Financial Markets and Institutions

Ninth Edition, Global Edition

Chapter 26
Web Chapter 26 Savings
Associations and Credit
Unions

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Chapter Preview (1 of 3)
Consumer banking was almost non-existent in the early
1800s. But, in the late 1800s, a new type of institution
opened—the savings and loan association. This is the topic
of chapter 26.

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Chapter Preview (2 of 3)
• We examine the role of savings and loan associations,
mutual savings banks, and credit union, collectively known
as thrift institutions. 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

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Chapter Preview (3 of 3)
– Savings and Loan Bailout: Financial Institution Reform,
Recovery, and Enforcement Act of 1989
– The Savings and Loans Industry Today
– Credit Unions

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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

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Savings and Loan Associations (1 of 3)
• 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

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Savings and Loan Associations (2 of 3)
• 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

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Savings and Loan Associations (3 of 3)
• S&Ls were successful, low-risk businesses for many years
following the changes.
• The next slide shows the distribution of S&L assets in
2015. Note that most of the assets are still held as
mortgages, true to their original intent.

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Figure 26.1 Distribution of Savings and Loan Assets, 2015

Source: http://www2.fdic.gov/qbp/2015mar/all2a.html.

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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.

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Savings and Loans in Trouble: The Thrift
Crisis (1 of 5)
• 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.

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Savings and Loans in Trouble: The Thrift
Crisis (2 of 5)
• 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

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Savings and Loans in Trouble: The Thrift
Crisis (3 of 5)
• 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.

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Savings and Loans in Trouble: The Thrift
Crisis (4 of 5)
• 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.

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Savings and Loans in Trouble: The Thrift
Crisis (5 of 5)
• 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.

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Political Economy of the Savings and
Loan Crisis (1 of 4)
Voter-taxpayers, regulators, and politicians have a moral
hazard problem - the principal-agent problem. This idea can
explain part of the problem during the S&L Crisis.

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Political Economy of the Savings and
Loan Crisis (2 of 4)
• 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

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Political Economy of the Savings and
Loan Crisis (3 of 4)
• 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.

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Political Economy of the Savings and
Loan Crisis (4 of 4)
• 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.

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Charles Keating and the Lincoln S&L
Scandal (1 of 2)
• 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.

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Charles Keating and the Lincoln S&L
Scandal (2 of 2)
• 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.

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Savings and Loan Bailout: Financial Institution
Reform, Recovery, and Enforcement Act of 1989
(1 of 2)

• 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

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Savings and Loan Bailout: Financial Institution
Reform, Recovery, and Enforcement Act of 1989
(2 of 2)

• 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.

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The Savings and Loan Industry Today
(1 of 3)

• 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.

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Figure 26.2 Total Assets of Savings and Loan Associations,
1979–2015

Source: http://www2.fdic.gov/sdi/main.asp.

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Figure 26.3 Number of Savings and Loans in the United
States, 1993–2015

Source: http://www2.fdic.gov/sdi/main.asp.

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The Savings and Loan Industry Today
(2 of 3)

• Consistent with the last slides, as the number of S&Ls has

fallen, the average assets held by the average S&L has
increased throughout the last twenty years (except during
the 2007–2009 Financial Crisis).
• The next slide shows this graphically.

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Figure 26.4 Average Assets per Savings and Loan
Association, 1984–2015

Source: http://www2.fdic.gov/qbp/2015mar/qbpsav.html.

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The Savings and Loan Industry Today
(3 of 3)

• The next three slides show the following:

– Consolidated balance sheet for the S&L industry
– The net income for S&Ls from 1984–2015
– Average ROE for S&Ls from 1993–2015
• 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.

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Table 26.1 Consolidated Balance Sheet for Savings and
Loan Associations ($ billions, fourth quarter, 2015)

Savings and Loan Association

Assets Blank Blank Liabilities Blank

Cash and reserves 78.9 Blank Deposits 840.5

Securities 291.8 Blank Other borrowed funds 89.2
Other loans 14.9 Blank All other liabilities 26.2
Commercial loans 62.9 Blank Equity 118.6
Consumer credit 135.3 Blank Total liabilities and equities 1074.5
All real estate loans 453.7 Blank Blank Blank

Goodwill 6.7 Blank Blank Blank

Miscellaneous 30.3 Blank Blank Blank

Total assets 1074.5 Blank Blank Blank

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Figure 26.5 Net Income of Savings and Loan Associations,
1984–2015

Source: http://www2.fdic.gov/qbp/2015mar/sav2.html.

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Figure 26.6 Average Return on Equity for Savings and Loan
Institutions, 1993–2015

Source: http://www2.fdic.gov/qbp/2013mar/sav1.html.

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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.

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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

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 Table 26.2 Ten Largest U.S. Credit Unions
Previous Current Name Assets City State Year
Year Year Rank ($ billions) Chartered
Rank
1 1 Navy 63.6 Vienna VA 1947
2 2 State Employees 29.5 Raleigh NC 1937
3 3 Pentagon 17.8 Alexandria VA 1935
4 4 Boeing Employees 13.1 Tukwila WA 1935
5 5 Schools First 10.7 Santa Ana CA 1935
6 6 The Golden 1 8.8 Sacramento CA 1933
8 7 Security Service 8.3 San Antonio TX 1956
7 8 Alliant 8.1 Chicago IL 1935
NR 9 First Technology 7.3 Mountain View CA 1970
10 10 Star One 7.2 Sunnyvale CA 1956

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Figure 26.7 Number of Credit Unions, 1933–2015

Source: http://www.ncua.gov/DataApps/Pages/CRSum.aspx.

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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

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Figure 26.8 Share Distribution

Source: http://www.ncua.gov/DataApps/Pages/CRSum.aspx.

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Figure 26.9 Loan Distribution

Source: http://www.ncua.gov/DataApps/Pages/CRSum.aspx.

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Credit Unions: Advantages and
Disadvantages
• Advantages
– Employer support
– Tax advantage
– Strong trade associations
• Disadvantages
– Common bond requirement

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Figure 26.10 Credit Union Membership, 1933–2015

Source: http://www.ncua.gov/DataApps/Pages/CRSum.aspx.

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Figure 26.11 Credit Union Assets, 1993–2015

Source: http://www.ncua.gov/Resources/Reports/statistics/yearend2015.

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Chapter Summary (1 of 4)
• 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

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Chapter Summary (2 of 4)
• 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

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Chapter Summary (3 of 4)
• 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

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Chapter Summary (4 of 4)
• Credit Unions: the history, form, and role of credit unions
was reviewed

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