newliterature review crises

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Chapter 2: Literature Review

2.2) Time Line of Crises

Latin American debt crisis1980

Israel Bank stock crisis1983

Black Monday1987

US Savings and Loan Crises1989-91

Japanese Asset Price Bubble Collapsed1990

Scandinavian Banking Crises,Swedish

Banking Crises,Finnish Banking Crises

1990's

Black Wednesday1992-93

Economic Crises in Mexico1994-95

Asian Financial Crises1997

Russian Financial Crises1998

Turkish Crises2000

Early 2000 Recession2001

Argentine Crises2001

Bursting of dot-com bubble2001

Financial Crises of 2007-082007

Icelandic financial Crises2008

European sovereign Debt Crises2010


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2.3) Brief of Major Crises

2.3.1) 1980- Latin American Debt Crises

In Latin America, banking crises emerged in the wake of the external debt crisis in1982. Where policymakers did not respond to banking problems with stringent fiscal

and monetary policies and bank regulators did not put disciplined bank restructuringprograms in place, Moreover, even where policymakers managed the crisis by followingappropriate policies, resolving banking crises took four or five years and required

major adjustments in the real economy. (Weisbrod, 1996).

In the 1960s and 1970s many Latin American countries, notably Brazil, Argentina,and Mexico, borrowed huge sums of money from international creditors forindustrialization; especially infrastructure programs. These countries had soaringeconomies at the time so the creditors were happy to continue to provide loans.Initially, developing countries typically garnered loans through public routes like theWorld Bank. After 1973, private banks had an influx of funds from oil-rich countries

and believed that sovereign debt was a safe investment. (Ferraro, 1994).

Between 1975 and 1982, Latin American debt to commercial banks increased at acumulative annual rate of 20.4 percent. This heightened borrowing led Latin Americato quadruple its external debt from $75 billion in 1975 to more than $315 billion in1983, or 50 percent of the region's gross domestic product (GDP). Debt service (interestpayments and the repayment of principal) grew even faster, reaching $66 billion in

1982, up from $12 billion in 1975. (The Debt Crisis in Latin America)

When the world economy went into recession in the 1970s and 80s, and oil pricesskyrocketed, it created a breaking point for most countries in the region. Developingcountries also found themselves in a desperate liquidity crunch. Petroleum exportingcountries flush with cash after the oil price increases of 1973-74 invested theirmoney with international banks, which 'recycled' a major portion of the capital as

loans to Latin American governments. (Ferraro, 1994).

As interest rates increased in the United States of America and in Europe in 1979,debt payments also increased making it harder for borrowing countries to pay back

their debts (Schaeffer)(http://www.pearsonhighered.com/assets/hip/us/hip_us_pearsonhighered/samplech

apter/0205742343.pdf)

Deterioration in the exchange rate with the US dollar meant that Latin Americangovernments ended up owing tremendous quantities of their national currencies, aswell as losing purchasing power. (Cristina & Garca, 1991)

While the dangerous accumulation of foreign debt occurred over a number of years,the debt crisis began when the international capital markets became aware that Latin

America would not be able to pay back its loans. (Dullum)(http://www.wright.edu/~tdung/asiancrisis-hill.htm) (Pastor).


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This occurred in August 1982 when Mexico's Finance Minister, Jesus Silva-Herzogdeclared that Mexico would no longer be able to service its debt. (Pastor)

(http://www.sfmyologie.org/logs/mortgage/mortgage-calculator-extra-payment.html)

They say that the cause of the crisis was leverage limits such as U.S. governmentbanking regulations which forbid its banks from lending over ten times the amount oftheir capital, a regulation that, when the inflation eroded their lending limits, forced

them to cut the access of underdeveloped countries to international savings. (Kanitz).

In response to the crisis most nations abandoned their import substitutionindustrialization (ISI) models of economy and adopted an export-orientedindustrialization strategy, usually the neoliberal strategy encouraged by the IMF,though there are exceptions such as Chile and Costa Rica who adopted reformiststrategies.(http://www.dailyfx.com/forex/fundamental/article/guest_commentary/2013/01/28

/Guest_Commentary_Trade_Balance_Threatens_European_Miracle.html?view=m)(Bresser-Pereira, 2009)

A massive process of capital outflow, particularly to the United States, served todepreciate the exchange rates, thereby raising the real interest rate. Real GDP growthrate for the region was only 2.3 percent between 1980 and 1985, but in per capita

terms Latin America experienced negative growth of almost 9 percent.

2.3.1.1) Reasons

1. Petrodollar Recycling by Commercial Banks to Developing Countries Gave Rise

to the Debt Crisis.

Most observers believe the "petrodollar recycling" of the 1970s gave rise to the debtcrisis. During that period, the price of oil rose dramatically. Oil-exporting countries inthe Middle East deposited billions of dollars in profits they received from the price hikein U.S. and European banks. Commercial banks were eager to make profitable loansto governments and state-owned entities (as well as private companies) in developingcountries, using the dollars flowing from the Middle Eastern countries. Developingcountries, particularly in Latin America, were also eager to borrow relatively cheap

money from the banks. (Carrasco)

2. Decreased Exports and High Interest Rates in the Early 1980s Caused Debtor

Countries to Default on Their Foreign Loans.

