The NY Times today has a story that the bail-out plans for the “liar loans” is not going to happen. The 1980s S&L crisis was another crisis created by reckless lending. My ex-wife was a mortgage banker and worked for the RTC for a while. She found lots of bad behavior in the institutions she reorganized or liquidated. This all began some years before when the Jimmy Carter inflation was raging. Fernand St Germain was a Congressman from Rhode Island. I don’t agree with everything in that link but it has this right.
One night in 1980, Representative Fernand St Germain (D-Rhode Island), whose $10,000-to-$20,000-a-year restaurant and bar tab was paid for by the S&L industry’s chief lobbyist, proposed raising federal insurance on S&L savings accounts from $40,000 to $100,000- even though the average size of an S&L account was $6,000. He waited until after midnight, when only eleven representatives were still on the floor of the House; they approved his proposal unanimously. But St Germain was just getting warmed up. In 1982, he cosponsored a bill that removed all controls on what S&Ls could charge for interest and released them from their century-old reliance on home mortgages.
This version is a bit less emotional. The reason why this bill was passed was not just St. Germain’s bar bill. The S&L industry was founded in the Depression to support home ownership. The movie “It’s a Wonderful Life” tells the story of the origins. Here is a law professor’s version of the movie. It makes the same point. The S&L paid 4% interest on savings and the money was loaned at 6% to finance homes. The deposits, as depicted in the movie, were supposed to be long term savings. This worked well until inflation took off in the 1970s. Then we had the consequences of what is called “lending long and borrowing short.”
My medical partner built a new home in 1978. His construction loan had an interest rate of 19%. When the home was finished, the permanent financing had an interest rate of 21%. His neighbors on either side, both professionals, could not qualify for the permanent financing of their homes and both houses went into foreclosure. How did this happen ?
It began with Lyndon Johnson and his decision to fund the Vietnam War at the same time he expanded the welfare state with The Great Society. The pressure on the currency eventually resulted in Richard Nixon taking the country off the gold standard. The effect, as noted in that link was to confound the Keynesians. Maybe gold was not really an archaic relic, after all. Anyway, the result was wild (Not of Weimar magnitude but unique in US history) inflation. This produced huge pressure on interest rates and efforts to take a middle course resulted in “Stagflation” or a combination of inflation and a weak economy.
The effect on S&Ls was disastrous. Regulation Q limited the interest rates that S&Ls could pay depositors. If inflation was 10% and interest rates on deposits was 4%, the depositor was losing 6% per year on his money. I remember this time well. New vehicles appeared for investment. Previously, only banks and major corporations could find higher returns on investments. What happened was a surge in buying of houses, with corresponding inflation of home prices, and of art objects and gold. I put much of my pension plan into second trust deeds on homes in Mission Viejo that paid 20% interest. I had US Trasury bonds that paid 16% interest. The ownership of gold, except for jewelry, had been illegal for US citizens since 1933. Many friends of mine put money into gold coins in Switzerland, even at negative interest rates.
UBS History 1972- In Switzerland new restrictions on bank lending enter into force combined with new negative interest rates of up to 10% per quarter (40% p.a.) on the growth of foreign deposits in Swiss Francs with domestic banks. The restrictions are in force until 1975/1979.
The S&Ls hemorrhaged money. Congress came to their rescue with the St. Germain law. Not only would they be allowed to pay higher interest rates to keep depositors, the FDIC for S&Ls (called FSLIC) would now guarantee deposits to $100,000. The train wreck was now inevitable. It arrived on Reagan’s watch, a timing that has confused many people (some purposely) about the origins. It began with government subsidy and the failure to allow the bad decisions to result in bad outcomes has resulted in more bad decisions.Let’s hope that wiser heads will prevail now. The bailout of the S&Ls guaranteed the “liar loan” crisis we have now. Maybe somebody learned something. I wish I was more optimistic.
Constantly amazed by the breadth of your detailed expositions here. I would only add that ‘inflation’ can be looked at on one hand as nominal price increases for the same goods over time. And on the other as the expansion of credit, or the ability of a borrower to obtain funds based less on the borrowers documented means of repaying said loans, than based on the asset for which the loan was obtained. Or, the liar loans of your scenario. Of course, the whole mess collapses when the asset’s underlying ‘value’ no longer rises, or the borrower is unable to maintain a repayment schedule. Well done.
Started buying gold/silver and mining stocks in 2003. Gold then was 350, and silver was just over 5. Now it’s around 800, and 15, give or take. Several miners have provided nice profits as well. It’s not over by a long shot. I keep on the watch for more entry points after taking profits. But as you point out, it’s mostly just a currency play. The big money will be made when stagflation sets in and the metals disconnect from the financial markets. Now they are too much in sync. Fear and greed will drive gold up and the stock/bond mkts down. At least that’s how it’s gone down historically. I don’t guarantee one bit of that, just aware of the past.
I was researching the same thing when I saw this.. I can not agree more – but I am still going to look for a better source
Construction, when you find a better source, report back. I’m interested too.