VALUED INSIGHTS

Invaluable Valuation Knowledge for the Real Estate Stakeholder

SERIES:
The Savings and Loan Crisis of the 80s:
A Primer for Navigating Today’s Risk
CHAPTER
  1. Reflections On The S&L Crisis: Lessons From The Valuation Profession
    (Published: June 26, 2024)

  2. Overview Of The Savings & Loan Crisis – A Real Estate Appraiser’s Perspective
    (Available: July 17, 2024)

  3. Deregulation’s Role
    (Available: July 24, 2024)

  4. Interest Rate Volatility
    (Available: July 31, 2024)

  5. Regional Real Estate Impacts of the S&L Crisis
    (Available: August 7, 2024)

  6. Regulatory Failures & Inaction in the S&L Crisis
    (Available: August 14, 2024)

  7. The Resolution Process: Cleaning Up the S&L Wreckage
    (Available: August 21, 2024)

  8. Legislative & Regulatory Reforms After the S&L Debacle
    (Available: August 28, 2024)

  9. Striking Parallels to the 2008 Financial Crisis
    (Available: September 4, 2024)

  10. Corporate Governance Meltdown in the S&L Debacle
    (Available: September 11, 2024)

  11. Conclusion: Safeguarding Valuation Integrity to Prevent the Next Crisis
    (Available: September 28, 2024)

SERIES:
The Savings and Loan Crisis of the 80s:
A Primer for Navigating Today’s Risk
CHAPTER:

Deregulation’s Role

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Author: Reagan Schwarzlose, FRICS | MAI | CRE | CCIM
Published: July 24, 2024

Introduction

For decades prior to the 1980s, the savings and loan (S&L) industry had operated within a tightly regulated environment, its activities narrowly focused on accepting deposits from customers and issuing long-term, fixed-rate mortgages for residential housing. This traditional business model, combined with restrictions on expanding into other lending areas, had allowed S&Ls to thrive as a vital component of the U.S. housing finance system through much of the 20th century. 

However, by the late 1970s, a growing chorus of voices within the S&L sector and its lobbying arms had begun advocating for deregulation. Their argument was that the industry needed greater flexibility to diversify its business activities and revenue streams in order to remain competitive and profitable in the face of changing economic conditions.

Reagan R. Schwarzlose
FRICS I MAI I CRE I CCIM
CEO | Managing Director
+1-480-440-2842 EXT 06

Policymakers proved receptive to these calls, embarking on an aggressive wave of deregulation that would ultimately remove the longstanding barriers separating S&Ls from other areas of lending like commercial real estate, construction financing, and corporate debt investments. While well-intentioned, this sweeping overhaul failed to implement sufficient safeguards and oversight, enabling a rapid expansion by S&Ls into new asset classes they had minimal expertise in evaluating or managing.

From my perspective as a seasoned commercial real estate valuation professional, the consequences of this deregulation were both predictable and devastating.

The Deregulation Wave

The first major piece of legislation that kicked off the deregulation of the S&L industry was the Depository Institutions Deregulation and Monetary Control Act of 1980. This act allowed S&Ls to offer adjustable-rate mortgages, issue 40-year loans, and raise capital through brokered deposits from outside their local markets. While seemingly modest, these provisions marked a departure from the traditional model and opened the door for further deregulation just two years later.

The real game-changer was the Garn-St. Germain Depository Institutions Act of 1982, which delivered on the S&L industry’s calls for expanded powers by allowing thrifts to invest up to 40% of their assets in areas like:

  • Commercial real estate loans
  • Acquisition and development of real property 
  • Corporate debt securities and commercial loans
  • Consumer lending and credit card activities
 

Essentially, this act eliminated the barriers separating S&Ls from commercial banks and opened up a pandora’s box of new lending areas that S&Ls had minimal historical exposure to. The rationale was that this flexibility would allow S&Ls to pursue higher-yielding investments and offset the declining profitability they faced from interest rate volatility. 

