chapter 19 savings associations and credit unions

Chapter 19

Savings Associations and Credit Unions

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 19-2

Chapter Preview

• We examine the role of savings and loan associations, mutual savings banks, and credit union, collectively known as thrift institutions. We begin with their history and move into the nature of the industry today. Topics include:

– Mutual Savings Banks

– Savings and Loan Associations

– Savings and Loans in Trouble: The Thrift Crisis

– Political Economy of the Savings and Loan Crisis


Chapter Preview (cont.)

– Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989

– The Savings and Loans Industry Today

– Credit Unions


Mutual Savings Banks

• Depositors are the owners of the firm

• Stock in the bank is not sold or issued, but rather depositors own a share of the bank in proportion to their deposits

• Generally have fewer liabilities than other banks because deposits are ownership, not a liability

• Principal-agent problem still present, but managers tent to be more risk-averse


Savings and Loan Associations

• Created by Congress in 1816 to promote home ownership

• About 12,000 S&Ls in operation by the 1920s

• Regulation was at the state level



• The Great Depression led to the failure of thousands of thrift institutions and the loss of $200 million in personal savings.

• The Federal Home Loan Bank Act of 1932– created the Federal Home Loan Bank Board

• In 1934, the FSLIC was created to insure depositors



• S&Ls were successful, low-risk businesses for many years following the changes.

• The next slide shows the distribution of S&L assets in 2004. Note that most of the assets are still held as mortgages, true to their original intent.


Figure 19.1 Distribution of Savings and Loan Assets, 2004



Savings and Loan Associations vs. Mutual Savings Banks

• Mutual savings banks are concentrated in the northeast, whereas S&Ls are found throughout the country.

• Mutual savings banks insure their deposits with the state or the FDIC. S&Ls may not.

• Mutual savings banks are not as heavily invested in mortgages and have more flexibility in their investing practices.


Savings and Loans in Trouble: The Thrift Crisis

• By 1979, inflation was running at 13.3%, but Reg Q restricted interest on deposits to only 5.5%.

• Further, money market accounts offered depositors market interest rates on their short-term funds.



• Financial deregulation and the permissive 1980s led to several problems:

– Managers lacked expertise in new product lines

– Rapid growth in lending, particularly real estate

– Regulators could not keep pace with the growth

– The moral hazard problem led to excessive risk-taking

– 1981–1982 were particularly bad year for some areas, such as the Texas real estate market



• Rather than close insolvent S&Ls, regulators adopted the policy of regulatory forbearance, essentially sidestepping their responsibility using temporary Band-Aids.

• This policy led to further risk-taking, as insolvent S&Ls had nothing to lose by extreme risk-taking.



• To further the problems, insolvent S&Ls offered higher rates to their depositors to attract new funding.

• This meant that healthy S&Ls had to compete with insolvent S&Ls going for broke. Needless to say, this caused further problems for the industry.



• Competitive Equality in Banking Act of 1987– Allowed the FSLIC to borrow $10.8 billion to cover

depositors’ losses (not nearly enough)

– Directed the FHLBB to continue regulatory forbearance

• Losses in the S&L industry approached $20 billion in 1989 alone. The collapse of the real estate market in the late 1980s only worsened the problem.


Political Economy of the Savings and Loan Crisis

The relationship between voter-taxpayers and the regulators and the politicians creates a particular type of moral hazard problem—the principal-agent problem. This idea can explain part of the problem during the S&L Crisis.



• Regulators and politicians are ultimately agents for voter-taxpayers.

• To act on taxpayers’ behalf, regulators seek to minimize the cost of deposit insurance:– Restrict S&Ls from holding assets that are

too risky

– Require higher bank capital

– Close insolvent S&Ls



• However, regulators have an incentive to “hide” the problem and hope that the situation corrects itself.

• Regulators are also funded through Congressional appropriations, which means that politicians may be able to influence the actions of regulators.



• Further, both Congress and the president passes legislation in the early 1980s that promoted risk-taking and required additional oversight.

• Yet, in years following, Congress refused to fund regulators at a necessary level to monitor S&L activities.


