Move over, Charles Keating - causes of the savings and loan scandal

Washington Monthly, May, 1995 by Amy Waldman

In 1979, the storm broke. Paul Volcker, the chairman of the Federal Reserve, "spiked" interest rates--sending them over 20 percent at one point--to control escalating inflation. That year, only seven percent of S&Ls were losing money; only one year later, 85 percent were in the red.

Throughout the seventies, as deposit interest rates rose, the thrifts had been pushing for adjustable rate mortgages, which would allow them to tie home loans to market interest rates. In other words, if a thrift's deposit payments went up, so would its charges on loans.

This was crucial. Thrifts' primary income was the interest they collected on loans. And their primary expense was the interest they paid on deposits. Take yourself as an example. If your housing costs and grocery bills doubled, say, and your income stayed fixed, you would be in trouble.

As interest rates rose, S&Ls saw this situation coming and were in effect begging Congress for a simple and effective way to up their income. Jerry Levy, a politically active Wisconsin thrift executive, repeatedly visited his senator, William Proxmire, to push for adjustable rate mortgages. Proxmire, like most of his colleagues, said no. His reason? "Consumer sentiment was opposed."

So who were these consumers? In the seventies, consumer lobbying had come of age, producing landmark legislation to protect safety and the environment. Besides Ralph Nader, these activists included the Consumers Union, minority groups, and the Gray Panthers, the network of firebrand elderly activists--"Old, Bold and Angry," one headline read--who pressed for fair treatment on issues from hearing aids to housing. Consumer groups had built-in credibility with the press and politicians: They were presumed to speak for the American people. Often, they did.

But not always. These groups believed that if someone were going to pay more to absorb rising interest rates, it should be business, and not consumers--even if it drove businesses into the ground. And so throughout the seventies, consumer groups beat back the industry's effort to charge market interest on loans, objecting to adjustable rate mortages as too confusing and too costly.

Then, in 1980, the same groups launched a campaign to lift the limit on the amount of interest that banks and S&Ls could pay on their federally insured deposits. Small savers--many of them senior citizens--could not meet the minimum investments required for high interest money market accounts, and even many seniors who did have enough money for money market accounts mistrusted them because of their lack of federal insurance. And so the Gray Panthers led the fight to lift the cap, spreading buttons with their slogan--"Savings can be hazardous to your wealth"--far and wide. The Panthers worked the press. They went to Capitol Hill.

They also found unexpected allies in historical opponents: the banks. Banks had long chafed under the deposit interest rate cap because it forced them to pay less deposit interest than thrifts and prevented them from competing with money market accounts. Now they saw a way to capitalize on Congress's soft spot for consumers. Citicorp ran a full-page advertisement in The Washington Post aimed squarely at Congress, with the words, "Give us $100, and we'll give you $75 back," in reference to small savers' inability to keep up with inflation at banks and thrifts.