It has been said over the years that the origin of the word “Crisis” may be related to two seemingly opposing or contradictory definitions as related to Chinese characters or symbols. These two symbols may represent the words “Danger” and “Opportunity.” Just as Love and Fear are thought to be the two primary core emotions for Human Beings which all other feelings are just based upon, an Economic or Financial Crisis like the ongoing “Credit Crisis” offers investors both danger or opportunities if one focuses on their goals in life much more than the obstacles which may stand in their way.
Over the past 40 years, the two economic eras which have offered both significant amounts of danger and opportunity for Real Estate investors have been during and after the depths of “The Savings and Loan (S & L) Crisis” and the ongoing “Credit Crisis.” A high percentage of investors who held onto their Real Estate during these wildly fluctuating “Boom” and “Bust” eras were eventually rewarded with future all-time record high prices once access to capital was greatly improved with both conventional and non-conventional forms of lending options.
The Savings and Loan Boom and Bust
To better understand the comparisons between the “S & L Crisis” and the more recent “Credit Crisis”, one needs to learn more about the origins and basic reasoning for these respective “Boom and Bust” cycles:
* 1967 – The state of Texas approves much more flexible legislation for their in-state Savings and Loans. Property development loans are approved for upwards of 50% of a borrower’s entire net worth.
* 1978 – The Financial Institutions Regulatory and Interest Rate Control Act created. This act allows Savings and Loans to invest up to 5% of their assets in land development, construction, and education loans.
* 1980 – 1982 – The U.S. government tries to help the S & L industry become more competitive by passing a series of new acts and laws to encourage more Americans to bank with their local Savings and Loan branch. The government wants to help S & Ls become more profitable by allowing them to offer more loans than just the traditional long term mortgage loan.
* March 1980 – The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) act is created. The interest rate cap ceiling is eliminated for most federal Savings and Loans. This allows S & Ls to compete with banks, credit unions, and other financial entities by offering similar rates of deposits paid to their respective customers. In addition, S & Ls are allowed to make more land acquisition, development, and construction loans.
* December 1982 – The Garn – St. Germain Depository Institutions Act of 1982 is created. President Reagan, partly in response to the 21.5% Prime Rate when he took office (Jan. ’81), helps support a new act which encourages the expansion of powers to all federally chartered Savings and Loans. Some of these features include the entire elimination of all deposit rate ceilings caps, the deletion of all previous statutory limits on loan to value ratios, and the expansion of the asset powers of all federal S & Ls. Savings and Loans are now able to invest up to 40% of their assets into commercial mortgages, up to 30% of their assets into consumer loans, and up to 10% of their assets into commercial leases.
The deregulation of the Savings and Loan industry allowed many financial institutions to overbuild too many new commercial office buildings in areas like Dallas and Houston, make highly leveraged land loans to land developers, and construction loans up to 106% loan to value to builders (100% of the development costs and fees to the builder, and up to 6% in loan fees for the lender).
* December 1982: The Nolan Bill passes in California as a response to the high number of defections of state chartered S & Ls to the more flexible federally chartered system. The Nolan Bill allows California chartered S & Ls to invest 100% of their deposits in any type of venture. Texas and Florida later adopt similar plans in their respective states.
* 1983: As interest rates continue to drop from their previous record highs (i.e. Prime Rate at 21.5% in January 1981), many Savings and Loans begin to improve their overall financial strength. 35% of all existing Savings and Loans, however, report negative earnings. Almost 10% of all Savings and Loans are insolvent, according to GAAP (Generally Accepted Accounting Principles).
March 1983: Edwin Gray is appointed Chairman of the Federal Home Loan Bank Board. Under his leadership, new tougher regulations begin to tighten the guidelines which were ease tremendously by the prior deregulation.
* November 1983: The Federal Home Loan Bank Board raises the net worth requirements for newly chartered Savings and Loans up to 7%.
* March 1984: Empire Savings Bank (Texas) closes down. There were allegations of inappropriate lending practices at Empire. The failure of Empire Savings later costs taxpayers close to $300 million.
* July 1984: The Federal Home Loan Bank Board requires Savings and Loans management to create new policies and procedures for managing interest rate risk.
* January 1985: The Federal Home Loan Bank Board limits the amount of brokered deposits to just 5% of total deposits at FSLIC insured financial institutions that fail to meet their minimum net worth requirements.
* March 1985: Ohio bank holiday. The governor of Ohio closes down all Savings and Loans in his state upon hearing that Home State Savings Bank of Cincinnati is about to “collapse” and shut down. The Ohio governor was concerned about a “run” on deposits by customers at other Ohio financial institutions. Later, those Savings and Loans that could qualify for federal deposit insurance by meeting the minimum net worth standards are later allowed to reopen.
* May 1985: Several S & Ls fail in Maryland. These failures eventually cause an enormous loss to Maryland’s state deposit insurance fund. The losses later cost Maryland taxpayers $185 million.
* July 1985: Chairman Edwin Gray starts the transfer of federal examiners to the twelve regional Federal Home Loan Banks so they are no longer overseen by the OMB (Office of Management and Budget). Their salaries are then paid directly by the Federal Home Loan Bank Board system.
* August 1985: The FSLIC insurance fund only has $4.6 billion in their accounts. Chairman Gray asks Capitol Hill for support to recapitalize the depleted insurance fund. In 1986, GAO (the U.S. government’s General Accountability Office) estimates that the total projected loss to the fund is closer to $20 billion.