However, from an appraiser’s perspective, the glaring oversight in this legislation was the failure to implement modernized capital requirements, enhanced regulatory oversight, or underwriting guardrails as S&Ls rapidly expanded their scope. Longstanding expertise in areas like commercial real estate valuation, lease analysis, and construction risk assessment was sorely lacking.

Lack of Safeguards

Emboldened by their newfound powers, S&Ls wasted little time diversifying into the more lucrative commercial real estate lending space. They poured billions into speculative office, retail, and hotel developments as well as providing acquisition and construction financing for apartment complexes, industrial properties, and other income-producing assets.

However, this overheated expansion into unfamiliar territory was not accompanied by commensurate upgrades to risk management practices, capital buffers, or regulatory oversight from entities like the Federal Home Loan Bank Board (FHLBB). Many S&Ls simply treated these new asset classes as rough equivalents to their traditional mortgage holdings from an underwriting standpoint. 

The consequences of this shortcoming became evident by the mid-1980s as the first major losses began piling up on overleveraged commercial property investments made with inadequate due diligence or market analysis. S&Ls had embraced a herd mentality, blindly following each other into local real estate manias without properly evaluating fundamentals like:

  • Supply/demand imbalances and overbuilding risks
  • Rent growth and vacancy rate projections
  • Appropriate capitalization and discount rates for valuations
  • Tenant credit analysis and re-leasing exposure
  • Construction budgets, timelines, and execution risks

 

As an appraiser, the underwriting failures were staggering – S&Ls simply did not have the institutional knowledge or controls in place to prudently underwrite large, complex commercial properties and development projects. They relied excessively on overly rosy projections from sponsors without independently stress-testing those assumptions.

Moreover, the lack of robust regulatory intervention from the FHLBB enabled this reckless behavior to continue unchecked. The Reagan administration’s deregulatory agenda fostered an environment of “regulatory capture,” where S&L executives wielded undue influence over policymakers to avoid increased capital requirements or lending restrictions.

High-profile scandals like the Lincoln Savings & Loan case exemplified these governance shortcomings. Executives like Charles Keating essentially captured the oversight process through lobbying efforts and political contributions, allowing them to continue risky lending practices that ultimately led to multi-billion dollar losses for taxpayers.

At Lincoln, Keating’s team made a series of speculative investments into risky development projects and junk bonds despite a lack of expertise in those areas. They also grossly inflated asset valuations and funneled funds to Keating’s personal business ventures. However, lax oversight from regulators enabled these activities until it was too late. 

By the time Lincoln was finally seized by regulators in 1989, its failure cost the federal government over $3 billion to resolve – one of the most expensive collapses of the entire S&L crisis. Keating himself was ultimately convicted on 73 counts of fraud, racketeering and other felonies related to his role in looting Lincoln.

The Lincoln scandal highlighted the consequences of deregulation without proper safeguards. S&Ls had been granted significant new powers, but not the capital requirements, regulatory oversight, or institutional controls to manage those expanded activities prudently. This created an environment ripe for excessive risk-taking, speculative investing, and outright fraud and abuse.

Parallels to Modern Deregulation 

While the S&L crisis occurred over three decades ago, the role deregulation played in catalyzing that meltdown offers cautionary parallels to more recent efforts to loosen regulatory oversight of the financial sector. The 2008 global financial crisis and ensuing Great Recession have been widely attributed to excessive deregulation combined with unchecked risk-taking by major banks and investment firms.

In the years preceding that crisis, the repeal of Glass-Steagall legislation combined with a hands-off regulatory approach enabled large institutions to rapidly expand into new product areas like mortgage-backed securities, collateralized debt obligations, and credit default swaps. Much like S&Ls in the 1980s, banks moved into these complex structured products without adequate risk controls, capital buffers, or oversight.

The consequences infected real estate markets globally, with $4 trillion in wealth destroyed from residential property values alone in the U.S. Commercial real estate fared even worse, experiencing value declines of 25-35% from the 2007 peak. Delinquencies on commercial mortgages and construction loans spiked, reaching over 8% by 2010 according to data from the Mortgage Bankers Association.

