Congress, Regulators, RAP, and the Savings and Loan Debacle

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Legislative and regulatory policies prolonged and eventually heightened the problems of the savings and loan industry. The "Alice in Wonderland" regulatory accounting principles (RAP) used by the regulators contributed to the disaster.

It is estimated that the cost of the savings and loan debacle will cost taxpayers $183 million plus interest. Actions taken by Congress and regulators, as well as regulatory accounting principles (RAP), have been widely cited as major contributing factors for having "misled" and "masked" the speed and extent of the financial deterioration of the thrift industry. A greater understanding of the magnitude and manner in which the actions of Congress and regulators and the use of RAP contributed to the severity of losses suffered by the thrift industry might help those trying to sort out what went wrong.

Although innumerable variables affected the severity of losses suffered by the thrift industry, there were four major legislative and regulatory policy objectives:

1. Enhance both the short-term and long-term economic survival of the thrift industry by reducing the industry's exposure to interest rate risk through asset diversification;

2. "Bide" time for legislative and regulatory efforts to affect an economic recovery by facilitating the avoidance of violations of capital requirements by troubled thrifts which would result in regulatory supervision and/or dissolution ("forbearance");

3. Encourage "leveraged" asset growth through debt financing; and

4. Halt and prevent the massive withdraws of funds by depositors (disintermediation).


Traditionally, the thrift industry included savings and loan associations and mutual saving banks (sometimes credit unions). The principal activity of the thrift industry was to promote home ownership by providing low-cost mortgage financing. Thrifts commonly distinguished from commercial banks as they were regulated by different agencies and were insured by different insurance corporations. In addition, the balance sheet of thrifts contained different assets and liabilities. The thrift industry was regulated by the Federal Home Loan Bank Board (FHLBB) and deposits were insured by the Federal Savings and Loan Insurance Corporation (FSLIC).

Thrifts sought funds from depositors in the form of savings accounts and other short-term liabilities. These funds were then loaned to finance the purchase of residential housing through fixed-rate mortgages (long-term assets). The economic survival of the thrift industry depended upon the return on assets (ROA) being greater than the cost of funds (COF). ROA largely reflected the level of long-term interest rates on fixed rate mortgages which were established years earlier. The COF was the rate of interest paid to depositors on savings and short-term time deposits, which reflected current short-term interest rates.


One of the most far-reaching policy decisions of regulators was the decision to enhance the economic viability of the thrift industry by reducing interest rate risk through asset diversification.

Interest rate risk is the risk that changes in interest rates result in operating losses and/or decreases in the market value of assets. The exposure to interest rate risk for thrifts was twofold. If the short-term COF increased above the ROA, thrifts could do little in the short run to reduce losses, since ROA was tied almost solely to long-term fixed-rate mortgages. Secondly, if interest rates were to increase, the market value of the mortgage portfolio would decrease, since the fixed cash flows represented by mortgages are discounted by the market using a higher discount (interest) rate. In such a scenario, losses would be realized if a thrift were forced to sell a portion of the mortgage portfolio by the need to increase its cash holdings. Compared to banks, thrifts were particularly vulnerable to interest rate risk due to a lack of diversification in both the type and maturity of their assets. …