A Brief History, the Savings and-Loan Crisis of the 1980s

The last time that short sales (then called short pay) were commonplace in real estate was dur­ing the Savings and Loan Crisis of the late 1980s. During the late 70s and early 80s, the ques­tionable financial decisions of private Savings and Loan Institutions and the financial climate in the United States led to what is now known as the Savings and Loan Crisis.

The competitive environment that existed caused these institutions to pay depositors higher interest rates on their money than they were being paid on the instruments that the institutions owned. This meant that an institution may have to pay a depositor 10% on his deposits when they were only making 5% on money they had lent to borrower’s, This caused the value of these institutions to begin to erode. In order to compete with higher interest money market funds, the S&Ls had to pay even higher interest rates on deposits. This caused many institutions to lend money on high interest, high-risk mortgages that resulted in a tremendous amount of defaults. In an effort to curb inflation, Paul Volcker, then the Chairman of the Federal Reserve ("The Fed"), raised short-term lending rates a number of times beginning in 1979. Inflation was slowed and came down from a peak of 13.5% in 1981 to 3.2% in 1983 and according to government calculations has remained low since. The side effect of reeling in this inflation in the US through interest rate hikes was the recession of the early 1980s that included the highest unemployment levels since the Great Depression of the 1920s and 30s.

When Ronald Reagan was inaugurated in January 1981 approximately 3,300 out of 3,800 S&Ls in the United States were losing money. In late 1981, Congress passed a bill allowing S&Ls to sell the mortgages that they held and use the cash to seek better returns on their invest­ments. The irony of the situation was that these institutions sold their mortgages at discounts to major Wall Street firms. Then once they were packaged into government-backed bonds, they repurchased them.

In August of 1981 the Tax Reform Act of 1981 was enacted and provided a powerful tax incen­tive for individuals to invest in real estate. This created a boom in construction, but as history proved the boom was in reality caused by overbuilding due to speculation and a rush to pur­chase on the part of institutions and individuals.

In September 1981, Federally Insured S&Ls were permitted to issue "income capital certificates" that were purchased by the Federal Savings and Loan Insurance Corporation (FSLIC). This caused explosive growth in the size of S&Ls, while at the same time the Federal Home Loan Bank Board responsible for examining S&Ls, reduced in size by 52% from 1982 to 1985. In this same period many S&Ls were growing at a rate of 100% or more per year. This growth did not however equal profitability. Many of these institutions were still losing money but showing projected incomes and profits to depositors and stock holders.

Beginning in 1983, Edwin Gray, the chairman of the Federal Home Loan Bank Board, began reversing the process of deregulation in an attempt to control the crisis that was evident in ate economy. These efforts were unsuccessful, and in 1985, Home Savings Bank of Cincinnati was the first federally insured institution to fail. Depositors who had more than $100,000 in any single account lost their money. Those that didn't had to wait for payments from the govern­ment. This was only the first failure. Within days, then months, others followed suit. In total, over 1,000 institutions failed in "the largest and costliest venture in public, misfeasance, malfeasance and larceny of all time.'"

By the late 80s the Resolution Trust Corporation (RTC) was formed by the Federal Government to replace the Federal Home Loan Bank Board and manage the asset liquidation of the failed S&Ls. In 1995 the functions of the RTC were transferred to the Federal Deposit Insurance Corporation (FDIC) that remains in place today.

Much of the real estate that was liquidated then in an environment of high unemployment and low consumer confidence was sold for a fraction of its value. This led to continued challenges in the real estate market for a number of years.

History Repeat’s itself, The Mortgage Crisis Today

The main difference between the S&L Crisis and what is now being called the Subprime Lending Crisis (or international mortgage crisis) is that during the S&L crisis institutions and corporations were the principals in the majority of the mortgages that went bad. These defaults caused the Market collapse described above.

In the current subprime lending crisis, the mortgage principals are almost all homeowners and the mortgag­es that are at issue are on residential properties. Similar to the S&L crisis, the market is being affected by both reduced capital availability from lenders and rapid deprecation of property values in many ar­eas. This crisis is further exacerbated by the following issues:

Homeowners purchased much more property than they could actually afford due to the exotic mortgage programs they used as previously explained.

1. Prices in many areas were artificially inflated by the increased buying power of those individuals that previously could not qualify. Artificially because so many of the mort­gages that were issued used introductory or temporary rates that increase and borrowers can no longer afford the payments.
2. New construction was pushed, in many areas, to all time highs. This again caused an artificial inflation of the market due to speculative investors purchasing new construc­tion properties for resale.
3. Many individuals purchased second homes either as investment or as true second homes that again created a false appreciation in the residential market
   
   
   1. In 2004, 36% of all homes were investment or second homes.
   2. In 2005, vacation and investment home sales accounted for almost 4 out of 10 total residential sales. Investment homes accounted for 27.7% of all purchase and vacation homes were 12.2% of all sales.¹⁶
   3. In 2006, second home sales dropped. However they still accounted for 36% of all residential property sold.¹⁷
4. In the rush to invest, many individuals actually purchased more than one property, building inventories of residential property for which there was not a second purchaser.
5. Since late 2006, when issues in the market started becoming apparent, 276 major mortgage lenders have gone out of business.
6. Company closures have significantly decreased the options that homeowners have when purchasing a new or investment home.
7. Many borrowers are defaulting prior to mortgage resets-often times within the first few months after a mortgage is written.
8. In addition to company closures, those lenders that are still in business have reduced their product offering and in many cases eliminated entire categories of loans that were previously driving residential sales.
9. In many areas, distressed homeowners are either selling short or have already gone through the foreclosure process, and these listings are on the marker further depressing property values.

<sub>14. John Kcinnerli Gathrairli, The Cuirure of Cnntera-mcin.. (1-f oughton Mifflin, 1992).
15. httplinarblogl seal rors.org/nivrypeinarinthcncws/2006/04 iscconctlionie_sales_hir anothcrIcrul
16. 1ittp://narblog,1.reaItors.org/myrypeinarintlicpews/2006104/Nccondhome_salcs_hit_anothedirrul
17. http ://www.reaItor.orgipress_roominovs_releascs/2007/1)11.si.:apr07_vacation_liamc_sales_ri.m2.html
18. http://ml-implode.coinf
19. http-lim I-im p lodc.comi</sub>