The frenzied lending and borrowing came to a halt with the global recession in theearly 1980s. The significant drop in debtor countries' exports, combined with a strongdollar, (i.e., the value of the dollar increased relative to the value of other currencies)and high global interest rates, depleted foreign exchange reserves that debtor countriesrelied upon for international financial transactions.

(http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)


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Debtor countries consequently began to feel the strain of having to make timelypayments on their foreign debt, which became much more expensive to pay offbecause the loans carried floating interest rates that increased along with global rates.These problems were compounded by massive capital flight - outward transfers ofmoney by private individuals and entities in developing countries. In August 1982,

Mexico stunned the financial world by declaring that it could no longer continue to payits foreign debt. Not long after Mexico's declaration came similar announcements fromother Latin American debtor countries, such as Brazil, Venezuela, Argentina, andChile. The prospect of massive defaults posed grave problems for creditor countries,such as the United States. Government regulators discovered that commercial bankcreditors, particularly the big U.S. ("money center") banks, had dangerously low levelsof capital that could be used to absorb losses resulting from massive loan defaults.Policymakers were also worried that there was no central authority or forum thatcould oversee an orderly resolution of the crisis, such as a global bankruptcy system.

(Carrasco) (http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)3. Case-by-Case Debt Restructuring Negotiations Saved the International

Financial System from Collapse.

Yet the principal players in the crisis - governments, banks, the IMF and the WorldBank - averted a collapse of the international financial system by resorting to case-by-case debt restructuring negotiations, popularly known as the "muddling through"approach. The approach entailed engaging in a series of work-outs with hundreds ofcommercial bank creditors throughout the world via Bank Advisory Committees or

Steering Committees, which were composed of banks with the greatest exposures todebtor countries. (Work-outs for government-to-government lending took place underthe auspices of the Paris Club, a forum open only to sovereign states.) Under thisapproach, commercial banks agreed to (i) provide new loans to debtor countries, and(ii) stretch out external debt payments. In return, debtor countries agreed to abide byIMF and World Bank stabilization and structural adjustment programs intended tocorrect domestic economic problems that gave rise to the crisis. IMF stabilizationprograms typically included drastic reductions in government pending in order toreduce fiscal deficits, a tight monetary policy to curb inflation, and steep currencydevaluations in order to increase exports. World Bank structural adjustment programsfocused on longer-term and deeper "structural" reforms in debtor countries. (Carrasco)(http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)

4. "Debt Fatigue" Appeared in the Mid-1980s

After a few years of repeated restructuring deals, "debt fatigue" began to appear. Newloans to debtor countries plummeted as commercial bank creditors contemplated thepossibility that debtor countries were facing insolvency rather than a temporary dropin their ability to pay back the foreign debt. In October 1985, U.S. Treasury Secretary

James Baker proposed a strategy, dubbed the Baker Plan, that attempted to alleviatethe debt fatigue. The plan was designed to renew growth in fifteen highly indebtedcountries through $29 billion in new lending by commercial banks and multilateral


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institutions in return for structural economic reforms such as privatization of state-owned entities and deregulation of the economy. The strategy failed, however, becausethe projected financing did not materialize and, to the extent it did, the new lendingmerely added to debtor countries' already crushing debt burden.During this period,Latin American debtor countries were making massive net outward transfers of

resources In light of what appeared to be an intractable problem, government officials,academics, and private entities began to propose plans that would provide debtorcountries with debt reliefrather than debt restructuring. In the meantime, variousdebtor countries suspended debt payments and fell out of compliance with, orotherwise refused to adopt, IMF adjustment programs. This eventually prompted thebig creditor banks to admit publicly (by adding to "loan loss reserves") that many of the

loans to debtor countries would not be repaid. (Carrasco)

5. The Brady Initiative in 1989 Focused on Debt Reduction Strategies.

The Brady Initiative, announced in March 1989 by U.S.Treasury Secretary Nicholas F.Brady, marked a change in U.S. policy towards the debt crisis. Given the persistentlyhigh levels of foreign debt, the Initiative shifted the focus of the strategy from increasedlending to voluntary, market-based debt reduction (reduction of outstanding principal)and debt service reduction (reduction of interest payments) in exchange for continuedeconomic reform by debtor countries. (Carrasco)

Debtor countries obtained significant (but not massive) debt relief under the BradyInitiative through: (i) direct cash buybacks; (ii) exchange of existing debt for "discountbonds" (bonds issued by the debtor country with a reduced (discounted) face value but

carrying a market rate of interest); (iii) exchange of existing debt for "par bonds" (bondsthat carry the same face value as the old loans but carry a below-market interest rate);and (iv) interest rate reduction bonds (bonds that initially carry a below-marketinterest rate that rises eventually to the market rate). Commercial bank creditors thatdid not wish to participate in a debt or debt service reduction option could choose togive debtor countries new loans or receive bonds created from interest payments owedby debtor countries. Debtor countries sweetened the deals by providing"enhancements," such as principal and interest collateral (U.S. Treasury bonds)

(Carrasco)

6. Brady Deals Combined with Economic Reforms and Increased Flows of Capital

to Debtor Countries Led Some Observers in the Early 1990s to Declare that the

Debt Crisis was Over.