In the aftermath, the Dodd-Frank Act aimed to implement new safeguards and oversight to prevent a similar crisis from recurring. Capital requirements were enhanced, stress testing mandates implemented, and new resolution mechanisms created to handle the failure of systemically important institutions. 

However, more recent efforts to roll back provisions of Dodd-Frank have reignited concerns about excessive deregulation once again outpacing the industry’s risk management capabilities. A 2018 law exempted dozens of banks from heightened capital and oversight rules, while other proposals have aimed to ease liquidity requirements and stress testing regimes.

From a commercial real estate perspective, any further erosion of regulatory guardrails could prove destabilizing if it enables a return to the types of underwriting lapses and governance shortcomings that characterized the S&L crisis. Maintaining disciplined risk management standards, robust capital cushions, and an adherence to proven valuation methodologies is paramount – even during periods of economic exuberance.

The lessons from the S&L debacle remain highly relevant – any expansion of permissible activities by financial institutions must be accompanied by modernized capital standards, enhanced regulatory oversight with proper insulation from political interference, and a demonstrated ability to prudently manage those new areas through comprehensive risk controls and governance.

Conclusion

The savings and loan crisis of the 1980s will forever be remembered as a textbook example of how deregulation, when implemented without sufficient safeguards and oversight, can catalyze a financial meltdown of catastrophic proportions. By lifting restrictions that had long constrained the S&L industry’s activities, the Garn-St. Germain Act of 1982 opened the floodgates for a rapid overexpansion into new lending areas like commercial real estate and corporate debt.

From my perspective as a real estate valuation professional, the consequences were devastating and entirely predictable. S&Ls lacked the institutional expertise, underwriting standards, and risk management capabilities to safely navigate asset classes like large income-producing properties, speculative construction projects, and corporate credit portfolios. This shortcoming was compounded by a lack of regulatory oversight and governance failures that enabled excessive risk-taking to spiral out of control. 

The hard-learned lessons of that era should serve as a stark reminder to today’s policymakers and industry participants about the importance of implementing proper safeguards whenever expanding permissible activities for financial institutions. Deregulation cannot simply be a blank check for unchecked growth – it must be accompanied by modernized capital requirements, enhanced regulatory oversight insulated from political interference, and a demonstrated ability to manage those new areas through robust risk management and governance frameworks.

As we look ahead, the potential risks of repeating the S&L crisis remain ever-present. Certain sectors are already exhibiting signs of overheated valuations, excessive leverage, and weakening underwriting standards reminiscent of that period. Maintaining a prudent, forward-looking perspective rooted in comprehensive risk analysis and adherence to proven valuation methodologies is essential.

In the next article, we will examine how unprecedented interest rate volatility in the late 1970s and early 1980s further exacerbated the pressures facing the S&L industry. This dynamic, combined with their unchecked expansion into new asset classes, formed a toxic cocktail that precipitated the crisis. As real estate professionals, understanding this critical catalyst is key to navigating future economic cycles.

Sources:

FDIC – History of the Eighties Vol 1

Harvard Law Review – Deregulation and the Roots of the U.S. Financial Crisis 

Federal Reserve History – Savings and Loan Crisis

Journal of Real Estate Research – Lessons from the S&L Crisis

FDIC Banking Review – Origins of the Crisis

Federal Reserve Bank of Atlanta – The Savings and Loan Debacle

The New York Times – The Keating Five Scandal, 25 Years Later

Financial Crisis Inquiry Commission Report

Mortgage Bankers Association – Commercial/Multifamily Delinquencies

Harvard Law Review – Dodd-Frank and the Future of Modern Financial Regulation

Wall Street Journal – Dodd-Frank Rules Rolled Back for Dozens of Banks

Commercial Investment Real Estate Magazine – Lessons from the S&L Crisis