Synopsis

For three decades following World War II, savings and loan executives thrived by following the simple “3/6/3 rule”—take in deposits at 3 percent interest, make loans at 6 percent interest, and be on the golf course by 3:00 every afternoon. Fluctuating interest rates and government deregulation blew up that business model. During the 1980s, aggressive savings and loan managers advertised high interest rates to attract deposits from all over the country. Most of the new funds were invested not in home loans but in high-yield junk bonds, commercial real estate development projects, and raw (undeveloped) land.

Discussion Questions

1. Explain the phrase “borrowing short and investing long.” Why were savings and loans vulnerable to interest rate risk?
2. What caused banks and thrifts to lose so much money during the late 1970s and early 1980s?
3. Why didn’t financial institutions’ financial statements communicate the full extent of their losses?
4. How did Regulatory Accounting Principles (RAP) help savings and loans hide their insolvency?
5. Define the term “moral hazard.” Explain how reducing the net worth requirement from 5 percent to 3 percent of insured deposits encouraged S&L owners to invest in risky assets.