Commercial bank creditors agreed to Brady deals with a good handful of countries,including Argentina, Costa Rica, Mexico, Nigeria, the Philippines, Venezuela, Uruguayand Brazil. In the meantime, Latin American countries implemented substantialeconomic reforms. In 1991, the region registered capital inflows that exceeded outflowsfor the first time since the onset of the debt crisis. This led some observers to proclaim

that the debt crisis was over for major Latin American debtor countries. (Carrasco)

2.3.2) Israel Bank stock crisis


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The Bank stock crisis was a financial crisis that occurred in Israel in 1983, duringwhich the stocks of the four largest banks in Israel collapsed, and

were nationalized by the state.

2.3.2.1) Background

During the 1970s, Bank Hapoalim, and its dominant manager, Yaakov Levinson,began trying to control the bank's stock price in the Tel Aviv Stock Exchange. To thisend they recommended to their customers to invest in the bank's stocks. Theseinvestments allowed the bank to increase its available capital for investments, loans,etc. To get customers to continue investing in the bank's stock, the bank began buyingback its own stock, thus creating the appearance of constant demand for the stock,and constantly increasing its value. The bank also gave out generous loans to allow

the customers to continue their investments, also profiting from the interest.

These manipulations, or adjustments of the stock prices, by artificially creatingdemand, seemed to the other banks like a good way of procuring capital from thepublic, and they slowly adopted the practice as well. Eventually all major banksmanipulated their stock price this way, among them Bank Leumi, DiscountBank, Bank Igud, Bank HaMizrachi, and Bank Clali (General Bank, nowU-Bank). Theonly prominent bank not to join the adjustments frenzy was HaBank

HaBinleumi (a.k.a. the First International Bank of Israel - FIBI).

The adjustments were performed through the use of other companies. For example,Bank Leumi used the "Holdings and Development of The Jewish Colonial

Trust Company". The funding for these actions originated in loans from the bank'spension funds and similar sources. Sometimes the banks would practice mutualpurchases - one bank would sell its stocks to a second bank, and buy the second

bank's stocks for a similar sum.

Under the pressure of the Israeli Securities and Exchange Commission, the banksreported the adjustments in their reports, but these reports were partial, misleading,and sometimes even false. Toward their clients the bank's acted in manner laterdescribed by the Beisky Commission as based in their own interests, ignoring the

clients' interests.

The adjustment were made possible, in large part, due the banks' unique ownershipstructure. Bank Hapoalim was controlled by the Histadrut labor union's WorkersCompany (Hevrat HaOvdim) and Bank Leumi by the "Jewish Colonial Trust".The Hapoel HaMizrachi organisation had almost none of Bank HaMizrachi's stocks,but all of its control shares. The owners' representatives were usually members of theruling political parties (especially Alignment, and the National Religious Party, or closeto them). The banks' managers ran the banks for owners who understood little ofbanking, and did not involve themselves in these actions. The fourth major bank to

join this practice, Discount Bank, was held by the Recanatti Family. Its head, RafaelRecanatti joined the adjustments practice reluctantly, unable to resist the temptation.They later continued the adjustments, unable to stop.
http://en.wikipedia.org/wiki/Bank_Leumihttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/Union_Bank_of_Israelhttp://en.wikipedia.org/wiki/Bank_Mizrahi-Tfahothttp://en.wikipedia.org/w/index.php?title=Bank_Clali&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=U-Bank&action=edit&redlink=1http://en.wikipedia.org/wiki/First_International_Bank_of_Israelhttp://en.wikipedia.org/wiki/First_International_Bank_of_Israelhttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/Israel_Securities_Authorityhttp://en.wikipedia.org/wiki/Beisky_Commissionhttp://en.wikipedia.org/wiki/Histadruthttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/Hapoel_HaMizrachihttp://en.wikipedia.org/wiki/Alignment_(political_party)http://en.wikipedia.org/wiki/National_Religious_Partyhttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/National_Religious_Partyhttp://en.wikipedia.org/wiki/Alignment_(political_party)http://en.wikipedia.org/wiki/Hapoel_HaMizrachihttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/Histadruthttp://en.wikipedia.org/wiki/Beisky_Commissionhttp://en.wikipedia.org/wiki/Israel_Securities_Authorityhttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/Jewish_Colonial_Trusthttp://en.wikipedia.org/wiki/First_International_Bank_of_Israelhttp://en.wikipedia.org/wiki/First_International_Bank_of_Israelhttp://en.wikipedia.org/w/index.php?title=U-Bank&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Bank_Clali&action=edit&redlink=1http://en.wikipedia.org/wiki/Bank_Mizrahi-Tfahothttp://en.wikipedia.org/wiki/Union_Bank_of_Israelhttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/Israel_Discount_Bankhttp://en.wikipedia.org/wiki/Bank_Leumi


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Also contributing to the possibility of the adjustment was the capital structure of theIsraeli market. During the years following the establishment of the State of Israel, thegovernments used the banks as a channel for procuring capital, and instructed themon how to invest their funds. This level of control, coupled with the control of interestrates, allowed the government to effectively "print money", by getting the banks to buy

government bonds. Additionally, the banks usually assumed that since theirinvestments and loans in major players of the Israeli market, such as the Kibutzim,were according to the government's wishes, the government would guarantee these

loans.

