The Savings and Loan Crisis
Reagan pursued an active policy of deregulation, removing many of the stifling restrictions which were contributing to our businesses' lack of competitiveness. On the whole, this policy was successful, helping to rejuvenate many parts of the economy. Unfortunately, however, deregulation did not stop with businesses which produced goods, but was extended to the financial system as well.
The economy contains means of production, businesses which produce a product or service as a means of making money, and the institutions of capitalism, which make money by managing other people's money. Since the 1930's, the institutions of capitalism had been protected from competition. The rationale for this was that although competition increased efficiency it also led to failure, and failure of the institutions of capitalism would be destabilizing and would shake people's confidence in the economic system. To protect against this danger, the government set the interest rates banking institutions could pay on deposits, as well as designating where those deposits could be invested. Savings and loans were perhaps the most protected of the banking institutions; by law they were only allowed to use their deposits to make home loans.
The banking system, which had remained remarkably stable for years, was undermined by the inflation created by the government's irresponsibility, with savings and loans being especially affected. Most of their money was tied up in long term mortgages which were paying interest rates below the rate of inflation. Because the maximum interest rate the government allowed them to pay depositors was below the rate of inflation as well, they were losing deposits to other types of institutions which could pay higher interest rates.
The president and Congress decided deregulation would help make the savings and loans more profitable. The ceiling on interest rates was lifted for the banking industry as a whole, and the savings and loans were allowed to put money in investments other than home mortgages. Savings and loans were suddenly exposed to a very competitive banking environment.
Historically, savings and loans had been extremely stable; when commercial banks were failing by the hundreds in the depression, savings and loans were comparatively unaffected. Due to this historic stability and the degree to which savings and loans were protected by the government from competition, the government oversight of the operations of savings and loans was much less strict than the government's oversight of commercial banks; the Federal Savings and Loan Insurance Corporation had far fewer tools for policing than did the Federal Deposit Insurance Corporation. Thus when the government deregulated the savings and loans, there was not
an effective oversight body in place. The savings and loans were allowed to operate in the competitive environment of commercial banking without having to satisfy the stringent management requirements the government demanded of commercial banks.
Many savings and loans did quite well in the new competitive environment. On the whole, however, the large majority have faired poorly, due to a combination of factors. Many were unprepared for the harshness of the competition and invested their deposits in junk bonds and high risk ventures. Those in the southwest were hurt by the collapse in energy prices and the regional recession this created. And perhaps most importantly, an amazingly large number of savings and loan directors were using deposits to speculate for their own benefit. Put bluntly, they were stealing money. Clearly, a higher level of oversight was needed. Yet congress was unwilling to take the steps necessary to correct the situation because the savings and loan industry had developed a very powerful lobby.
Here was a perfect example of the effects of activist government and the incentives it gives businesses to apply pressure to the political system. For years there had been no change in the government regulations controlling savings and loans. Consequently, the savings and loan lobby was almost non-existent. There was nothing for which to lobby other than to allow home owners to continue to deduct their mortgage interest payment; this was the only benefit they received from government.
Deregulation drastically changed this situation. Suddenly the savings and loans were free to pursue higher profits in the banking world. Almost overnight, a powerful lobby developed, intent on making sure the government did not retract the benefits which had been granted.
Millions of dollars were directed to congressional campaign funds to head off any movement toward re-regulation. The government's attempts at oversight were also compromised. Dishonest savings and loan directors channeled hundreds of thousands of dollars to congressmen in return for bringing pressure to bear on regulators threatening to shut down their thrifts.
What was happening with the savings and loans was apparent to everyone, yet Congress was unwilling to cut off a bountiful source of donations, and so ignored the situation for years. This allowed more and more savings and loans to fall to competition and corruption. It was only recently that there has been a move to strengthen oversight and crack down on fraud, yet it was too late. Because Congress had unobtrusively raised the deposit insurance offered by the government from $40,000 to $100,000 in the early eighties, the government will now have to reimburse the depositors of the failed thrifts as much as 500 billion dollars. The pockets of Congressmen and Congresswomen were being lined with money which was essentially stolen from the taxpayer, and so they were willing to look the other way while one half trillion dollars was drained from our government.
The 500 billion the government owes from the savings and loan crisis will be added to the 3 trillion dollar debt government has from operating shortfalls. Once again, Keynesian economic policy had fallen short of its promise; Reagan's prediction that the government would be able to grow out of the deficit proved to be untrue. Unfortunately Reagan had not been able to cut the spending of the federal government. The budget continued to increase, much as it had for the previous fifty years. The permanent deficit had worked exactly the way Keynes thought it would; once the habit of spending more than we took in was established, it was inevitable that government spending would rise.
Next: The End of Utopianism