Savings and Loan Bailout: Financial Institution Reform, Recovery, and

Enforcement Act of 1989

• The Bush administration proposed FIRREA to provide adequate funding to close insolvent S&Ls.

• Its major provisions included:– The Office of Thrift Supervision assumed

regulatory responsibility, replacing the FHLBB

– The FDIC assumed replaced the FSLIC

– The RTC was established to sell assets of failed S&Ls


Savings and Loan Bailout: Financial Institution Reform, Recovery, and

Enforcement Act of 1989

• The bailout cost taxpayers in the neighborhood of $150 billion.

• The bailout continued to cost depositors as FDIC insurance rates rose.

• FIRREA essentially re-regulated the thrift industry and made it easier for regulators to remove thrift managers.


The Savings and Loan Industry Today

• Despite the problems of the 1980s, the S&L industry did survive.

• The next two slides show the totals assets and the number of S&Ls in the U.S.


Figure 19.2 Total Assets of Savings and Loan Associations, 1979–2004



Figure 19.3 Number of Savings and Loans in the United States, 1993–2004




• Consistent with the last two slides, as the number of S&Ls has fallen, the average assets held by the average S&L has increased steadily throughout the last twenty years.

• The next slide shows this graphically.


Figure 19.4 Average Assets per Savings and Loan Association, 1984–2004




• The next three slides show the following:– Consolidated balance sheet for the S&L industry

– The net income for S&Ls from 1984-2003

– Average ROE for S&Ls from 1993-2004

• Many economists believe that S&Ls will disappear based on these findings. However, this does not appear to be a rapid trend. We may again see deregulation before all is said and done.


Figure 19.5 Net Income of Savings and Loan Associations, 1984–2003



Figure 19.6 Average Return on Equity for Savings and Loan Institutions, 1993–2004



Credit Unions

• Idea developed in Germany were a group pooled assets to use a collateral for a loan

• The loan proceeds were then loaned to members of the group.

• Default was rare since all the group members knew each other.


Credit Unions: Types of Organization

• Mutual Ownership– Owned by depositors

• Common Bond Membership– Defined field of membership

• Nonprofit, Tax-Exempt Status– Lower service fee

• Regulation and Insurance

• Central Credit Unions– Help with members’

credit needs

– Invest excess funds

– Hold clearing balances

– Provide educational services

• Credit Union Size

• Trade Associations

National Credit Union Administrationhttp://www.ncua.gov

http://www.ncua.gov/


Credit Unions


Figure 19.7 Number of Credit Unions, 1933–2003

Credit Unions


Credit Unions: Types of Accounts

• Regular Share Accounts– Savings accounts

– Receive no interest

– Do receive dividends

• Share Certificates– Compatible to CDs

• Share Draft Accounts– Pay interest

– Write drafts against account


Figure 19.8 Share Distribution

Credit Unions: Share Distribution


Figure 19.9 Loan Distribution

Credit Unions: Type of Loans


Credit Unions: Advantages and Disadvantages

• Advantages– Employer support

– Tax advantage

– Strong trade associations

• Disadvantages– Common bond requirement


Figure 19.10 Credit Union Membership, 1933–2003

Credit Unions: Memberships


Figure 19.11 Credit Union Assets, 1993–2003

Credit Unions: Assets


Chapter Summary

• Mutual Savings Banks: the role of this form of thrift institution represents the first style of saving organization was reviewed

• Savings and Loan Associations: since the Federal Home Loan Bank Act of 1932, this form of savings institution was very successful until the late 1980s


Chapter Summary (cont.)

• Savings and Loans in Trouble: The Thrift Crisis: the reasons behind the crisis, including interest rate volatility, arcane regulations, and increased risk-taking were discussed

• Political Economy of the Savings and Loan Crisis: adding the problem, moral hazard on the part of regulators and politicians added to this costly failure of the S&L industry



• Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989: this sweeping reform called for significant changes in the oversight and insurance of the S&L industry

• The Savings and Loans Industry Today: empirical evidence shows that this industry is shrinking in some respects, possibly suggesting its eventual demise



• Credit Unions: the history, form, and role of credit unions was reviewed

chapter 19 savings associations and credit unions

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