1. Chapter 19 Savings Associations and Credit Unions

2. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-2 Chapter Preview Consumer banking was almost non- existent in the early 1800s. Commercial banks were common, but their business was primarily restricted to commercial loans and services. But, in the late 1800s, a new type of institution opened – the savings and loan association. This is the topic of chapter 19.

3. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-3 Chapter Preview We examine the role of savings and loan associations, mutual savings banks, and credit union, collectively known as thrift institutions. We begin with their history and move into the nature of the industry today. Topics include: – Mutual Savings Banks – Savings and Loan Associations – Savings and Loans in Trouble: The Thrift Crisis – Political Economy of the Savings and Loan Crisis

4. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-4 Chapter Preview (cont.) – Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989 – The Savings and Loans Industry Today – Credit Unions

5. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-5 Mutual Savings Banks Depositors are the owners of the firm Stock in the bank is not sold or issued, but rather depositors own a share of the bank in proportion to their deposits Generally have fewer liabilities than other banks because deposits are ownership, not a liability Principal-agent problem still present, but managers tent to be more risk-averse

6. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-6 Savings and Loan Associations Created by Congress in 1816 to promote home ownership About 12,000 S&Ls in operation by the 1920s Regulation was at the state level

7. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-7 Savings and Loan Associations The Great Depression led to the failure of thousands of thrift institutions and the loss of $200 million in personal savings The Federal Home Loan Bank Act of 1932 – created the Federal Home Loan Bank Board In 1934, the FSLIC was created to insure depositors

8. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-8 Savings and Loan Associations S&Ls were successful, low-risk businesses for many years following the changes. The next slide shows the distribution of S&L assets in 2006. Note that most of the assets are still held as mortgages, true to their original intent.

9. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-9 Savings and Loan Associations

10. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-10 Savings and Loan Associations vs. Mutual Savings Banks Mutual savings banks are concentrated in the northeast, whereas S&Ls are found throughout the country. Mutual savings banks insure their deposits with the state or the FDIC. S&Ls may not. Mutual savings banks are not as heavily invested in mortgages and have more flexibility in their investing practices.

11. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-11 Savings and Loans in Trouble: The Thrift Crisis By 1979, inflation was running at 13.3%, but Reg Q restricted interest on deposits to only 5.5%. Further, money market accounts offered depositors market interest rates on their short-term funds.

12. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-12 Savings and Loans in Trouble: The Thrift Crisis Financial deregulation and the permissive 1980s led to several problems: – Managers lacked expertise in new product lines – Rapid growth in lending, particularly real estate – Regulators could not keep pace with the growth – The moral hazard problem led to excessive risk-taking – 1981–1982 were particularly bad year for some areas, such as the Texas real estate market

13. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-13 Savings and Loans in Trouble: The Thrift Crisis Rather than close insolvent S&Ls, regulators adopted the policy of regulatory forbearance, essentially sidestepping their responsibility using temporary Band-Aids. This policy led to further risk-taking, as insolvent S&Ls had nothing to lose by extreme risk-taking.

14. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-14 Savings and Loans in Trouble: The Thrift Crisis To further the problems, insolvent S&Ls offered higher rates to their depositors to attract new funding. This meant that healthy S&Ls had to compete with insolvent S&Ls going for broke. Needless to say, this caused further problems for the industry.

15. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-15 Savings and Loans in Trouble: The Thrift Crisis Competitive Equality in Banking Act of 1987 – Allowed the FSLIC to borrow $10.8 billion to cover depositors’ losses (not nearly enough) – Directed the FHLBB to continue regulatory forbearance Losses in the S&L industry approached $20 billion in 1989 alone. The collapse of the real estate market in the late 1980s only worsened the problem.

16. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-16 Political Economy of the Savings and Loan Crisis The relationship between voter-taxpayers and the regulators and the politicians creates a particular type of moral hazard problem—the principal-agent problem. This idea can explain part of the problem during the S&L Crisis.

17. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-17 Political Economy of the Savings and Loan Crisis Regulators and politicians are ultimately agents for voter-taxpayers. To act on taxpayers’ behalf, regulators seek to minimize the cost of deposit insurance: – Restrict S&Ls from holding assets that are too risky – Require higher bank capital – Close insolvent S&Ls

18. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-18 Political Economy of the Savings and Loan Crisis However, regulators have an incentive to “hide” the problem and hope that the situation corrects itself. Regulators are also funded through Congressional appropriations, which means that politicians may be able to influence the actions of regulators.

19. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-19 Political Economy of the Savings and Loan Crisis Further, both Congress and the president passes legislation in the early 1980s that promoted risk-taking and required additional oversight. Yet, in years following, Congress refused to fund regulators at a necessary level to monitor S&L activities.

20. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-20 Charles Keating and the Lincoln S&L Scandal Charles Keating acquired Lincoln S&L in 1984. Regulators allowed this, despite his being accused of fraud by the SEC. Used the S&L to fund his construction firm with loans. Quickly changed Lincoln’s investing, using futures, junk bonds, and land tracks in Arizona.

21. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-21 Charles Keating and the Lincoln S&L Scandal Regulators eventually recommended seizure in 1986, but he fought in vigorously, spending millions in lawyer fees. He also made campaign contributions to prominent senators – including John McCain. His tactics worked! By 1987, no examiner went near Lincoln – that is, until it failed in 1989.

22. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-22 Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989 The Bush administration proposed FIRREA to provide adequate funding to close insolvent S&Ls. Its major provisions included: – The Office of Thrift Supervision assumed regulatory responsibility, replacing the FHLBB – The FDIC assumed replaced the FSLIC – The RTC was established to sell assets of failed S&Ls

23. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-23 Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989 The bailout cost taxpayers in the neighborhood of $150 billion. The bailout continued to cost depositors as FDIC insurance rates rose. FIRREA essentially re-regulated the thrift industry and made it easier for regulators to remove thrift managers.

24. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-24 The Savings and Loan Industry Today Despite the problems of the 1980s, the S&L industry did survive. The next two slides show the totals assets and the number of S&Ls in the U.S.

25. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-25 The Savings and Loan Industry Today

26. 19-26 The Savings and Loan Industry Today

27. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-27 The Savings and Loan Industry Today Consistent with the last two slides, as the number of S&Ls has fallen, the average assets held by the average S&L has increased steadily throughout the last twenty years. The next slide shows this graphically.

28. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-28 The Savings and Loan Industry Today

29. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-29 The Savings and Loan Industry Today The next three slides show the following: – Consolidated balance sheet for the S&L industry – The net income for S&Ls from 1984-2006 – Average ROE for S&Ls from 1993-2006 Many economists believe that S&Ls will disappear based on these findings. However, this does not appear to be a rapid trend. We may again see deregulation before all is said and done.

30. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-30 The Savings and Loan Industry Today

32. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-32 The Savings and Loan Industry Today

33. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-33 Credit Unions Idea developed in Germany where a group pooled assets to use a collateral for a loan The loan proceeds were then loaned to members of the group. Default was rare since all the group members knew each other.

34. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-34 Credit Unions: Types of Organization Mutual Ownership – Owned by depositors Common Bond Membership – Defined field of membership Nonprofit, Tax-Exempt Status – Lower service fee Regulation and Insurance Central Credit Unions – Help with members’ credit needs – Invest excess funds – Hold clearing balances – Provide educational services Credit Union Size Trade Associations National Credit Union Administration http://www.ncua.gov

35. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-35 Credit Unions

36. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-36 Credit Unions

37. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-37 Credit Unions: Types of Accounts Regular Share Accounts – Savings accounts – Receive no interest – Do receive dividends Share Certificates – Compatible to CDs Share Draft Accounts – Pay interest – Write drafts against account

38. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-38 Credit Unions: Share Distribution

39. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-39 Credit Unions: Type of Loans

40. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-40 Credit Unions: Advantages and Disadvantages Advantages – Employer support – Tax advantage – Strong trade associations Disadvantages – Common bond requirement

41. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-41 Credit Unions: Memberships

42. Credit Unions: Assets

43. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-43 Chapter Summary Mutual Savings Banks: the role of this form of thrift institution represents the first style of saving organization was reviewed Savings and Loan Associations: since the Federal Home Loan Bank Act of 1932, this form of savings institution was very successful until the late 1980s

44. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-44 Chapter Summary (cont.) Savings and Loans in Trouble: The Thrift Crisis: the reasons behind the crisis, including interest rate volatility, arcane regulations, and increased risk-taking were discussed Political Economy of the Savings and Loan Crisis: adding the problem, moral hazard on the part of regulators and politicians added to this costly failure of the S&L industry

45. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-45 Chapter Summary (cont.) Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989: this sweeping reform called for significant changes in the oversight and insurance of the S&L industry The Savings and Loans Industry Today: empirical evidence shows that this industry is shrinking in some respects, possibly suggesting its eventual demise

46. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 19-46 Chapter Summary (cont.) Credit Unions: the history, form, and role of credit unions was reviewed