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ESSAYS ON ISSUES

DECEMBER 1990
NUMBER 40

THE FEDERAL RESERVE BANK
OF CHICAGO

Chicago Fed Letter
T he incredible shrinking
S&L industry
The savings and loan debacle has
important repercussions for many
parties. Among these is the savings
and loan association (S&L) industry
itself, which is shrinking rapidly as a
major financial player. For most of
the post-World War II period, savings
and loans were the great success story
among financial institutions in the
U.S. The assets of the industry grew
rapidly, not only in absolute dollar
terms, but also relative to most other
major types of financial institutions.
The market share of S&L assets in­
creased steadily from 6% of the assets
of 11 major types of financial institu­
tions in 1950, to 12% in 1960, to 14%
in 1970, and to 15% in 1980 (see
Table 1). In contrast, the market
share of commercial bank assets de­
clined from 52% in 1950 to 37% in
1980, of life insurance companies
from 22% to 12%, and of mutual
savings banks from 8% to 4%. Only
pension funds among the larger types
of institutions had increased their
market share more rapidly in this
period. S&Ls grew from the fourth
largest type of institution in 1950 to
the second largest in 1980, behind
only commercial banks.

S&Ls lost money in 1982, and when
measuring their assets and liabilities
on a market-value basis, some twothirds of the associations were insol­
vent. Although interest rates de­
clined sharply in the mid-1980s, many
S&Ls continued to lose money be­
cause of bad loans, excessive operat­
ing costs, including very high rates on
deposits, and fraud. Furthermore,
S&Ls incurred a sharp increase in
deposit insurance premiums—from
.08% to .21%—which also increased
operating costs significantly. Never­
theless, through 1988 they increased
their market share relative to com­
mercial banks and to life insurance
companies, which were the third
largest type of financial institution.
MS

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.

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■

' '

'

•

This scenario changed abruptly after
1988. First, regulators adopted a
tougher attitude, particularly with
respect to permitting insolvent asso­
ciations to remain in operation and
to expand rapidly. Second, in 1989
Congress enacted the Financial Insti­
tutions Reform, Recovery and En­
forcement Act (FIRREA). The act
accelerated the resolution of insol­
vent associations by providing greatly
increased funds to the FDIC, so that
it could make up the shortfall be­
tween the value of the institutions’
assets and the guaranteed par value
of their deposits. The resolution of
these insolvent associations resulted
in lower deposit growth, as the exces­
sive interest paid by many of the asso■ '

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■

1. M arket share changes for financial interm ediaries

Interm ediary

Assets 1990a
(billions
of dollars)

Commercial banks
Life insurance companies

■ lillliil

% of total interm ediary assets3
1950
1960
1970
1980
1990

3,279

52

38

38

37

32

1,378

22

20

15

12

13

Private pension funds

1,194

2

6

9

12

12

S&Ls

1,159

6

12

14

15

11

State & local pension funds

753

2

3

5

5

7

M utual funds

588

1

3

4

2

6

Finance companies

539

3

5

5

5

5

Shrinking shares and numbers for
S&Ls . . .

Casualty insurance com panies

507

4

5

4

4

5

Money market funds

453

-

-

-

2

4

S&Ls maintained their market shares
through most of the 1980s despite a
precarious financial situation. Pri­
marily as a result of losses from lend­
ing long and borrowing short when
interest rates soared in the late 1970s
and early 1980s, about 85% of all

M utual savings banks

284

8

7

6

4

3

Credit unions
Total

213

-

1

1

2

2

10,347

100

100

100

100

100

SOURCE: Board of Governors of the Federal Reserve System, Flow o f Funds Accounts, various years.
aSecond quarter for 1990. Fourth quarter for all other years.

ciations to attract funds quickly was
reduced. In addition, the act re­
quired higher capital-to-asset ratios at
the remaining institutions.1 This also
slowed deposit growth because most
associations chose to increase their
capital ratios by reducing deposits
rather than by increasing capital.
More recently, a significant percent­
age of the deposits at insolvent asso­
ciations closed by the Resolution
Trust Corporation (RTC) was pur­
chased by commercial banks and left
the S&L industry.

