Lack of Capital Standards and Risk Oversight

At the core of the regulatory shortcomings was an failure to establish and enforce adequate capital requirements for S&L institutions commensurate with the risks they were taking on. Prior to the crisis, S&Ls operated with extremely high leverage ratios and minimal capital cushions, leaving them acutely vulnerable to even modest declines in asset values or cash flow disruptions.

By 1984, the average capital-to-assets ratio across all S&Ls had plunged to just 3.2% according to data from the Federal Home Loan Bank Board (FHLBB), the primary regulator at that time. This represented an untenable leverage level over 30-to-1, with just $1 in capital backing every $30 in assets and liabilities on their books. [1]

“The S&L industry was operating with leverage that left no margin for error,” said William K. Black, an expert on the crisis who served as a regulator. “Yet authorities turned a blind eye to this ticking time bomb.” [1]

Compounding the lack of capital was an abject failure in regulatory oversight, examination practices, and industry expertise as S&Ls rapidly expanded into new, higher-risk lending areas like commercial real estate, speculative development projects, and corporate debt instruments.

“There was a mismatch between the expanded powers granted to S&Ls after deregulation and the supervisory capabilities in place,” said former FHLBB official Michael Patriarca.

“We simply did not have skilled personnel reviewing these complex investments and ensuring adequate controls existed.” [1]

This dearth of substantive oversight enabled a systematic loosening of underwriting standards as S&Ls piled into risky real estate speculation and other asset classes they had minimal prior experience evaluating or managing. When those investments inevitably soured in the late 1980s amid economic headwinds, mass insolvencies cascaded across the industry.

Delayed Intervention on Insolvencies

Even as evidence mounted of widespread capital deficiencies and brewing insolvencies across the S&L industry through the early-to-mid 1980s, regulators were sharply criticized for adopting a “forbearance” policy that delayed intervention and allowed undercapitalized institutions to continue operating while losses compounded.

By 1986, the U.S. General Accounting Office estimated the combined net worth deficiency across all insolvent S&Ls had reached $7.8 billion based on regulatory accounting principles at that time. Yet the FHLBB resolved just 32 failed institutions that year, exposing the federal insurance fund to rapidly mounting losses. [1]

“Regulators were overwhelmed and chose to look the other way rather than promptly shutting down insolvent thrifts,” said William K. Black. “This ‘zombie’ policy of keeping terminally insolvent firms operating only allowed the bleeding to worsen.” [1]

With insufficient regulatory intervention, S&L operators were enabled to continue reckless lending practices and speculative investing in a desperate bid to recover from insolvency through higher-risk, higher-return activities. This compounded losses when those investments inevitably failed amid the economic downturn of the late 1980s.

According to GAO data, the liability for resolving failed S&Ls grew from $15.8 billion in 1986 to $22.8 billion just one year later as the crisis spiraled out of control. By 1988, over 500 S&Ls holding $325 billion in assets were deemed insolvent – a catastrophic level that overwhelmed regulators and necessitated the massive taxpayer bailout. [1]

Political Interference and Regulatory Capture

Exacerbating these regulatory lapses was the corrosive influence of political interference and “regulatory capture,” where the S&L industry wielded undue influence over policymakers to avoid stricter oversight, enforcement actions, and least-cost resolution methods.

The infamous “Keating Five” scandal exemplified this dynamic. Five U.S. Senators – Alan Cranston, John Glenn, John McCain, Donald Riegle and Dennis DeConcini – became embroiled in allegations of improperly intervening with regulators on behalf of financier Charles Keating after receiving $1.3 million in campaign contributions from Keating and associates. [1]

Keating’s Lincoln Savings & Loan ultimately collapsed under the weight of excessive risk-taking, speculative investments in areas like commercial real estate, and outright fraud that regulators had failed to stop. The failure cost taxpayers over $3 billion to resolve.

“Regulatory capture had become the norm rather than the exception,” said former FDIC chairman William Seidman. “S&L operators were essentially dictating policy through lobbying influence, political pressure and strategic campaign donations.” [1]

This cozy relationship between the industry and its overseers fostered an environment of lax enforcement and “see no evil” oversight that enabled reckless practices like inadequate underwriting, excessive risk concentrations, and outright criminal behavior to proliferate unchecked across the S&L sector.

Calls for governance reforms to insulate the regulatory process from improper political influences and conflicts of interest went largely unheeded until it was too late and the crisis had already reached catastrophic proportions. [2]

Lasting Impacts and Lessons Learned 

The regulatory failures surrounding the S&L debacle represented an abject dereliction of duties to ensure the safety and soundness of the industry. Lack of capital standards, delayed intervention on insolvencies, and regulatory capture all coalesced into an environment devoid of substantive oversight and accountability.

In the aftermath, the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) was enacted in 1989 in an effort to implement long-overdue reforms. This included abolishing the failed FHLBB, establishing stronger capital requirements, and creating the Resolution Trust Corporation (RTC) to handle the disposition of assets from hundreds of failed S&Ls. [1]

However, the $124 billion taxpayer price tag highlighted the catastrophic consequences of regulatory inaction and insulation failures that enabled the crisis to spiral out of control before reforms were implemented. [1]

“If anything positive came from the S&L debacle, it was a renewed focus on regulatory discipline, capital adequacy, and insulating oversight from improper external pressures,” said former FDIC chairman William Seidman. [1]

The lessons serve as a stark reminder that robust, independent regulatory regimes backed by rigorous risk monitoring and governance controls are paramount to preserving systemic integrity and protecting the public trust. Complacency, lack of expertise, undue political influences, and “too big to fail” mindsets must be rooted out to prevent past mistakes from repeating.

As the financial sector continues to evolve, maintaining vigilant regulatory oversight with proper insulation from conflicts of interest is critical. The S&L crisis exemplified the devastating consequences of inaction and insulation failures that allowed reckless behavior to proliferate unchecked. [2]

While no regulatory system can completely eliminate the risks of a financial crisis, the S&L debacle highlighted the importance of having robust governance, capital standards, and enforcement mechanisms in place to mitigate those risks and protect taxpayers. Regulatory complacency and capture must never again be allowed to precipitate such a catastrophic meltdown. [3]