Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
In corporate finance we studied that companies had an option when it came to compensating their equity shareholders. They could both pay these shareholders cash dividends from the earnings of the current year or alternatively they could conduct a share repurchase program and buy back some shares from the same proceeds. The monetary effect would […]
Municipalities use a wide range of financial instruments in order to borrow funds from the money market. This includes the issuance of short-term debt as well as commercial paper. However, over time they have started using one more type of financial instrument. This instrument is called variable rate demand obligation and is the result of […]
A lot of new-age start-ups are very innovative in their business models. However, a lot of these start-ups also follow the same type of model in a different industry. The aggregator model is a great example of such a start-ups. Companies like Uber and Airbnb can all be called aggregators. Also, there is a dearth […]
In the previous article, we have already discussed what neo banks are. We now know the business model of neo banks. We are also aware of the various characteristic features of neo banks. It is important to note that a significant number of business organizations in Europe have already started migrating their banking needs to […]
Personal finance is defined in such a way that it is supposed to be linked with the financial decisions of an individual or their family. Any decision which is taken at a higher level is not considered to be a part of the personal-finance domain. However, it is important to realize that decisions related to […]
The United States banking industry and the economy in general was rocked by the Savings and Loans crisis in the 1980’s. The savings and loans associations had been an important part of the United States banking system. Hence, when one out of every four savings and loans in the US went under water, the nation panicked.
The common man was concerned about the safety of his savings. As a result of the magnitude of this crisis and the unconventional regulatory approaches followed by the regulators, the President had to intervene. The savings and loan crisis ended up growing so big that at one point it threatened to bankrupt the nation. In this article, we will look at this crisis in a bit more detail.
The savings and loans crisis started with the failure of a few institutions for genuine reasons. Later, however the reasons for the growth and spread of this crisis were completely different. Hence, the reasons that caused the first few institutions to fail can be considered to be the primary causes of the failure. They are as follows
Therefore, these institutions had a mismatch on their balance sheet and started bleeding red ink! The most leveraged savings and loans institutions started collapsing. However, this collapse was thought of as momentary since such high interest had to be a transient phenomenon and could not last forever. Thus as interest rates reset to their normal levels, the savings and loans would be back into profitable business. This early failure of the savings and loans associations was what led to a crisis situation later.
The rising interest rates had knocked a lot of savings and loans out of business. However the regulators let them continue being in business despite the fact that they were technically insolvent. This was because of multiple reasons:
Hence, an era of living dead savings and loans institutions came into existence. These companies were called zombie savings and loans companies. Since these companies had virtually nothing to lose they started taking excessive risks. These were the companies that started offering exorbitant interest rates to depositors. They also made wild investment bets in the market particularly in the commercial real estate sector causing a small real estate crash in the process as well.
The zombies had no incentive to conduct cautious business. They only had two options, one was to be spectacularly successful and become solvent once again or the other was to be a miserable failure and leave the regulators holding the bag in the end.
The zombie savings and loans institutions also created problems for the other members of the industry. The high interest rates that they offered drove business away from other industry members also encouraging them to undertake risky practices. The business scenario being what it was, more risk lead to increasingly large number of defaults and within a short span of time, the entire industry was in the red. Classic cases of massive bankruptcies emerged.
Vernon savings had been voted one of the most profitable institutions in the nation a couple of years back and now more than 96% of the loans it made had defaulted. Another superstar from the savings and loans associations, Lincoln savings ended up wiping more than $3 billion from its market capitalization.
It was now that the regulators had serious bankruptcies on their hands and this time the mess could not be solved by overlooking the problem in the name of regulatory forbearance!
The end of the savings and loans crisis saw significant steps being taken by the President. The first was to capitalize the agencies with tax payer money so that they could pay out the depositors insurance and shut the zombie institutions for good. Also, two of the nation’s largest regulatory bodies were disbanded and powerful bureaucrats became unemployed as newer and stricter regulatory norms were created.
Your email address will not be published. Required fields are marked *