Evaluate the following statement:
Exposure to interest rate risk had little to do with the crisis in the savings and loan industry in the early 1980's.
Labels: Exam 2 Question 8
posted by Eschenfelder at 8:44 AM
Money and Banking Spring 2006
The following posts are the questions which appeared on last semester's exams. Students should use the comment sections to answer the questions and respond to the posts of other students.
Thursday, February 22, 2007
Exposure to interest rate risk had little to do with the crisis in the savings and loan industry in the early 1980's.
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Contributors
2 Comments:
I disagree with this statement. Infact,interest rate risk was the main cause of the crisis in the savings and loan industry in the early 1980’s. Interest rate risk is a mismatch in the maturities of assets and liabilities. Prior to the 1980’s, savings and loans were creating fixed rate mortgages, and paying low rates on demand deposits. As rates on demand deposits increased and mortgage rates remained the same, savings and loans were squeezed and had to engage in riskier behavior; loaning to less credit worthy individuals and investing in more risky ventures.
The exposure to interest rate risk marked the beginning of the crisis in the savings and loan industry. Small savers shifted their funds out of banks and thrifts in response to rising market interest rates. This was a big problem for S&L because they were almost entirely dependent on small savers for funds. After the abolishment of Regulation Q, S&Ls could compete for funds as money market rates rose. The bad news was that S&Ls had invested primarily in long-term (30-year) fixed-rate residential mortgages. S&Ls were stuck with these mortgages that were made in the 1970s which were earning less than 8%, while renewed short-term rates were nearly double that.
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