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CRT M2

collaborative review task module two

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41 views3 pages

CRT M2

collaborative review task module two

Uploaded by

Bemnet Zewge
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CRT M2

CASE STUDY: The Savings and Loan Crisis

Introduction

The S&L crisis was caused by a mismatch of rules to market conditions, speculation, and moral hazard. A
mix of taxpayer guarantees and deregulation led banks to assume much too much risk. The collapse of
the Savings and Loan Association (S&L) contributed to the banking crisis.

1. Identify key role players from the inception to the demise of the S&L market.

The demise of the S & L market was contributed to by many factors and many players, indirectly and
directly. The first five players below played a Key direct role.

Direct Players:

•The US Parliament

•Federal Savings and Loan Insurance Corporation (FSLIC)

•The Federal Home Loan Bank Board (FHLBB)

•Office of Thrift Supervision (OTS)

•Federal Deposit Insurance Corporation (FDIC)

Indirect players:

•US Federal Reserve Bank due to its interest rate policy

•US President, due to signing into law of the Garn-St. Germain Depository Institutions Act which
eliminated caps on interest rate

2. Identify and analyze shortfalls of the regulation which affected the

S&L market. Your answer does not need to be contained to the crisis years.

Regulatory and supervisory failures

The reactionary response used reveals a fundamental flaw in the regulatory structure. This was due to
resource constraints as well as a lack of fraud and risk controls in the S&L industry.

Deregulation as a tool to resolve the crisis

The S&L market was left in a state of chaos after it was deregulated. Only the strong survive under such
market conditions, but only for a short time. This is especially true when players become more
inventive, aggressive, and willing to take on greater risk, taking advantage of accounting gimmicks and a
lack of responsibility.

Lack of proactivity and slow response to the crisis

The failure to stress test the S&L market early on, along with the regulators' tardy response to the
market's interest rate risk sensitivities, left the market open to fraud and consequent losses.
3. In reference to article 2, make an argument for which level of regulation the article describes (see
Lecture 2 M2) the GarnSt.Germain Depository Institutions Act was.

Industry Specific regulation

The regulation was a direct regulation because it was imposed on the S&L market. The regulation's
articles were more focused on the Savings and Loan industry than on the financial markets in general.

Government level regulation

The law was passed by the US Congress and signed by US President (Ronald Reagan). In fact, I contend
that it was a regulation enacted at the federal level.

Direct regulation

The legislation also applied to the S&L market, affecting direct market variables such as interest rate,
profitability, and so on. As a result, I believe this was a direct regulation.

Domestic regulation

Because it was aimed at the S&L market in the United States of America, the Act is also domestic.

Given the foregoing, I contend that the regulation was Direct, Industry Specific, Government, and
Domestic.

4. What did the Enron crisis and the Savings & Loan crisis have in common?

The S&L fiasco and the Enron crisis of 2001 have striking similarities.

Deregulation facilitated financial innovation, which was aided in this case by a variety of new
information and communication technologies that increased the anonymity of economic transactions
(Balleisen, 2017, pp. 356–364), resulting in excessive risk-taking, which in some cases led to fraud and
company failure (Balleisen, 2017, pp. 356–364). Large-scale ethical infractions were also present.

5. How were the ethics violations different in the Enron crisis and the S&L crisis?

The Enron controversy centered on deceptive and immoral practices such as using Special Purpose
Entities to disguise loans as commodities swaps and using mark-to-market accounting to inflate alleged
sales and profits.

However, there was stagflation during the S&L crisis, prompting the S&L banks to seek Congress to lift
the low interest rate limits. As a result, President Ronald Reagan signed the Germain Depository
Institutions Act, which repealed the interest rate ceiling and authorized the S&L to make hazardous
loans. S&L was authorized to participate in speculative real estate in Texas and other states. Previously,
banks utilized historical accounting, which meant that real estate prices were only adjusted when the
property was sold. This gave the impression that the banks were in better shape than they actually were
(especially when the price of real estate collapsed due to oil price collapse). Texas' Empire S&L was
involved in unlawful property flips and other crimes, costing taxpayers more than $300 million. The
senator's campaign contributions were funded by Lincoln S&L, putting pressure on the Federal Home
Loan Board to overlook the fraud at Lincoln.
6. Pick either Enron crisis OR S&L crisis (NOT BOTH) that you think the problem is more difficult to fix.

S&L crises, in my opinion, are more difficult to resolve. Let's start with the Enron scandal.

The Enron scandal included employing commodities swaps to hide debts in SPEs and Mark to Market
accounting to show presumed gains as real profits. These difficulties can be easily resolved by
implementing new accounting principles and Sarbanes-Oxley reporting within the regulatory framework.
Once fair and transparent accounting practices and standards are in place, it will be rare to see another
Enron-style scandal.

S&L crises, on the other hand, are a more structural problem. During every crisis, central
banks/regulators must provide banks with surplus cash for lending in order to relieve the monetary
supply (by reducing the capital reserve requirements). Banks would lend and, as a result of the excess
money supply, would be tempted to lend to riskier channels. This, along with a corrupt nexus between
the lender and the organization receiving the loan, might result in the loan money being used for
speculative reasons, increasing the risk of the loan becoming a bad one.

Conclusion.

Overregulation's shortcomings sparked the crisis, which was exacerbated by deregulation. The Garn-St.
Germaine Depository Institutions Act is a shining example of direct domestic state industry regulation,
loosening market constraints despite the economy's complexity and dynamics.

References

. https://www.federalreservehistory.org/essays/savings-and-loan-crisis

. https://www.thebalance.com/savings-and-loans-crisis-causes-cost-3306035

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