable; these groups
continued to lobby against viable solutions. The eventual result was a solution that cost
everyone in the U.S. exponentially more than a timely resolution would have cost.

The efforts of the Carter administration in passing DIDMCA were admirable.
Had the law been passed ten years earlier, it might have worked. As it was, it deregulated
the liability side more quickly than the asset side. In the high interest rate environment of
the early 19805, this perhaps made the industry’s problems a bit worse, at least until rates
dropped. However, it provided for a firture in which thrifts could compete for deposits
with unregulated investment options such as money market mutual funds. It also

permitted some degree of asset diversification. While it was no panacea, it was a sincere,

 

79 Dennis F. Thompson, “Mediated Corruption: The Case of the Keating Five” The American Political
Science Review, Vol. 87, No. 2 (Jun., 1993) 376.

208

feasible, and sensible beginning, especially considering the difficulty involved in passing
legislation that affected so many influential interest groups.

It is more difficult to find kind words for the Garn-St. Germain Act and the
FHLBB’S deregulatory program of the early 19805. The strategy was created by a
combination of political pragmatism, ideological fervor, and outright greed. Reagan’s
need to please his broad constituency limited the approaches his administration was
willing to take in solving the S&L problem. Also, his administration’s ardent neo-liberal
belief that “government is the problem,” and their ability to convince most of America to
have faith in what they called the free market, sent them down a wild path of extreme
deregulation. However, as David Stockman found out the hard way, the Reagan
administration was not truly devoted to free market outcomes. They adhered precisely to
Lenny Glynn’s Sunbelt ideology. They did not do away with, or even significantly out
most New Deal programs. In the case of savings and loans, they simply deregulated,
allowing and even inviting constituents to gamble and commit fiaud, repaying their debt
to generous campaign contributors. Thus, savings and loan deregulation delayed and
disguised the problem, while benefiting many of Reagan’s Sunbelt supporters, who used
the perverse incentives inherent in deregulation as a means for becoming rich. Reagan
succeeded in his strategy, managing to leave office without having to formulate a genuine
solution to the S&L problem. He left that unpleasant task for his successor, George Bush.
It would take a $50 billion bailout to clean up the mess. With interest and additional
costs, economists estimate the final bill anywhere from $150-$300 billion.

This era represented the beginning of a strong faith in deregulation and a desire to

let the marketplace produce its outcomes unfettered. The Reagan administration

209

displayed a reverence for the market and an embracing of greed not present in America’s
political dialogue since the Great Depression. Though the S&L disaster shook that faith a
bit, it did not break it. The deregulatory impulse continued, across Republican and
Democratic administrations alike. The prosperous 19905 only reinforced the sentiment.
In 1994, the Riegle-Neal Act allowed for the chartering of multi-state bank holding
companies and authorized full interstate bank branching for all states not choosing to
override the legislation. By 1999, Democratic President Bill Clinton gave deregulation
his official blessing, signing the Gramm-Leach Bliley Act. This act undid Glass-
Steagall’s separation of commercial and investment banking, allowing the creation of
financial service conglomerates, institutions that would become “too big to fail.”80

In light of the financial collapse of the fall of 2008, a disaster costing $150-$300
billion does not sound as large as it once did. However, the significance of the savings
and loan story goes far beyond its cost to taxpayers. It calls into question the ability of
American Democracy to effectively legislate, at least with regard to economic issues. It
was part of and reflected a new outlook that normalized speculation, greed, and
gambling. The savings and loan debacle, which took place before the backdrop of a
restructuring U.S. economy, was molded by a series of changes that made the U.S.
economy look more like a casino than like a global industrial power. As the mass
production, mass consumption postwar economy crumbled under the weight of
overproduction in the early 19705, U.S. capitalism might have collapsed as Karl Marx
had predicted. However, the system proved resilient. Capitalists remade it, turning
away from productive capacity and towards a complex game of speculative risk, a game

stacked in favor of the wealthiest Americans. Deregulation became part of that game as

 

‘° Donald D. Hester, “U.S. Banking in the Last Fifty Years,” 19-23.

210

it allowed capitalists to exploit new investment Opportunities the way that they exploited
workers of the past. Today, we are just beginning to discover where this road will take

US.

211

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Phone Interviews:

In the course of my research, I was able to interview two people who took part in
the legislative processes surrounding the Depository Institutions Deregulation and
Monetary Control Act (DIDMCA) and the Garn-St. Germain Act. In studying the
passage of DIDMCA, I read numerous memos between Stu Eizenstat, Carter’s Chief
Domestic Policy Advisor and Orin Kramer, Associate Director of the Domestic Policy
Staff. I wrote letters to both men asking them to speak with me about the legislative path
traveled by DIDMCA and Mr. Kramer responded that he was willing. I interviewed him
by telephone on September 17, 2008. During the course of our interview, Mr. Kramer
recommended that I also contact Robert H. Dugger, past Chief Economist of the Senate
Banking Committee and Senior Staff Member of the House Financial Institutions
Subcommittee. Dr. Dagger also agreed to a phone interview, which took place on
November 21, 2008.

223