* December 1985: The Bank Board allows Savings and Loan examiners to “classify” questionable loans and other assets for the purpose of requiring loan loss reserves.
* 1986 – 1989: Losses compound as too many under capitalized financial institutions are allowed to remain open.
* August 1986: The Bank Board increases the net worth standard for existing Savings and Loans to 6%. Up to 2% of that percentage is set up to offset any reduced interest rate risk.
* 1987: The losses at several major Savings and Loans in Texas make up almost 50% of all losses nationwide. Of the 20 largest Savings and Loan losses nationwide, 14 are in the state of Texas. The Texas economy goes into a major recession, crude oil prices drop by almost 50% (as opposed to increasing by 50% over the past year or two now), commercial office vacancy rates exceed 30%, and overall real estate prices (residential and commercial) drop dramatically.
* January 1987: GAO declares the FSLIC fund to be insolvent by almost $4 billion (see Bond Insurers and many banks today). Capitol Hill, partly blocked by powerful Savings and Loan lobbyists, does not take decisive action to help recapitalize the depleted insurance fund as the new regulations are deemed “too harsh and arbitrary” by many S & L managers and lobbyists.
* February 1987: The Bank Board requires prior supervisory approval for Savings and Loans making investments which exceed 2.5 times their overall tangible capital.
* April 1987: Chairman Edwin Gray ends his term as leader of the Federal Home Loan Bank Board. Danny Wall later replaces him as the new chairman. Lincoln Savings, led by Charles Keating, fails shortly thereafter. The losses at Lincoln Savings eventually cost taxpayers over $2 billion.
* May 1987: The Bank Board begins to phase out the balance of the flexible RAP (Regulatory Accounting Principles) accounting standards. Savings and Loans must now conform to GAAP accounting standards as U.S. banks do. The effective date for this new accounting practice is set to begin on January 1st, 1989.
* August 1987: The Competitive Equality Banking Act of 1987 is enacted. The new act authorizes a $10.8 billion recapitalization of the FSLIC insurance fund. A maximum allotment of up to $3.75 billion is allowed to be distributed during any 12 month time period. The act also has forbearance measures designed to postpone or prevent Savings and Loan closures.
* February 1988: The Bank Board creates the “Southwest Plan” to consolidate and package insolvent Texas Savings and Loans to be sold off to the highest bidders. The plan is established to help offset insolvencies quickly in order to preserve cash for the increasingly insolvent FSLIC insurance fund. The Bank Board creates a number of strategies to help pay for the difference between assets and liabilities of the failed S & Ls and Thrifts. These assets and liabilities may include FSLIC notes, tax incentives, income, capital value, and yield guarantees. The Bank Board successfully sells 205 Savings and Loans through the “Southwest Plan”. The total projected assets from the “Southwest Plan” fire sale are close to $101 billion.
* February 1989: President Bush helps provide a new Savings and Loan bailout plan. In August 1989, the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) is unveiled to the public. FIRREA then abolishes the Federal Home Loan Bank Board and FLSIC. S & L regulation is then transferred to the newly created Office of Thrift Supervision (OTS). All deposit insurance is now governed by FDIC.
* August 1989: The Resolution Trust Corporation (RTC) is then newly created. The RTC is established to help dispose of all remaining assets (i.e. real estate, etc.) tied to the failed financial institutions. Bargain basement real estate deals are readily available to savvy real estate investors standing by.
Bank Implosions and Crisis Opportunities
Once short-term interest rates began to reach all-time highs for banks and investors back in the early 1980s (i.e., some long-term 30 year fixed mortgage rates reached 15%+), then foreclosure rates for many borrowers skyrocketed. These high mortgage default rates later led to many conventional banks greatly restricting their access to loans for their customers. It was only later during the 1990s when more non-conventional forms of banking capital improved, directly or indirectly supplied from Wall Street, that the housing boom took off again.
For those investors who had very “Deep Pockets” with lots of cash available, they were able to purchase Real Estate for a small fraction of their market values such as Apartment Units in Texas for as little as a few hundred dollars per unit. Private or Hard Money Loans became very popular back after the “S & L Crisis”, and they provided the early versions of the “Fix and Flip Money” as seen today.
In very recent years, the “Credit Crisis”, a “Quadrillion (1,000 trillion +) Dollar implosion” which dwarfs the S and L implosion by a factor of perhaps 100 + times, is providing investors with many more opportunities today than last seen with the collapse of the Savings and Loan sector. Banks need to liquidate their assets for much needed cash partly to pay off their multi-trillion dollar Derivatives investments (e.g., Credit Default Swaps, Interest Rate Option Derivatives, etc.).
With so many quality distressed properties available to choose from nationally, those investors who can fund the quickest will be the most rewarded with the best deals. The investors today who are using the most creative forms of purchase financing options in our ongoing “Credit Crisis World” will financially benefit for years or decades to come just like so many courageous and wise investors did after the Savings and Loan meltdown. The biggest risk is truly to not take advantage of this oxymoronic “Crisis Opportunity” situation!!!
Author: Rick Tobin
Rick Tobin has a diversified background in both the Real Estate and Securities fields for the past 25+ years. He has held seven (7) different Real Estate and Securities brokerage licenses to date.
Rick has an extensive background in the financing of residential and commercial properties around the U.S with debt, equity, and mezzanine money. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Equity Funds, and foreign money sources.
You can visit Rick Tobin at RealLoans.com.