Due to these reasons, the banks believed they could act as they pleased, withoutfearing the consequences. The banks used the adjustments to get "easy money" byissuing more and more stocks, until, during the 1980s, the banks' stocks accountedfor more than 90% of all issued stocks in the stock market. They used the capital thusgained to give out loans and invest, often without due inspection of the debtor's

creditworthiness. Also, the banks grew exponentially, building hundreds of newbranches and hiring thousands of new employees. The banks' managers paidthemselves lavish salaries, and expended money based on the banks' nominal profits,completely unrelated to their real profits.

The large banks got addicted to the easy capital, but this method soon became a trap.Like the government, fearing recession, the banks avoided any move to limit theirexpenses. They feared for the pockets and jobs of the managers, but also the fact thatthe first bank to make such a move would appear inferior compared to the other

banks.All of the regulatory bodies were well aware of the adjustments regime, but aside fromslight warnings, easily dismissed by the banks' managers, did nothing, failing even towarn the public. The Minister of the Treasury, Aridor, even remarked on television that

had he had the funds to do so, he would invest in the stock market.

The adjustments were based in the promise of a constant rise in the banks' stockprices, irrelevant of the economic situation. The artificial prices thus achieved createdan Economic bubble, where everyone involved continued investing growing sums of

money for lesser returns. Every new issue of bank stocks further destabilized them,since more of the capital was invested in maintaining the adjustment regime, insteadof profitable loans. Also, as the bank stock market share grew, the adjustment becameweaker, as every cent (Agora, actually) invested by them became a smaller part of the

total invested capital.

The real gain (i.e. over and above the Consumer price index) by investing in the banks'stocks diminished, from a 41% gain in 1980, to 34% in 1981, to 28% in 1982. Otherinvestment options, especially purchasing US Dollars became more appealing, and thebanks had to transfer more and more funds from their offshore tax havens to keep

maintaining the illusion of safety of investing in their stocks.
http://en.wikipedia.org/wiki/Kibutzimhttp://en.wikipedia.org/wiki/Economic_bubblehttp://en.wikipedia.org/wiki/Agorahttp://en.wikipedia.org/wiki/Consumer_price_indexhttp://en.wikipedia.org/wiki/US_Dollarhttp://en.wikipedia.org/wiki/US_Dollarhttp://en.wikipedia.org/wiki/Consumer_price_indexhttp://en.wikipedia.org/wiki/Agorahttp://en.wikipedia.org/wiki/Economic_bubblehttp://en.wikipedia.org/wiki/Kibutzim


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2.3.2.2) Crisis

In the beginning of 1983, a crisis occurred in the free stock market (all the non-bankstocks), and large supplies in all market sectors forced the banks to invest very large

sums of money maintaining their stocks' stability. During the months of Januarythrough March some regulators, among them the Minister of Treasury, Aridor, and theGovernor of the Bank of Israel, Mendelbaum, approached the banks several times,trying to get them to gradually reduce their adjustments. Although some bankmanagers realized they could not continue this for long, they did not stop. Fearing amarket collapse, Ministry of Treasury officials kept knowledge of this from the public.

Failing to stop the banks, Ministry of Treasury heads wished to execute alarge devaluation of the Shekel, serving as an excuse to stop the adjustments.However, the August 8% devaluation was far too small for that end. Additionally, thesupplies in the stock market grew steadily, and reached new heights in September.

The public unremittingly sold bank stocks, and purchased US Dollars.

The crisis erupted fully on October 2. That day, the first day of trade after the Sukkotholiday, the public sold more bank stocks than in the entire month of September. OnOctober 4, the Minister of Treasury appeated on television saying "We will not let thepublic dictate our moves", to say the large supplies would not bring about a

devaluation or change of policy.

During those years the public trust in the Minister of Treasury's promises was nonexistent. Most of the public assumed the Minister would lie at any time, and gave noattention to his statements. Most of all, Aridor's denial made it clear that at this pointthe public was dictating the government's moves.

Later Aridor met with the banks' managers, who demanded the government limit thepublic's purchases of US Dollars, and allow it only for plane tickets. They assumedthat without an option to save the money themselves, due to the high inflation, thepublic would be forced to invest in the banks' stocks. Even if their thesis was correct,one can assume such a move would only fuel the panic, and exacerbate the current

crisis.

On October 5, the stock exchange again opened with large numbers of sell offers, andon October 6, 1983, nicknamed "Black Thursday", was an onslaught of sales. It wasclear a collapse was a matter of days at most, since the banks declared that day they

would be unable to absorb additional supplies without government assistance.

That night, in a meeting in Aridor's home, it was decided that the government wouldpurchase the banks' stocks from the public, to prevent the loss of their investments.On Sunday, October 9, the stock exchange remained closed, and stayed closed till

October 24. In the meantime a devaluation of 23% was executed. The stocks sold bythe public were bought by the Bank of Israel at an average loss of 17%. 35% of thestocks' value was lost.
http://en.wikipedia.org/wiki/Bank_of_Israelhttp://en.wikipedia.org/wiki/Devaluationhttp://en.wikipedia.org/wiki/US_Dollarhttp://en.wikipedia.org/wiki/US_Dollarhttp://en.wikipedia.org/wiki/Devaluationhttp://en.wikipedia.org/wiki/Bank_of_Israel


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2.3.2.3) Results

The immediate consequences of the crisis were the loss of a third of the public'sinvestments in them, the acquisition of the banks by the government, at a total cost of6.9 billion US Dollars (for reference, Israel's entire Gross Domestic Product in 1983was about US$27 billion), and the nationalization of the major banks (Leumi,Hapoalim, HaMizrachi, Discount, and Clali).

