Savings and Loan Associations

Savings and Loan Associations (also known as S&Ls or Thrifts) are financial institutions that specialize in accepting savings deposits and providing residential mortgage loans. Think of them as the original community-focused banks, born from the idea that a local pool of savings should be used to help local people buy homes. Unlike larger commercial banks that serve a wide range of corporate and consumer needs, S&Ls historically had a much narrower mandate. They were often structured as mutual ownership companies, meaning they were owned by their depositors and borrowers rather than outside stockholders. This structure was designed to align the institution's interests with those of its community. While their role has evolved significantly over time, their story—especially the infamous S&L crisis of the 1980s—offers timeless lessons for every investor about risk, regulation, and the dangers of straying from a simple, proven business model.

For much of the 20th century, running an S&L was considered one of the most stable and straightforward jobs in finance. The business model was so simple it was famously dubbed the “3-6-3 rule”: pay depositors 3% interest, lend that money out for mortgages at 6%, and be on the golf course by 3 PM.

The classic S&L business model thrived in a stable economic environment. They performed a simple but vital function: they borrowed money short-term (through customer deposits that could be withdrawn at any time) and lent it out long-term (through 30-year fixed-rate mortgages). This practice, known as maturity transformation, was the engine of post-World War II suburban expansion in the United States, making the dream of homeownership a reality for millions. For decades, it was a low-risk, predictable business that served its community well.

The sleepy world of S&Ls was turned upside down in the late 1970s and 1980s. A perfect storm of economic shifts and misguided policies led to one of the most significant financial collapses in U.S. history. The key ingredients were:

• Spiraling Interest Rate Risk: Sky-high inflation forced the Federal Reserve to raise interest rates dramatically. S&Ls were now forced to pay double-digit interest rates on new deposits to stop customers from pulling their money out. However, their income was still trickling in from a portfolio of old, low-interest, fixed-rate mortgages. This created a devastating asset-liability mismatch where their costs soared far above their revenues, leading to massive losses.
• Deregulation Gone Wrong: In an attempt to help the struggling industry, the government passed laws like the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982. This deregulation allowed S&Ls to move beyond safe home loans and into riskier ventures like commercial real estate development and junk bonds. Many lacked the expertise to manage these new risks.
• Moral Hazard: Federal deposit insurance, provided by the FSLIC (Federal Savings and Loan Insurance Corporation), guaranteed customer deposits up to a certain limit. This safety net had an unintended consequence: it encouraged failing S&Ls to make massive, speculative bets to try and save themselves—a “heads I win, tails the taxpayer loses” gamble.
• Fraud and Incompetence: With the new rules came new opportunities for fraud and mismanagement. Inexperienced or corrupt executives plunged their institutions into disastrous projects, leading to widespread insolvency.

The result was the failure of over 1,000 S&Ls, costing taxpayers an estimated $124 billion. The government created the Resolution Trust Corporation (RTC) to manage and sell the assets of the failed thrifts, a monumental cleanup operation.

The S&L industry that survived the crisis is a shadow of its former self. Most have either been acquired by banks or have converted to behave more like traditional community banks. The regulatory environment is also vastly different. The Office of Thrift Supervision (OTS) was created to oversee the industry and was later merged into the Office of the Comptroller of the Currency (OCC), placing thrifts under a much tighter watch. Today, the lines between an S&L and a community bank are often blurred, though their primary focus often remains on real estate lending.

For a value investor, the story of the S&Ls is not just a history lesson; it's a goldmine of wisdom. It powerfully illustrates several core principles of sound investing.

• Understand the Business Model: The crisis is a textbook example of what happens when a simple business model is squeezed by external forces (interest rates) and corrupted by poor decisions. It underscores the need to look beyond reported earnings and deeply understand how a company—especially a financial one—makes money and what can make it lose money.
• Stay Within Your Circle of Competence: Many S&L managers who were experts in 30-year mortgages were novices in commercial real estate or junk bonds. They strayed from their circle of competence with catastrophic results. As an investor, the lesson is to avoid investing in businesses whose risks you don't fully comprehend. Financial institutions, with their complex balance sheets, are a classic area where investors can easily get into trouble.
• Management Is Key: The crisis exposed a stark difference between prudent, conservative managers and reckless gamblers. Before investing in any company, a thorough assessment of management's competence, integrity, and rational approach to capital allocation is non-negotiable.
• Crisis Creates Opportunity: The RTC's fire sale of assets created immense opportunities for savvy investors who could analyze and value distressed real estate and loans. This is a recurring theme in markets: the greatest bargains are often found amidst the rubble of a crisis, but only for those who have done their homework and have the cash and courage to act.