The Savings and Loan Disaster — Management's Repudiation of Responsibility
During the 1980's, there were a series of fiascoes in the banking industry, and the industry seemed on the verge of collapse. The author proposes to examine some of the "ethical mistakes" that occurred during this crisis.
A handful of examples are given, but they have the same central theme: a swindler gets control of an S&L, makes a lot of loans to questionable individuals, then the bank goes under. This happened quite a lot. In some instances, it was found that the swindler was doing something patently illegal (making loans to personal acquaintances, taking kickbacks etc.), but in many instances, it was taking extreme risks in an entirely legal manner.
In each case, the FDIC bailed out the individual accountholders, so the cost of the bailout was ultimately borne by taxpayers, through a combination of increased taxes and reduced government services.
The general sentiment was that it was precisely this coverage that made S&Ls so lucrative to individuals who wanted to take on high-risk investments with other people's money - and because most of them operated within the law, there was no personal accountability.
There were also some environmental factors that encouraged risky behavior. For example, rising interest rates meant that banks had long-term loans at low fixed rates while having to pay higher rates to depositors. For the same reason, the value of mortgage-backed securities decreased working capital. Hence, banks were pressed for income, and some felt compelled to take on higher risk.
Generally, the charges leveled against bank management were:
- They allowed expenses to get out of control during a time when the profit spread was narrowing
- They embarked on a wild spree of highly speculative undertakings
- There was a rash of outright white-collar crime: fraud, asset-stripping, and corruption.
Lessons Learned
There is the question of what level of risk is acceptable in business, and at what stakes a risk becomes irresponsible and bad custody of shareholder assets. However, this is something of a balancing act: given the environment, taking on too little risk would have made the bank insolvent. The "skill" in management is finding a happy medium.
In looking at the banks that weathered the crisis, the lesson seems to be that austerity beats audacity. Banks that trimmed back expenses to conserve money weathered the storm better than those who took on riskier investments in order to generate additional revenue to cover the expenses.
There is also the influence of insurance - knowing that there was a government "crutch" to cover the account holders emboldened management in the face of risk. In the worst of cases, the accountholders would be bailed out, and no harm done. However, this ignores the damage done to shareholders, and damage done to the public.