Samuel Clemens, also known as Mark Twain, didn't live to see the bank runs and market crash of 1929, nor was he around for 1987’s "Black Monday,” the Great Recession of 2008, or the latest banking crisis centered on the demise of Silicon Valley Bank (SVB). But a famous aphorism often ascribed to Twain sums up the financial panics that have come and gone since his time: "History doesn't repeat itself, but it often rhymes."
The reverberations that have spread through the banking system after SVB’s collapse seem to rhyme very closely with a particular panic from the late 1980s: the savings and loan (S&L) crisis. Both then and now, the Federal Reserve was rapidly hiking interest rates to fight stubborn inflation. The ploy worked—and appears to be working again today—but at the cost of devaluing interest rate-sensitive assets, like the U.S Treasuries and mortgage-backed securities that make up a large portion of many banks’ balance sheets. Add to that lax regulations, executive mismanagement, and an overreliance on a single type of depositor, and a potential repeat of the nightmare S&L crisis is creating sleepless nights for many of today’s regional bank executives.
The memory of 2008 and the Great Financial Crisis is coloring regulators’ response to the new crisis, particularly with relaxations of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act being blamed for SVB’s demise. But the possibility of regional bank contagion after SVB’s collapse recalls the specifics of the S&L crisis more than anything, as the billionaire investors Ray Dalio and Larry Fink both pointed out soon after it started.
For his part, Fink wrote in his annual shareholder letter last week that “we don’t know yet” whether the consequences of the latest crisis “will cascade throughout the U.S. regional banking sector (akin to the S&L Crisis) with more seizures and shutdowns coming.” But like the S&Ls of the ‘80s, the recent failures of SVB, as well as Silvergate Bank and Signature Bank, add up to the loss of regional institutions that, taken together, posed such a systemic risk that D.C. put taxpayer money on the line.
The now-defunct SVB and Signature Bank also faced issues that the CEOs of S&Ls in the ‘80s couldn’t have imagined due to the rise of social media. But as George Ball, chairman of the investment firm Sanders Morris Harris, put it in an interview with Fortune:
“The case of SVB may be very different from the S&Ls in some ways, but the arithmetic behind it was timeless—long leverage, with depositors or lenders losing faith, creates instant catastrophe, no matter what.”
Fortune spoke with economists, former Fed officials, investment managers, and more about the similarities and differences between financial crises of the past and today’s banking instability. The combination of rising interest rates and the systemic risk posed by the failure of small and medium-sized regional financial institutions drew comparisons to the S&L crisis from every one of them. And it’s worth being alert to this rhyme of financial history because the S&L crisis saw more than 1,000 lenders go bust nationwide over a 15-year period between 1980 and 1995 during the S&L crisis, as the U.S. General Accountability Office has calculated, ultimately costing taxpayers more than $160 billion.
A brief history and a moral hazard
A short history lesson: Savings and loan associations were first established in Pennsylvania in 1831, when banks didn’t offer residential mortgages. These institutions, also called “thrifts,” allowed communities to band together to help each other purchase homes.
Many S&Ls came to provide lower mortgage rates than banks, but correspondingly paid out lower rates on deposits. The status of these lenders in the U.S. banking system grew over the coming years due to their low costs, and by 1932, the Federal Home Loan Bank Act was established to supervise the S&L industry with the goal of helping lower-income Americans achieve home ownership. Two years later, the Federal Savings and Loan Insurance Corporation (FSLIC) was created to insure deposits at S&Ls as they expanded.
By 1980, there were almost 4,000 S&Ls nationwide with total assets of $600 billion—including roughly half of all outstanding U.S. home mortgages at the time. But when Federal Reserve Chairman Paul Volcker took office in 1979, he was determined to slay what economists have now come to call “the Great Inflation.” In a model that current Fed Chair Jerome Powell seems to have taken to heart, Volcker jacked up interest rates with unprecedented speed and aggression, leading President Jimmy Carter to endure a brutal recession toward the end of his only term in office. Within a few years (and after another brief recession), a period of price stability called the “Great Moderation” set in, but not before everything changed for S&Ls.
