Mortgage Mess Of Today Rivals S&L Crisis of '80s?

The meltdown in the mortgage market and its impact on the credit markets may have some historical precedent: the collapse of the savings and loan industry and its subsequent government bailout in the late 1980s and early 1990s was also a major lending debacle.

The collapse of the S&L industry was the result of flawed deregulation, poor regulation and reckless lending practices, which in some cases, included balance sheet fraud. Political inaction once the severity of the problem was evident didn't help, either.

As part of the bailout, Congress passed legislation creating the Resolution Trust Corporation to liquidate real estate and other assets of failed S&Ls through equity partnerships. Its mission complete, the RTC was dissolved in 1995.

Though the RTC was extremely successful, the federal S&L bailout cost taxpayers an estimated $150 billion. Now some 20 years later, there’s talk of another, similar bailout.

For some perspective on the crises, spoke to Lawrence White, deputy chair of economics at New York University’s Stern School of Business. From 1986 to 1989, White served as a member of the Federal Home Loan Bank Board, which regulated the S&L industry.

Larry White
Larry White

Though the board was dissolved as part of the bailout legislation, the Home Loan Bank System was left intact and remains a key source of low-cost funding to financial institutions for mortgages and other loans — some of which, like Countrywide Financial, are at the center of the mortgage mess.

White, who was also an economist for the US Justice Department and President’s Council of Economic Advisors, later wrote a book about his experiences, "The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation."

Q: How is the current mortgage mess/credit crunch similar to the S&L crisis?

A: The basic similarity is you have a bunch of people making loans that are not going to be repaid. The latest loss in nominal value is beginning to approach the $150 billion (1990 dollars) bailout of the S&L crisis. Part of the S&L debacle was carelessness to which they were making loans. Also, the S&Ls didn’t underwrite carefully. Clearly, carelessness is part of the story here. Investors bought securities based on subprime loans. They didn’t pay attention. They were not careful enough.

Q: What about the regulatory issues?

A: The S&L crisis was all about the safety and soundness of the system. What may be at issue is more consumer protection issues — were lending institutions and others sufficiently informing borrows about what they were lending, such as the teaser rates on mortgages, and satisfying their fiduciary duty. There was also some regulatory laziness for sure.

Q: What’s the major difference?

A: The big difference is that unlike that debacle which was focused on some 1000 depository institutions, where the liability holders, the depositors, were mostly covered the by federal depository insurance, which guaranteed a refund of their deposits. Another difference here is that the costs are clearly much more spread out. In some ways the pain will be less intense for an individual institution but spread more widely. It also makes it harder to determine the depth of the problem.

Another difference is that there is much more public and political sympathy for the borrower this time — unlike the S&L crisis, which was largely commercial borrowing, not residential household borrowing.


Finally, the workout is harder to do when a loan has become part of a package of securities held by various owners and investors. How do you negotiate and how do you get an agreement on the workout?

Q: Is this a case of regulators and others looking the other way?

A: I remember going to a conference in early February of this year and there were guys talking about the teaser rate mortgages and how toxic they could be. Also, in late 2006, early 2007, people were talking about how prices couldn’t keep rising.

Q: And that’s where the vicious circle comes in?

A. That’s right. That’s one of the pluses of President Bush’s proposal to get the Federal Housing Administration to buy some of these loans and get them back into the hands of a single entity then the possibility of the a one-on-one negotiation is likely.

Q: Isn’t that partly what the resolution Trust Corporation did in the S&L bailout.

A: There is some parallel. It was the mechanism for putting the insolvent S&Ls out of their misery and the workout.

The borrower is either going to work with initial lender, the particular S&L, or the RTC, but in that case it would still be dealing with a single entity. The difference here is multiple owners.


Q: Will The FHA proposal be hard to implement?

A: It will take some congressional action. Given part of the problem, the difficulty of doing a workout, I think the idea of having the Federal Housing Administration do this is better than Fannie Mae or Freddie Mac because the FHA is explicitly government.

Q: Is a cut in the fed funds rate partly a Wall Street bailout?

A: To the extent that there is a lowering of the federal funds rate, it’s a bailout out both sides; it makes it easier for borrowers to refinance and also helps out lenders. There’s sympathy for the borrowers, who got in over their heads, although clearly a good number were speculators.

The other half of the problem is the lenders. Now that they have been burned, they are very risk adverse.

Q: The S&L bailout through the RTC seemed to work pretty. How quickly will this problem be solved?

A: The RTC, for the most part, did fairly well and without major accusations of fraud. It took six years. This resolution will be quicker for sure. This one will work quickly. Within one to two years, whatever pain there is will be experienced. What we have to do is deal with the resetting of adjustable rate mortgages. By 2008, most of it will be worked through. By 2009, we’ll all be breathing a sigh of relief.