web chapter 26 savings associations and credit unions
TRANSCRIPT
Web Chapter 26
Savings Associations and
Credit Unions
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Chapter Preview
Consumer banking was almost non-existent in the early 1800s. But, in the late 1800s, a new type of institution opened—the savings and loan association. This is the topic of chapter 25.
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Chapter Preview
• We examine the role of savings and loan associations, mutual savings banks, and credit union, collectively known as thrift institutions. 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
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Chapter Preview (cont.)
─ Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989
─ The Savings and Loans Industry Today─ Credit Unions
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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
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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
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Savings and Loan Associations
• 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
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Savings and Loan Associations
• S&Ls were successful, low-risk businesses for many years following the changes.
• The next slide shows the distribution of S&L assets in 2006. Note that most of the assets are still held as mortgages, true to their original intent.
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Savings and Loan Associations
Figure 26.1 Distribution of Savings and Loan Assets, 2013
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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.
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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.
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Savings and Loans in Trouble: The Thrift Crisis
• 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
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Savings and Loans in Trouble: The Thrift Crisis
• 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.
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Savings and Loans in Trouble: The Thrift Crisis
• 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.
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Savings and Loans in Trouble: The Thrift Crisis
• 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.
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Political Economy of the Savings and Loan Crisis
Voter-taxpayers, regulators, and politicians have a moral hazard problem - the principal-agent problem. This idea can explain part of the problem during the S&L Crisis.
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Political Economy of the Savings and Loan 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
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Political Economy of the Savings and Loan Crisis
• 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.
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Political Economy of the Savings and Loan Crisis
• 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.
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Charles Keating and the Lincoln S&L Scandal
• Charles Keating acquired Lincoln S&L in 1984. Regulators allowed this, despite his being accused of fraud by the SEC.
• Used the S&L to fund his construction firm with loans. Quickly changed Lincoln’s investing, using futures, junk bonds, and land tracks in Arizona.
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Charles Keating and the Lincoln S&L Scandal
• Regulators eventually recommended seizure in 1986, but he fought in vigorously, spending millions in lawyer fees.
• He also made campaign contributions to prominent senators—including John McCain. His tactics worked! By 1987, no examiner went near Lincoln—that is, until it failed in 1989.
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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
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Savings and Loan Bailout: Financial Institution Reform, Recovery, and Enforcement Act of 1989
• The bailout cost taxpayers in the neighborhood of $150 billion.
• The bailout continued to cost depositors as FDIC insurance rates rose.
• FIRREA essentially re-regulated the thrift industry and made it easier for regulators to remove thrift managers.
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The Savings and Loan Industry Today
• Despite the problems of the 1980s, the S&L industry did survive.
• The next two slides show the totals assets and the number of S&Ls in the U.S.
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The Savings and Loan Industry Today
Figure 26.2 Total Assets of Savings and Loan Associations, 1979–2013
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The Savings and Loan Industry Today
Figure 26.3 Number of Savings and Loans in the United States, 1993–2013
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The Savings and Loan Industry Today
• Consistent with the last slides, as the number of S&Ls has fallen, the average assets held by the average S&L has increased throughout the last twenty years (except during the 2007-2009 Financial Crisis).
• The next slide shows this graphically.
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The Savings and Loan Industry Today
Figure 26.4 Average Assets per Savings and Loan Association, 1984–2012
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The Savings and Loan Industry Today
• The next three slides show the following:─ Consolidated balance sheet for the S&L industry─ The net income for S&Ls from 1984-2012─ Average ROE for S&Ls from 1993-2012
• Many economists believe that S&Ls will disappear based on these findings. However, this does not appear to be a rapid trend. We may again see deregulation before all is said and done.
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The Savings and Loan Industry Today
Table 26.1 Consolidated Balance Sheet for Savings and Loan Associations ($ billions, fourth quarter, 2012)
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The Savings and Loan Industry Today
Figure 26.5 Net Income of Savings and Loan Associations, 1984–2012
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The Savings and Loan Industry Today
Figure 26.6 Average Return on Equity for Savings and Loan Institutions, 1993–2013
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Credit Unions
• Idea developed in Germany where 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.
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Credit Unions: Types of Organization
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Credit Unions
Table 26.2 Ten Largest U.S. Credit Unions
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Credit Unions
Figure 26.7 Number of Credit Unions, 1933–2012
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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
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Credit Unions: Share Distribution
Figure 26.8 Share Distribution
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Credit Unions: Type of Loans
Figure 26.9 Loan Distribution
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Credit Unions: Advantages and Disadvantages
• Advantages─ Employer support─ Tax advantage─ Strong trade associations
• Disadvantages─ Common bond requirement
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Credit Unions: Memberships
Figure 26.10 Credit Union Membership, 1933–2012
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Credit Union Assets
Figure 26.11 Credit Union Assets, 1993–2012
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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
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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
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Chapter Summary (cont.)
• 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
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Chapter Summary (cont.)
• Credit Unions: the history, form, and role of credit unions was reviewed