Beisky Commission

Following the scandal, in 1984, the State Comptroller issued a report on the crisis,causing the State Review Committee of the Knesset, on January 7, 1985, to decide onestablishing a national commission of inquiry. Heading the commission was Judge

Moshe Biesky. The commission presented its findings on April 16, 1986.

The Beisky Commission came to the conclusion that the October 1983 crisis was a

direct result of the stock adjustment. The commission pointed to four criminal offensesallegedly performed during the adjustment: financing and giving loans for thepurchase of bank stock by the banks themselves; fraud and deceit of the client to getthem to purchase stocks; conditioning one service on another; and perjury before the

commission.

Following the commission's conclusions, and after a long struggle, the banks'managers were dismissed, but no criminal charges were brought against them, asthere was no "public interest" in that, according to the State's Attorney. In 1990 theSupreme Court decided to bring to trial the banks' managers, and the accountants

who lied to the commission.

The commission's report states the regulatory bodies acted negligently and

irresponsibly, but there were no recommendations for actions against them.

On the administrative side, the commission concluded that investmentrecommendation should be separated from ownership, that is, the banks should beseparated from the Pension Funds and Trust Funds. These recommendations were notexecuted, due to the banks' pressure, and the government's conflict of interest, as the

banks' owner at the time.The government later sold some of the banks to private investors, selling BankHapoalim in 1996, HaMizrachi in 1998. The government also sold a major part of its

stock in Discount bank in 2006, and of Leumi in 2005.

In the early years of the 21st century, some of the commission's recommendationswere finally put into place. After all four banks were sold by the mid-2000s, therecommendations of the subsequent Bach'ar commission, which reached the sameconclusions regarding separating the banks' depository and investment banking/fund

management operations as the Beisky commission's were finally carried out as well. Itmay be argued that the timing of the crisis may have also had some additional positiveeffect as the implementation of the subsequent tough banking regulations and
http://en.wikipedia.org/wiki/Gross_Domestic_Producthttp://en.wikipedia.org/wiki/State_Comptroller_of_Israelhttp://en.wikipedia.org/wiki/Beisky_Commissionhttp://en.wikipedia.org/wiki/Beisky_Commissionhttp://en.wikipedia.org/wiki/State_Comptroller_of_Israelhttp://en.wikipedia.org/wiki/Gross_Domestic_Product


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reforms, albeit somewhat belatedly, were put in place just in time to help Israeli banksavert many of the problems experienced by banks in many other Western countriesduring the late-2000s financial crisis by limiting Israeli banks' exposure to riskyactivities. This helped ensure a stable domestic banking sector which contributedsignificantly to the relative resilience of the Israeli economy in face of the late-2000s

recession.

(Blass, A. and Grossman, R. (2001), ASSESSING DAMAGES: THE 1983 ISRAELI BANK

SHARES CRISIS. Contemporary Economic Policy, 19: 4958.)

Black Monday

In finance,Black Monday refers to Monday October 19, 1987, when stockmarkets around the world crashed, shedding a huge value in a very short time. The

crash began in Hong Kong and spread west to Europe, hitting the United States afterother markets had already declined by a significant margin. The Dow Jones IndustrialAverage (DJIA) dropped by 508 points to 1738.74 (22.61%). (Browning, E.S. (2007-10-15). "Exorcising Ghosts of Octobers Past". The Wall Street Journal (Dow Jones &

Company). pp. C1C2. Retrieved 2007-10-15)

2.3.3.1) Market effects

By the end of October, stock markets in Hong Kong had fallen45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.45%, the United States

22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, fallingabout 60% from its 1987 peak, and taking several years to recover. (Share Price Index,1987-1998, Commercial Framework: Stock exchange, New Zealand Official Yearbook

2000. Statistics New Zealand, Wellington. Accessed 2007-12-12)

(The terms Black Monday and Black Tuesday are also applied to October 28 and 29,1929, which occurred after Black Thursday on October 24, which started the StockMarket Crash of 1929. In Australia and New Zealand the 1987 crash is also referred toas Black Tuesday because of the timezone difference.) The Black Monday decline was

the largest one-day percentage decline in the Dow Jones. (Saturday, December 12,1914, is sometimes erroneously cited as the largest one-day percentage decline of theDJIA.

In reality, the ostensible decline of 24.39% was created retroactively by a redefinitionof the DJIA in 1916. (Setting the Record Straight on the Dow Drop". New York Times.1987-10-26).

Following the stock market crash, a group of 33 eminent economists from variousnations met in Washington, D.C. in December 1987, and collectively predicted that

the next few years could be the most troubled since the 1930s (Group of 7, Meet theGroup of 33". The New York Times. 1987-12-26) However, the DJIA was positive forthe 1987 calendar year. It opened on January 2, 1987 at 1,897 points and closed on
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December 31, 1987 at 1,939 points. The DJIA did not regain its August 25, 1987

closing high of 2,722 points until almost two years later.