1
----------------------------------------------------

1950

1960

Along with declines in market share,
the industry has also seen the num­
ber of associations decline. At yearend 1989, there were near 2,900
S&Ls in operation, and by year-end
1990, the num ber of associations may
be below 2,500.2 This num ber would
be nearly one-half the num ber of
associations in 1980 and only about
one-third the num ber in 1960, when
nearly 6,500 S&Ls were in operation.
Of course, during most of the period
of decreases in the number of associa­
tions, total S&L assets were increasing
rapidly, so that through 1988 the
remaining associations were larger,
on average. But since 1988 total assets
have declined faster than the total
num ber of associations, as propor­
tionately more larger associations
have become insolvent and resolved.
As a result, the average asset size of
the remaining associations has begun
to decline.
. . . But not shrinking services for
customers

The shrinking of the S&L industry
does not necessarily imply an equal

1980

1990c

Total residential m ortgages
(billions o f dollars)
45

142

S&Lsa

29

39

Commercial banks

21

M utual savings banks

As a result, S&L market share of fi­
nancial institutions slid from a peak
of 16% in 1984 to 15% by year-end
1988 and then more rapidly to only
11% by midyear 1990. This wiped
out the gains of 30 years of growth. It
is not unreasonable to project that by
year-end 1990, the market share of
S&Ls will not be greatly different
from what it was 35 years earlier in
the mid-1950s, when the associations
began their rapid growth.

1970

10

298

978

2,4 93

41

45

27

14

14

17

16

15

14

7

5

% D istribution

Life insurance com panies

19

18

9

2

1

Households

17

7

8

6

6

G overnm ent

3

5

7

8

6

M ortgage poolsb

-

-

1

9

31

Other
Total

1

2

6

6

8

100

100

100

100

100

SOURCE: Board of Governors of the Federal Reserve System, Flow o f Funds Accounts, various years.
inclu des mortgage pools.
bExcludes savings and loan associations.
cMidyear.

shrinking of the services it tradition­
ally provided, namely, residential
mortgage lending and savings deposit
gathering.
In fact, S&Ls have been reducing
their share of the residential mort­
gage market for some time with little
discernible negative effect on mort­
gage borrowers. In mid-year 1990,
S&Ls held 27% of all mortgages.3 As
can be seen from Table 2, this repre­
sents a decline of 40% from the 45%
market share in 1980 and is the low­
est percentage penetration since the
1940s.
This decrease in mortgage activity
reflects three developments in the
industry. First, S&Ls shifted into
other kinds of lending, such as con­
sumer loans and commercial mort­
gages, in response to the new powers
granted them by deregulation in the
early 1980s. Second, as noted earlier,
the growth in their overall asset base
slowed and then turned negative.
Third, residential mortgage lending
became more attractive to commer­
cial banks and life insurance compa­

nies with the advent of mortgagebacked securities, which, unlike
whole mortgages, are marketable.
It is difficult to identify precisely the
institutions that took up the slack in
mortgage investment from the avail­
able data, because the ownership of
mortgages that are pooled and securi­
tized cannot be broken out for inves­
tors other than S&Ls. Such mort­
gage-backed securities have grown
rapidly in recent years and now ac­
count for more than one-third of all
residential mortgages outstanding.
At the same time that S&Ls have de­
creased their residential mortgage
activity, they have been facing new
competition for savings deposits,
largely from money market funds.
Thus, the diminished role of S&Ls is
likely to result primarily in a reshuf­
fling of their activities to other types
of institutions. This is not to say that
there may not be some disruptions
and additional search required by
traditional S&L customers during the
transition period, but other sources
of these services will be out there.

What will S&Ls do in the future?

