The Thrift Crisis and the RTC

The mortgage industry suffered a major setback in 1989, the year of the savings and loan crisis. Billions of dollars in savings were lost, and taxpayers had to foot the bill for the huge bailout that was the result of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). An outgrowth of FIRREA was the Resolution Trust Corp. (RTC), a quasi-public agency that closed 747 thrifts and S&Ls, whose primary activity was mortgage loans, in six years. $90 billion in losses were incurred, and the amount paid for by taxpayers.

FIRREA created new regulations that required thrifts to have more capital to back up deposits; and it also allowed the government to take over the thrifts that did not meet the new requirements. Midsize thrifts were required to hold 70 percent of their portfolios in residential real estate mortgages, and small thrifts were restricted in the size of loans they could make, with the biggest loan possible being 10 percent of capital. FIRREA also opened up the Federal Home Loan Bank to commercial banks, giving them the same access to wholesale funds that were previously available only to thrifts. The legislation changed the S&L landscape forever, and many thrifts did not survive because they were unable to meet the stringent requirements, or unable to compete against larger, commercial banks. While risky ventures and in some cases, fraud were to blame for the failure of thrifts, many still blame the deregulation and FIRREA for making it impossible for thrifts to continue competing. In the midst of the crisis, many observers predicted that S&Ls would cease to exist entirely; and although today that has not happened, there are decidedly fewer of them, primarily among smaller communities. According to the Milken Institute, an independent economic think tank, fraud was a factor in only 10 percent of the S&L failures.

A major factor in their failure, besides new competitive pressures, was the fact that since the 1930s, S&Ls were required to fund their long-term mortgages with short-term deposits. Until the 1980s, long-term rates were higher than short-term rates, so they made a profit; but that situation was turned on its head in the 1980s, and S&Ls almost universally were in the red. New legislation allowed the S&Ls to engage in commercial real estate investments, which brought relief, but only temporarily, until the commercial real estate market suffered declines only a few years later. In 1989, more regulation raised the S&Ls’ capital requirements and caused them to move back towards home lending, purge their portfolios of producing high-yield bonds, and initiated accounting changes that required S&Ls to eliminate goodwill as an asset.

Nearly a trillion dollars of assets were seized from failed S&Ls, and the RTC was brought into being to dispose of them at fire-sale prices—creating opportunities for real estate entrepreneurs, but at the same time, being the spark that ignited the recession of the 1990s.