2.3.3.2) Timeline

In 1986, the United States economy began shifting from a rapidly growing recovery to

a slower growing expansion, which resulted in a "soft landing" as the economy slowedand inflation dropped. The stock market advanced significantly, with the Dow peakingin August 1987 at 2722 points, or 44% over the previous year's closing of 1895points.On October 14, the DJIA dropped 95.46 points (a then record) to 2412.70, andfell another 58 points the next day, down over 12% from the August 25 all-time high.On Friday, October 16, when all the markets in London were unexpectedly closed dueto the Great Storm of 1987, the DJIA closed down another 108.35 points to close at2246.74 on record volume. American Treasury Secretary James Baker stated concernsabout the falling prices. That weekend many investors worried over their stock

investments.The crash began in Far Eastern markets the morning of October 19. Laterthat morning, two U.S. warships shelled an Iranian oil platform in the Persian Gulf inresponse to Iran's Silkworm missile attack on the U.S. flagged ship MV Sea Isle City.(Motley Fool's Black Monday 10th Anniversary 1987 Timeline". 1997-10-19. Retrieved

2007-10-15)

2.3.3.3) Causes

Potential causes for the decline include program trading, overvaluation, illiquidity,and market psychology.The most popular explanation for the 1987 crash was selling

by program traders. U.S. Congressman Edward J. Markey, who had been warningabout the possibility of a crash, stated that "Program trading was the principalcause. In program trading, computers perform rapid stock executions based onexternal inputs, such as the price of related securities. Common strategiesimplemented by program trading involve an attempt to engagein arbitrage and portfolio insurance strategies. The trader Paul Tudor Jones predictedand profited from the crash, attributing it to portfolio insurance strategies which were"an accident waiting to happen" and that the "crash was something that was eminentlyforecastable". Once the market started going down, portfolio insurance futures sellers

were "forced to sell on every down-tick" so the "selling would actually cascade insteadof dry up".As computer technology became more available, the use of program tradinggrew dramatically within Wall Street firms.

After the crash, many blamed program trading strategies for blindly selling stocks asmarkets fell, exacerbating the decline. Some economists theorizedthe speculative boom leading up to October was caused by program trading, and thatthe crash was merely a return to normalcy. Either way, program trading ended uptaking the majority of the blame in the public eye for the 1987 stock market crash.NewYork University's Richard Sylla divides the causes into macroeconomic and internal

reasons. Macroeconomic causes included international disputes about foreignexchange and interestrates, and fears about inflation.
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The internal reasons included innovations with index futures and portfolio insurance.I've seen accounts that maybe roughly half the trading on that day was a smallnumber of institutions with portfolio insurance. Big guys were dumping their stock.Also, the futures market in Chicago was even lower than the stock market, and peopletried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in

the New York cash market. It made it hard -- the portfolio insurance people were alsotrying to sell their stock at the same time

Economist Richard Roll believes the international nature of the stock market declinecontradicts the argument that program trading was to blame. Program tradingstrategies were used primarily in the United States, Roll writes. Markets whereprogram trading was not prevalent, such as Australia and Hong Kong, would not havedeclined as well, if program trading was the cause. These markets might have beenreacting to excessive program trading in the United States, but Roll indicatesotherwise. The crash began on October 19 in Hong Kong, spread west to Europe, and

hit the United States only after Hong Kong and other markets had already declined bya significant margin.

Another common theory states that the crash was a result of a dispute in monetarypolicy between the G7 industrialized nations, in which the United States, wanting toprop up the dollar and restrict inflation, tightened policy faster than the Europeans.U.S. pressure on Germany to change its monetary policy was one of the factors thatunnerved investors in the run-up to the crash. The crash, in this view, was causedwhen the dollar-backed Hong Kong stock exchange collapsed, and this caused a crisis

in confidence.Some technical analysts claim that the cause was the collapse of the US and Europeanbond markets, which caused interest-sensitive stock groups like savings & loans andmoney center banks to plunge as well. This is a well documented inter-marketrelationship: turns in bond markets affect interest-rate-sensitive stocks, which in turnlead the general stock market turns. (Annelena, Lobb (2007-10-15). "Looking Back atBlack Monday:A Discussion With Richard Sylla". The Wall Street Journal Online (Dow

Jones & Company). Retrieved 2007-10-15.)

2.3.4) US Savings and Loan Crises

The savings and loan crisis of the 1980s and 1990s (commonly dubbed the S&Lcrisis) was the failure of about 747 out of the 3,234 savings and loan associations inthe United States. A savings and loan or "thrift" is a financial institution that accepts

savings deposits and makes mortgage, car and other personal loans to individualmembersa cooperative venture known in theUnited Kingdom as a Building Society.
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"As of December 31, 1995, RTC estimated that the total cost for resolving the 747failed institutions was $87.9 billion." The remainder of the bailout was anticipated tobe paid for by charges on saving and loan accounts. (Financial Audit: Resolution TrustCorporation's 1995 and 1994 Financial Statements" (PDF). U.S. General AccountingOffice. July 1996. pp. 8, 13)