As interest rates rose sharply, the value of the fixed rate assets—mainly mortgages—that were held by the S&Ls declined, said Konrad Alt, who had a front-row seat to the end of the S&L crisis as counsel to the U.S. Senate Banking Committee and later as Chief of Staff and Senior Deputy Comptroller at the Office of the Comptroller of the Currency between 1989 and 1996. “At the same time, the cost of their funding rose, so they had to pay more money to attract deposits. Eventually, they developed what we call negative spread,” which essentially means they all started to lose money and become insolvent.
Alt, who has since founded the investment firm Klaros Group, said that he was a young lawyer by the time he got involved in the S&L crisis, and what he saw “in almost every one of them was a lot of really sketchy behavior—very imprudent loans, other kinds of activities.” Just as with some of the more unsavory revelations about SVB giving out fine wines and all-expenses-paid ski trips to woo Bay Area clientele, S&Ls pulled in clients with “lending against racehorses, golf courses, and artwork” and lived lavish lifestyles—“the corporate jets, all that stuff was real.”
Alt said he thinks mismanagement at S&Ls was common during the late ‘80s because these were dying businesses that had the unwavering support of regulators—and S&L executives were well aware of that.
“If you have a business with no equity and no economic value, why not gamble? If you lose, the deposit insurer [FSLIC] takes over, and you didn't have any money in it anyways, so you haven't really lost anything. If you win, ‘Hey, that's great, Bonanza,’” he said. “And so that kind of behavior became rampant in the S&L industry.”
If he was a bank supervisor now, Alt said he’d definitely worry about the “moral hazard” issue in which a government bailout of a failed bank incentivizes excessive risk-taking by its leadership. Bank owners and managers who know their business is insolvent—as appeared to be the case with SVB—essentially know they won't be allowed to fail by the government. Alt said that fact could lead to an attitude where managers "throw the long bomb and take risks."
A familiar macroeconomic equation
The U.S. economy’s reopening in 2021 after coronavirus vaccines became available coincided with the highest inflation since Volcker's tenure in the ‘80s, and Powell has responded by raising rates faster than any of his predecessors in hopes of cooling the economy and quashing it. And just as in the 1980s, as interest rates have risen, the value of the fixed rate assets on banks' balance sheets (Treasuries and mortgage-backed securities) has gone down. As a result, U.S. banks were sitting on over $600 billion in losses in their loan portfolios as of the end of 2022, according to the FDIC.
The deterioration of value was especially bad at SVB. By the end of last year, the bank had over 90% of its bond holdings in long-dated mortgage-backed securities that were yielding less than 2%. Rising interest rates meant those bonds were now worth a lot less, so when depositors flooded the bank in early March to ask for their money back amid fears it would collapse, SVB didn’t have enough cash on hand to give them.
Konrad Alt noted that banks are now once again in a situation where interest rates are rising, long-dated fixed rate assets are losing value, and deposits are under pressure. “So, we're on track there. And if you look down that track, you might reasonably say, ‘Hmm, this could start to look a lot like the S&L crisis.’”
A deadly overconcentration
Another key similarity between the S&L crisis and the problems at SVB and Signature Bank is overconcentration on one sector. S&Ls almost entirely focused on providing mortgages, which led to problems when home values declined in the ‘80s amid rising interest rates. Meanwhile, SVB largely served tech companies that were often untested and unprofitable, leaving them at risk as rates rose and VC funding slowed. Ball, from Sanders Morris Harris, said that overconcentration by banks on any one sector will “ultimately create excesses that end up in catastrophe.”
He also noted that there was a key similarity between the situation at SVB and what happened to S&Ls that made the latest bank run happen fast.
“The bank lenders in the S&L era and the tech lenders personifying them in today's economy—like at SVB—both tacitly required their lenders to keep their deposits with the lending organization,” he said, explaining that both the S&Ls and SVB offered lots of extra bells and whistles to keep depositors invested. “You can't force a borrower to do that, it’s against the law, but you can use persuasion and influence them to do that.” For example, SVB handed out Amazon cloud computing credits, discounts on DocuSign services, and even fine wines to clients.
Ball argued that this way of doing business led deposits at SVB to be pulled quickly because its depositor base was so concentrated in large accounts of well-connected tech companies. “People with those big deposits looked to diversify them when they heard rumors, and then suddenly, the well was not three-quarters full, it was only one-eighth full. And at that point, you had insolvency.”
