The 1980s and the Savings and Loan Debacle

The widespread bank failures of the 1980s—more than sixteen hundred FDIC-insured banks were closed or received financial assistance between 1980 and 1994—revealed major weaknesses in the federal deposit insurance system. In the 1970s, mounting defense and social welfare costs, rising oil prices, and the collapse of American manufacturing vitality in certain key industries (especially steel and electronics) produced spiraling inflation and a depressed securities market. Securities investments proved central to the economic recovery of the 1980s, as corporations cut costs through mergers, takeovers, and leveraged buyouts. The shifting corporate terrain created new opportunities for high-risk, high-yield investments known as "junk bonds." The managers of the newly deregulated savings and loan (S&L) institutions, eager for better returns, invested heavily in these and other investments—in particular, a booming commercial real estate market. When the real estate bubble burst, followed by a series of insider-trading indictments of Wall Street financiers and revelations of corruption at the highest levels of the S&L industry, hundreds of the S&Ls collapsed. In 1988 the Federal Home Loan Bank Board began the process of selling off the defunct remains of 222 saving and loans. Congress passed sweeping legislation the following year that authorized a massive government bailout and imposed strict new regulatory laws on the S&L industry. The cost of the cleanup to U.S. taxpayers was $132 billion.

In addition to the S&L crisis, the overall trend within the banking industry during the 1980s was toward weaker performance ratios, declining profitability, and a quick increase in loan charge-offs, all of which placed an unusual strain on banks. Seeking stability in increased size, the banking industry responded with a wave of consolidations and mergers. This was possible in large part because Congress relaxed restrictions on branch banking in an effort to give the industry flexibility in its attempts to adjust to the changing economy. Deregulation also made it easier for banks to engage in risky behavior, however, contributing to a steep increase in bank failures when loans and investments went bad in the volatile economic climate. Legislators found themselves torn among the need to deregulate banks, the need to prevent failures, and the need to recapitalize deposit insurance funds, which had suffered a huge loss during the decade. In general, they responded by giving stronger tools to regulators but narrowly circumscribing the discretion of regulators to use those tools.

During the 1990s, the globalization of the banking industry meant that instability abroad would have rapid repercussions in American financial markets; this, along with banks' growing reliance on computer systems, presented uncertain challenges to the stability of domestic banks in the final years of the twentieth century. As the economy boomed in the second half of the decade, however, the performance of the banking industry improved remarkably, and the number of bank failures rapidly declined. Although it was unclear whether the industry had entered a new period of stability or was merely benefiting from the improved economic context, the unsettling rise in bank failures of the 1980s seemed to have been contained.