William K. Black wrote that Paul Volcker as Chairman of the Federal Reserve helpedcreate a criminogenic environment for the Savings and Loans in 1979 by doubling theinterest rate (to reduce inflation): S&Ls made long-term loans at fixed interest usingshort-term money. When the interest rate increased, the S&Ls could not attractadequate capital and became insolvent. Rather than admit to insolvency, some CEOsof S&Ls became "reactive" control frauds by inventing creative accounting strategiesthat turned their businesses into Ponzi schemes that looked highly profitable, therebyattracting more investors and growing rapidly, while actually losing money. The pushof the Reagan administration for deregulation made it harder to detect such fraud.This had two effects: it meant that the fraud continued longer and substantiallyincreased the economic losses involved, and it attracted "opportunistic" controlfrauds who were looking for businesses they could subvert into Ponzi schemes. Forexample, Charles Keating paid $51 million from Michael Milken's junk bond operationfor Lincoln Savings and Loan, which at the time had a negative net worth exceeding$100 million.

2.3.4.1) Background

The thrift industry has its origins in the British building society movement thatemerged in the late 18th century. American thrifts (known then as "building andloans" or "B&Ls") shared many of the same basic goals: to help working-class men andwomen save for the future and purchase homes. Thrifts were not-for-profit cooperativeorganizations that were typically managed by the membership and local institutionsthat served well-defined groups of aspiring homeowners. While banks offered a widearray of products to individuals and businesses, thrifts often made only homemortgages primarily to working-class men and women. Thrift leaders believed theywere part of a broader social reform effort and not a financial industry. According to

thrift leaders, B&Ls not only helped people become better citizens by making it easierto buy a home, they also taught the habits of systematic savings and mutualcooperation which strengthened personal morals. ( "Savings and Loan Industry, US".EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003)

The first thrift was formed in 1831, and for 40 years there were few B&Ls, found inonly a handful ofMidwestern and Eastern states. This situation changed in the late19th century as urban growth and the demand for housing related to the SecondIndustrial Revolution caused the number of thrifts to explode. The popularity of B&Lsled to the creation of a new type of thrift in the 1880s called the "national" B&L. The"nationals" were often for-profit businesses formed by bankers or industrialists thatemployed promoters to form local branches to sell shares to prospective members. The
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"nationals" promised to pay savings rates up to four times greater than any otherfinancial institution.

The Depression of 1893 (the Panic of 1893) caused a decline in members, and so"nationals" experienced a sudden reversal of fortunes. Because a steady stream of new

members was critical for a "national" to pay both the interest on savings and thehefty salaries for the organizers, the falloff in payments caused dozens of "nationals" tofail. By the end of the 19th century, nearly all the "nationals" were out of business(National Building and Loans Crisis). This led to the creation of the first stateregulations governing B&Ls, to make thrift operations more uniform, and theformation of a national trade association to not only protect B&L interests, but alsopromote business growth. The trade association led efforts to create more uniformaccounting, appraisal, and lending procedures. It also spearheaded the drive to haveall thrifts refer to themselves as "savings and loans" not B&Ls, and to convincemanagers of the need to assume more professional roles as financiers. ( "Savings andLoan Industry, US". EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003)

In the 20th century, the two decades that followed the end ofWorld War II were themost successful period in the history of the thrift industry. The return of millions ofservicemen eager to take up their prewar lives led to a dramatic increase in newfamilies, and this "baby boom" caused a surge in new mostly suburban homeconstruction. By the 1940s S&Ls (the name change occurred in the late 1930s)provided most of the financing for this expansion. The result was strong industryexpansion that lasted through the early 1960s.

An important trend involved raising rates paid on savings to lure deposits, a practicethat resulted in periodic rate wars between thrifts and even commercial banks. Thesewars became so severe that in 1966 the United States Congress took the highlyunusual move of setting limits on savings rates for both commercial banks and S&Ls.From 1966 to 1979, the enactment of rate controls presented thrifts with a number ofunprecedented challenges, chief of which was finding ways to continue to expand in aneconomy characterized by slow growth, high interest rates and inflation. Theseconditions, which came to be known as stagflation, wreaked havoc with thrift finances

for a variety of reasons. Because regulators controlled the rates thrifts could pay onsavings, when interest rates rose depositors often withdrew their funds and placedthem in accounts that earned market rates, a process known as disintermediation. Atthe same time, rising rates and a slow growth economy made it harder for people toqualify for mortgages that in turn limited the ability to generate income ( "Savings andLoan Industry, US". EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003)

In response to these complex economic conditions, thrift managers came up withseveral innovations, such as alternative mortgage instruments and interest-bearingchecking accounts, as a way to retain funds and generate lending business. Suchactions allowed the industry to continue to record steady asset growth and profitabilityduring the 1970s even though the actual number of thrifts was falling. Despite such
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growth, there were still clear signs that the industry was chafing under the constraintsof regulation. This was especially true with the large S&Ls in the western U.S. thatyearned for additional lending powers to ensure continued growth. Despite severalefforts to modernize these laws in the 1970s, few substantive changes were enacted.