In the longer run, the financial serv­
ices industry may very well resemble
the grocery industry: firms of every
conceivable size and shape would
cater to every conceivable taste on a
voluntary basis, with no product or
geographic regulation other than
that of the market place. Survival
and success will belong to the best
managed institutions in each niche.
Thus, the surviving S&Ls must be­
come sufficiently expert in some
activities to fend off competition
from a wide variety of other types of
institutions. It is likely, however, that
many of the S&L survivors will re­
main primarily residential mortgage
lenders, an area in which they have
long experience.
At the same time that the S&L indus­
try is undergoing this transition, the
entire depository institutions subsec­
tor of the financial services industry
may be expected to grow more slowly
or even to contract in the near fu­
ture as a result of three forces:1
1. Steeply higher premiums for fed­
eral deposit insurance. These premi­
ums are equivalent to a tax on these
institutions that is not levied on their
competitors.4 In part, this may be
viewed as reducing or even reversing
any implicit subsidies from underpricing deposit insurance in the past,
particularly for poorly capitalized or
insolvent institutions, which had en­
couraged rapid growth. Higher pre­
miums are particularly important in
light of a perceived implicit expan­
sion of the federal safety net to some
important quasi-government com­
petitors, such as the Federal Home
Loan Mortgage Corporation (Fred­
die Mac) and the Federal National
Mortgage Corporation (Fannie
Mae), without charging insurance
premiums.5 This lowers the cost of
funds to these institutions and per­
mits them to bid higher for invest­
ments and accept a lower interest
rate, putting depository institutions
at a competitive disadvantage.

2. Higher equity capital require­
ments. These requirements are costly
to meet because, unlike interest pay­
ments on deposits, dividend payments
on equity are not deductible from
taxable income.
3. Technological innovations in com­
puterization and telecommunications.
These reduce the comparative advan­
tage of depository institutions in gath­
ering and analyzing credit informa­
tion as well as transferring funds from
investors to borrowers. For example,
technology makes it possible to track
and monitor the hundreds of individ­
ual loans that make up a securitized
pool. In addition, technology makes
it easier for prime corporate borrow­
ers to issue commercial paper directly
to investors instead of obtaining bank
loans, particularly if the bank has
suffered during the industry’s recent
financial difficulties and so has a
lower credit rating than the ultimate
borrower. Thus, the cost structure of
financial intermediation by traditional
depository institutions may be too
high to make them economically vi­
able without a reduction in the result­
ing overcapacity.

y ear-end 1989, 281 associations w ith assets
o f $128 billio n w ere u n d e r th e supervi­
sion o f th e RTC. Six m o n th s later, on
J u n e 30, 1990, th e n u m b e r was 247 asso­
ciatio n s w ith $141 billion o f assets. T his
re p re s e n te d a b o u t 9% o f all associations
a n d 11 % o f all assets. D u rin g these six
m o n th s, 170 associations w ere sold,
m e rg e d , o r liq u id a te d a n d 136 o th e r
in so lv en t associations w ere tra n sfe rre d to
th e RTC.
3S&Ls o rig in a te d a la rg e r p e rc e n ta g e o f
new m o rtg ag es b u t sold th em to o th e r
investors.
4O n Ja n u a ry 1, 1990 p re m iu m s w ere
in c re a se d fro m .21% to .23% fo r S&Ls
a n d fro m .08% to .12% fo r co m m ercial
banks. P rem iu m s are sc h e d u le d to in ­
crease again fo r c o m m ercial b anks on
Ja n u a ry 1, 1991 to a t least .195% a n d
possibly h ig h e r fo r all in stitutions.
5 d e sc rip tio n o f th ese ag encies a n d th e ir
A
g o v e rn m e n t su p p o rt a p p e a rs in U n ite d
States G en e ra l A c c o u n tin g O ffice, Govern­
ment-Sponsored Enterprises: The Govern­
m ent’ Exposure to Risks, W ashington, D.C.,
s
A ugust 1990.