Some key differences
While the S&L crisis and the current era of banking instability may share many similarities, there are also a few key differences. Perhaps the most important of those is the ability of today’s regulators to step in and save the day.
In 1983, during the midst of the S&L crisis, regulators estimated it would cost roughly $25 billion to pay off the insured depositors at failed lenders. But the S&Ls' insurance fund, FSLIC, had reserves of just $6 billion, according to Fed historians.
“Deposit insurance for those institutions back then was woefully inadequate for the scale of the problem as fast as it came, and that affected the choices of the regulators,” Michael J. Orlando, a lecturer at the University of Colorado-Denver and managing director of Econ One Research, told Fortune. But these days, said Orlando, who also served as a research economist in the Federal Reserve System, regulators have plenty of “water to bring to the fire,” which should help reduce the economic fallout from recent bank failures—at least in the near term.
Another thing that differentiates the S&L crisis from the failures at SVB and Signature was the speed of the latest bank runs. The rise of social media and banking apps has enabled depositors to quickly recognize when there is an issue with their bank and withdraw their funds.
“[SVB] was a run largely in the technology sector that’s full of people well versed in social media, and their ability to wipe out all of the available cash within 48 hours was really tremendous,” Stephan Weiler, professor of economics at Colorado State University, told Fortune. “Whereas, in the savings and loan crisis, it took weeks, months, years. It was kind of a crash in slow motion.”
Some experts have even argued that SVB could be the first social-media led bank run in history, noting that well-known venture capitalists had quickly warned their portfolio companies to pull their money. David Bahnsen, chief investment officer of The Bahnsen Group, told Fortune that he believes there is “no question” that powerful venture capitalists helped “foster a run on the bank.” Slow motion, this was not.
The fallout: The great consolidation
Prof. Weiler, who also serves as co-director of the Regional Economic Development Institute, warned that of all financial institutions, smaller banks are likely to be hurt the most by the latest crisis. SVB’s collapse exposed how limited FDIC insurance, which protects depositors up to $250,000, is for smaller institutions compared with more systemically important ones. “The big banks have something that the little banks don't,” he said—a near “guarantee” of a full bailout. “Too big to fail makes the attraction of bigger banks pretty overwhelming.”
Smaller community banks have been declining in number ever since the S&L crisis. In 1980, there were more than 14,000 FDIC insured banks nationwide, but in 2021, there were less than 4,500, according to the FDIC.
Weiler says that’s a big problem, pointing to his research that breaks down the positive impacts that community and regional banks have on the U.S. economy, particularly in rural areas often underserved by larger institutions.
In a study published last year alongside Belmont University’s Luke Petach and the University of Wisconsin-Madison’s Tessa Conroy, Weiler found that areas with more community banks have “improved regional economic prospects, both generally and in terms of their resilience to macroeconomic shocks.” Benefits include fewer business closures, more resilient home prices, and better employment growth.
“We've done studies that show that community banks that have [assets of] $1 billion or less are actually crucial to entrepreneurship and job growth, especially in rural America,” he said. “But it's precisely those banks that may end up getting shut out because of this crisis.”
However, on Tuesday, Treasury Secretary Janet Yellen told the lobbying group the American Bankers Association that she could take “similar actions” to backstop depositors at “smaller institutions” if they “suffer deposit runs that pose the risk of contagion.”
The sad part is small banks’ pain was likely avoidable, according to multiple experts Fortune spoke with. Alt, who helped write legislation for regulators after the S&L crisis, said that his recommendations were often ignored in the late '80s and early '90s, and the U.S. economy is facing the repercussions of those missed opportunities today.
He gave the example of when he put into legislation a requirement for banks to test their balance sheets in a rising interest rate environment. “That was in statute. None of the agencies actually implemented that,” he said. “Today, there is still no interest rate risk component. So that was a lesson learned and quickly forgotten. And the fact is, we've known that this was a gap for a long time….regulators should have caught it, and they didn't catch it.”
The takeaway from looking back at the S&L crisis in the wake of recent bank failures may well be that regulators, executives, and investors tend to forget the most important lessons from financial history and repeat the same mistakes.
“The half-life of economic memory is about three to five years,” Ball said. “After that, everyone becomes oblivious to old risks and the cycle of uninformed lending begins again.”
