By Randall J. Black*
*CONCLUSION TO AN ARTICLE BEGUN IN VOL. 10, NO. 2
THE SAVINGS AND LOAN CRISIS - WOULD MARKET VALUE ACCOUNTING HAVE PREVENTED THE RED INK?
$500 Billion is a price tag many have placed on the savings and loan cr sis.1 Whenever discussions about market value accounting occur, market value accounting advocates believe the savings and loan crisis and its cost would have been prevented if thrifts had used market value accounting. More specifically, they believe that the use of historical cost accounting, instead of market value accounting, failed to expose the industry's true financial condition. If thrifts had used market value accounting, regulators and investors would have known about the precarious nature of the industry, acted to minimize future losses, and prevented the massive government bailout by the Resolutions Trust Corporation. But, would market value accounting truly have prevented the savings and loan crisis?
Granted, there were problems with the way savings and loans reported the results of operations and financial condition. But there were also other factors that contributed to the failure of the thrift industry. Rising interest rates, the deregulation of the financial services industry, government intervention, and the collapse of the real estate market all contributed to the demise of the thrift industry. Insider abuse also contributed to the industry's failure. The way in which savings and loans reported the impact of these items was only one factor in the crisis. A full understanding of all of the reasons for the savings and loan crisis must be explored before concluding that market value accounting would be better for the banking industry.
What Caused the Crisis?
The root cause of the savings and loan crisis lies in the deregulation and evolution of the financial services industry as the regulated thrift industry struggled to compete against its unregulated competition. In the early 1980s, the interest rate environment surged to extraordinarily high levels. Interest rates in the high teens were not uncommon. In addition, new investment opportunities, mutual fund competition, and the rapid evolution of financial services and products on Wall Street changed the environment thrifts had grown up in.2
Previously, the thrift industry had almost been guaranteed a profit. Interest rates on deposit products were set by regulation, and tax incentives for thrifts that invested in long-term mortgage products protected the industry.
However, competition emerged in the financial services industry as banks, insurance companies, mortgage brokers, brokerage houses, and even international financial players began to offer similar products and compete for the thrift industry's customers. Deregulation of interest rates and lending products eliminated the safe haven in which thrifts had previously operated. Now a customer of a savings and loan could shop for the best prices for the services he or she wanted. If the customers wanted to make an investment in certificates of deposit, they could look at the mutual fund industry. If the customers needed a loan for the purchase of a new home, they could visit one of the mortgage brokers to obtain their mortgage loan without ever entering a savings and loan. Before deregulation, thrifts enjoyed almost a monopoly on many of these items.
The rising interest rate environment and increasing competition affected the industry's ability to obtain funding and to prudently invest those funds it did receive. First, as rates rose, depositors, the lifeblood of the industry's funding source, sought out ever higher returns on their investment. As a result, depositors began to prematurely withdraw the deposits they had invested in their local thrift and reinvest the funds in higher yielding instruments at other competitor savings and loans, or to withdraw the funds from the savings and loan industry entirely. …