SKOPJE, Macedonia, Aug. 2 (UPI) -- Asset bubbles -- in stocks, real estate or commodities -- invariably burst and often lead to banking crises. One such calamity struck the United States in 1986-1989, and it is instructive to study the decisive reactions of the administration and Congress alike.
They tackled the ensuing liquidity crunch and the structural flaws exposed by the crisis with tenacity and skill.
The savings and loans association, or the thrift, was a strange banking hybrid, very much akin to the British building society. It was allowed to take deposits but was really merely a mortgage bank.
The Depository Institutions Deregulation and Monetary Control Act of 1980 forced S&Ls to achieve interest rate parity with commercial banks, thus eliminating the interest ceiling on deposits that they had previously enjoyed.
However, the act still limited their activities in commercial and consumer lending and trust services. Thus, these institutions were heavily exposed to the vicissitudes of the residential real estate markets in their respective regions.
Every normal cyclical slump in property values or a regional economic shock -- for example, a plunge in commodity prices -- affected them disproportionately.
Interest rate volatility created a mismatch between the assets of these associations and their liabilities. The negative spread between their cost of funds and the yield of their assets eroded their operating margins.
The 1982 Garn-St. Germain Depository Institutions Act encouraged thrifts to convert from mutual -- i.e., depositor-owned -- associations to stock companies, allowing them to tap the capital markets to enhance their faltering net worth.
But this was too little, too late. The S&Ls became unable to further support the price of real estate by rolling over old credits, refinancing residential equity and underwriting development projects. Endemic corruption and mismanagement exacerbated the problem. The bubble burst.
Hundreds of thousands of depositors scrambled to withdraw their funds and hundreds of S&Ls (out of a total of more than 3,000) became insolvent instantly, unable to pay their depositors. They were besieged by angry -- at times, violent -- clients who feared losing their life savings.
The illiquidity spread like fire. As institutions closed their gates one by one, they left in their wake major financial upheavals, wrecked businesses and homeowners, and devastated communities. At one point, the contagion threatened the stability of the entire banking system.
The Federal Savings and Loans Insurance Corp. -- which insured the S&Ls' deposits -- was no longer able to meet the claims and, effectively, went bankrupt. Though the obligations of the FSLIC were never guaranteed by the Treasury, it was widely perceived to be an arm of the federal government. The public was shocked. The crisis acquired a political dimension.
A hasty $300 billion bail-out package was arranged to inject liquidity into the shrinking system through a special agency, the Federal Housing Finance Board. The supervision of the banks was removed from the Federal Reserve. The role of the Federal Deposit Insurance Corp. was greatly expanded.
Before 1989, S&Ls were insured by the now-defunct FSLIC. The FDIC insured only banks. Congress had to eliminate the FSLIC and place the insurance of thrifts under the FDIC. The FDIC kept the Bank Insurance Fund separate from the Savings Associations Insurance Fund, to limit the ripple effect of the meltdown.
The FDIC is designed to be independent. Its money comes from premiums and the earnings of the two insurance funds, not from Congressional appropriations. Its board of directors has full authority to run the agency and they obey the law, not political masters. The FDIC has a preemptive role. It regulates banks and S&Ls with the aim of avoiding insurance claims by depositors.
When an institution becomes unsound, the FDIC can either shore it up with loans or take it over. If it does the latter, it can run it and then sell it as a going concern, or close it, pay off the depositors and try to collect the loans. At times, the FDIC ends up owning collateral and trying to sell it.
Another outcome of the scandal was the Resolution Trust Corp. Many S&Ls were treated as "special risk" and placed under the jurisdiction of the RTC until August 1992. The RTC operated and sold these institutions -- or paid the depositors and closed them.
A new government corporation (Resolution Fund Corp.) issued federally guaranteed bail-out bonds whose proceeds were used to finance the RTC until 1996.
The Office of Thrift Supervision was also established in 1989 to replace the dismantled Federal Home Loan Board in supervising savings and loans. OTS is a unit within the Treasury Department, but law and custom make it practically an independent agency.
The Federal Housing Finance Board regulates the savings establishments for liquidity. It provides lines of credit from 12 regional Federal Home Loan Banks. Those banks and the thrifts make up the Federal Home Loan Bank System. FHFB gets its funds from the System and is independent of supervision by the executive branch.
Thus a clear, streamlined, and powerful regulatory mechanism was put in place. Previously, banks and savings and loans had abused the confusing overlaps in authority and regulation among numerous government agencies. Not one regulator possessed a full and truthful picture. Following the reforms, it all became clearer: insurance was the FDIC's job, the OTS provided supervision, and liquidity was monitored and imparted by the FHLB.
Healthy thrifts were coaxed and cajoled to purchase less sturdy ones. This weakened their balance sheets considerably and the government reneged on its promise to allow them to amortize the goodwill element of the purchase over 40 years.
Still, there were 2,898 thrifts in 1989. Six years later, there were only 1,612. It now stands below 1,000. The consolidated institutions are bigger, stronger and better capitalized.
Later on, Congress demanded that thrifts obtain a bank charter by 1998. This was not too onerous for most of them. At the height of the crisis, the ratio of their combined equity to combined assets was less than 1 percent. But in 1994 it reached almost 10 percent and has remained there ever since.
This remarkable reversal was as much the result of serendipity as careful planning. Interest rate spreads between short- and long-term rates became highly positive. In a classic arbitrage, savings and loans paid low interest on deposits and invested the money in high-yielding government and corporate bonds. The prolonged equity bull market allowed thrifts to float new stock at high prices.
As the juridical relics of the Great Depression -- chief among them, the Glass-Steagall Act -- were repealed, banks were freed to enter new markets, offer new financial instruments, and spread throughout the U.S. Product and geographical diversification led to enhanced financial health.
The very fact that the surviving S&Ls were poised to exploit these opportunities is a tribute to politicians and regulators alike. This is true even though except for setting the general tone of urgency and resolution, the relative absence of political intervention in the handling of the crisis is notable.
It was managed by the autonomous, able, utterly professional, largely apolitical Federal Reserve. The political class provided the professionals with the tools they needed to do the job. This mode of collaboration may well be the most important lesson of the S&L crisis.
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