Credit unions and savings & loans during the interest rate crisis

Credit Unions

There were a few differences in the way that credit unions and savings & loan operations (S&L) were governed that made for differences in their health during the interest rate escalation in the late 1970s and early 1980s. For their part, savings & loans suffered substantially during this era. One of the primary factors was that a cap existed on the rate than savings & loans could pay to their depositors. As interest rates rose, this cap did not. The end result was that the savings & loans were capped at a rate than was lower than the prevailing money market rate. As a consequence, depositors were pulling their money from the S&L industry and shifting it to money market funds. Savings & loans were also holding a large amount of low interest mortgages, again hampering their ability to turn a profit in a high interest rate environment (Investopedia, 2016).

Credit unions also struggled during this era, but there are a couple of differences that helped them to perform better. First, a credit union is member-owned, which creates a greater incentive for a depositor to keep his or her money with the credit union. They reap whatever profits are earned, and their membership creates more of a bond with the credit union, which is ultimately a barrier to leaving. Further, credit union deposits were subject to federal insurance. This was introduced in 1971 and strengthened the credit union industry, providing an incentive equivalent to that which banks received for depositors to remain with the institution (Wilcox, 2005). The combination of these greater incentives for depositors to remain helped to lend credit unions greater stability than either banks or S&Ls during this era, when otherwise it made sense to pull deposits in favor of money market funds.

The membership aspect is important because the credit union's depositors are also its owners. As such, they have a greater stake in maintaining the credit union as an ongoing concern. Many credit unions are sponsored by specific communities, such as the membership of unions, and as such there is a much higher attachment to the financial institution on the part of credit union depositors. With the savings and loans, there is no so attachment, and never was. They compete on the basis of being able to offer healthy rates on deposits, and lower-interest mortgages. They are, however, completely governed by market forces in terms of attracting depositors. When depositors realized that they could make more money with money market funds than with their capital in the savings & loan, it made sense to take their money elsewhere, and they had no disincentive against doing so. This contrasts with the credit union depositor, who would have both a financial and community interest in the credit union. That barrier would be enough in some cases to override the financial considerations. As such, a lower percentage of deposits would leave the credit union compared with other institutions, something that was born out in the statistics when analyzed later (Wilcox, 2005). That added barrier to leaving, plus the depositor protection being stronger at credit unions, helped them to outperform the savings & loans, even not counting the financial considerations, where credit unions could be more competitive with their interest rates than could savings & loans.

2. The Resolution Trust Corporation was created by the federal government to seek to manage the savings & loan crisis. The RTC sought to manage and dispose of the assets of failed savings & loans, as a means of stabilizing the industry as it struggled. Ultimately, the RTC lasted until the end of 1995, resolved 747 such entities and nearly $400 billion in assets (Investopedia, 2016).

Legally, the RTC had to be created by law, have its powers defined and extended by law, and it was dissolved by law as well. This means that Congress had to become involved in the crisis, and this was related to the size of the crisis, which was the largest mass failure of financial institutions since the 1930s (Investopedia, 2016).

Among the legal and regulatory ramifications was that the RTC restored the industry's insurance fund, which was unable to cope with the failures, and to alter the way that the industry was regulated. The federal government had sought twice prior to intervene in the crisis, but those attempts had failure, so it built the RTC on the regulatory framework of the FDIC. This provided a set of best practices for governance of the industry that helped the RTC to more successfully manage the S&L crisis. The FDIC, for example, administered the new insurance fund that was created, after the Financial Institutions Reform, Recovery and Enforcement Act abolished the industry's old insurance regime (Davison, 2005).