In sum, S&Ls are being hit from two
sides. Shrinkage from financial diffi­
culties is occurring simultaneously
with shrinkage of all depository insti­
tutions from technological and regu­
latory change. It is unlikely the S&Ls
will again achieve the relative impor­
tance they had in recent decades.
-George G. Kaufman,
J o h n S m ith P ro fesso r o f F in an ce a n d
E co n o m ics a t Loyola U niversity
o f C h icago a n d C o n su lta n t to th e
F ed eral R eserve B ank o f C hicago l
2
lA m o re d e ta ile d d e sc rip tio n o f th e provi­
sions o f FIRREA a p p e a rs in Elijah B rew er,
“ Full-blown crisis, half-m easu re c u re ,’’
Economic Perspectives, N o v e m b e r/D e c e m b e r 1989, p p . 2-17.
2T h e p recise n u m b e r o f S&Ls c u rre n tly in
o p e ra tio n is d ifficult to identify, as a large
n u m b e r o f in so lv en t associations a re o p e r­
a te d in c o n serv ato rsh ip o r receiv ersh ip by
th e RTC aw aiting final d isp o sitio n by sale,
m e rg e r, o r liq u id a tio n . F o r ex am p le, at

Karl A. S cheld, S e n io r V ice P re sid e n t a n d
D ire c to r o f R esearch; David R. A llard ice, Vice
P re sid e n t a n d A ssistant D ire c to r o f R esearch ;
J u d ith Goff, E d ito r.
Chicago Fed Letter is p u b lish e d m o n th ly by th e
R esearch D e p a rtm e n t o f th e F ed eral Reserve
B ank o f C hicago. T h e views e x p re sse d are th e
a u th o r s ’ a n d are n o t necessarily th o se o f th e
F ed eral Reserve B ank o f C h icag o o r th e
F ed eral R eserve System . A rticles m ay b e
r e p rin te d if th e so u rce is c re d ite d a n d th e
R e search D e p a rtm e n t is p ro v id e d with co p ies
o f th e re p rin ts .
Chicago Fed Letter is available w ith o u t ch arg e
fro m th e P ublic In fo rm a tio n C e n te r, F ed eral
Reserve B ank o f C hicago, P.O . Box 834,
C hicago, Illinois, 60690, (312) 322-5111.

ISSN 0895-0164

In August, manufacturing activity in the Midwest declined 0.6%, marking the
second monthly decline after the peak for the current expansion in June.
While over half of the 17 industries in the MMI recorded declines in August,
two key industries showed improvement—machinery and metalworking.
Over the last three months, strength in Midwest manufacturing activity has
centered on the metalworking and transportation industries. Nationally, the
Federal Reserve Board’s Index of Industrial Production has been buoyed by a
relatively strong durable goods manufacturing sector, also led by the metal­
working- and transportation-related industries. However, planned auto pro­
duction for the fourth quarter indicates softening in the transportation indus­
try in the months ahead.

Chicago Fed Letter
F E D E R A L R E S E R V E B A N K O F C H IC A G O
P u b lic In fo rm a tio n C en ter
P .O . B ox 834
C h ica g o , Illin o is 60690
(312) 322-5111

N O T E : T h e MMI a n d th e USM I are co m p o site
in d ex es o f 17 m a n u fa c tu rin g in d u strie s a n d
a re d eriv ed fro m e c o n o m e tric m o d e ls th a t
estim ate o u tp u t fro m m o n th ly h o u rs w o rk ed
a n d kilow att h o u rs data. F o r a discu ssio n o f
th e m e th o d o lo g y , see “R e c o n sid e rin g th e
R egional M a n u fa c tu rin g In d e x e s ,” Economic
Perspectives, F e d e ra l R eserve B ank o f C h icag o ,
Vol. X III, N o. 4, J u ly /A u g u s t 1989.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102