In 1979, the financial health of the thrift industry was again challenged by a return ofhigh interest rates and inflation, sparked this time by a doubling of oil prices. Becausethe sudden nature of these changes threatened to cause hundreds of S&L failures,Congress finally acted on deregulating the thrift industry. It passed two laws,the Depository Institutions Deregulation and Monetary Control Act of 1980 andthe GarnSt. Germain Depository Institutions Act of 1982. The deregulation not onlyallowed thrifts to offer a wider array of savings products (including adjustable ratemortgages, which fixed one important problem), but also significantly expanded theirlending authority and reduced supervision, which invited fraud.[5]These changes wereintended to allow S&Ls to "grow" out of their problems, and as such represented thefirst time that the government explicitly sought to increase S&L profits as opposed topromoting housing and homeownership. Other changes in thrift oversight includedauthorizing the use of more lenient accounting rules to report their financial condition,and the elimination of restrictions on the minimum numbers of S&L stockholders.Such policies, combined with an overall decline in regulatory oversight (knownas forbearance), would later be cited as factors in the collapse of the thrift industry.

2.3.4.2) Causes

Tax Reform Act of 1986

By enacting 26 U.S.C. 469 (relating to limitations on deductions for passive activitylosses and limitations on passive activity credits) to remove many tax shelters,especially for real estate investments, the Tax Reform Act of 1986 significantlydecreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability. This contributed to the end of

the real estate boom of the early-to-mid-1980s and facilitated the Savings and Loancrisis.[6]Prior to 1986, much real estate investment was done by passive investors. Itwas common for syndicates of investors to pool their resources in order to invest inproperty, commercial or residential. They would then hire management companies torun the operation. TRA 86 reduced the value of these investments by limiting theextent to which losses associated with them could be deducted from the investor'sgross income. This, in turn, encouraged the holders of loss-generating properties to tryto unload them, which contributed further to the problem of sinking real estate values.

Deregulation
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The deregulation ofS&Ls in 1980 gave them many of the capabilities of banks, withoutthe same regulations as banks. Savings and loan associations could choose to beunder either a state or a federal charter. Immediately after deregulation of the federallychartered thrifts, state-chartered thrifts rushed to become federally chartered, becauseof the advantages associated with a federal charter. In response, states such

as California and Texas changed their regulations to be similar to federal regulations. (Akerlof, G. A.; Romer, P. M. (1993). "Looting: The Economic Underworld of Bankruptcyfor Profit". Brookings Papers on Economic Activity (2): 173. JSTOR 2534564)

Imprudent real estate lending

In an effort to take advantage of the real estate boom (outstanding U.S. mortgageloans: 1976 $700 billion; 1980 $1.2 trillion) and high interest rates of the late 1970sand early 1980s, many S&Ls lent far more money than was prudent, and to ventureswhich many S&Ls were not qualified to assess, especially regarding commercial real

estate. L. William Seidman, former chairman of both the Federal Deposit InsuranceCorporation (FDIC) and the Resolution Trust Corporation, stated, "The bankingproblems of the '80s and '90s came primarily, but not exclusively, from unsound realestate lending. ( "Lessons of the Eighties: What Does the Evidence Show?" (PDF).FDIC. September 18, 1996)

Brokered deposits

Deposit brokers, somewhat like stockbrokers, are paid a commission by the customer

to find the best certificate of deposit (CD) rates and place their customers' money inthose CDs. Previously, banks and thrifts could only have five percent of their depositsbe brokered deposits; the race to the bottom caused this limit to be lifted. A small one-branch thrift could then attract a large number of deposits simply by offering thehighest rate. To make money off this expensive money, it had to lend at even higherrates, meaning that it had to make more, riskier investments. This system was madeeven more damaging when certain deposit brokers instituted a scam known as "linkedfinancing." In "linked financing", a deposit broker would approach a thrift and say hewould steer a large amount of deposits to that thrift if the thrift would lend certain

people money. The people, however, were paid a fee to apply for the loans and told togive the loan proceeds to the deposit banker.

End of inflation

Another factor was the efforts of the Federal Reserve to wring inflation out of theeconomy, marked by Paul Volcker's speech of October 6, 1979, with a series of rises inshort-term interest rates. This led to a scenario in which increases in the short-termcost of funding were higher than the return on portfolios of mortgage loans, a largeproportion of which may have been fixed rate mortgages (a problem that is known as

an asset-liability mismatch). Interest rates continued to rise, placing even morepressure on S&Ls as the 1980s dawned and led to increased focus on high interest-
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rate transactions. Zvi Bodie, professor of finance and economics at BostonUniversity School of Management, writing in the St. Louis Federal

Reserve Reviewwrote, "asset-liability mismatch was a principal cause of the Savingsand Loan Crisis". ( Bodie, Zvi. "On Asset-Liability Matching and Federal Deposit andPension Insurance." Federal Reserve Bank of St. Louis Review. July/August 2006,

88(4), pp. 323-29)

Major causes according to United States League of Savings Institutions

The following is a detailed summary of the major causes for losses that hurt thesavings and loan business in the 1980s. (Strunk, Norman; Case, Fred (1988). WhereDeregulation went Wrong: a Look at the Causes behind Savings and Loan Failures inthe 1980s. Chicago: United States League of Savings Institutions. pp. 1516. ISBN 0-929097-32-7 9780929097329 Check |isbn= value (he)

Lack of net worth for many institutions as they entered the 1980s, and a whollyinadequate net worth regulation.

Decline in the effectiveness ofRegulation Q in preserving the spread between the costof money and the rate of return on assets, basically stemming from inflation and the

accompanying increase in market interest rates.

Absence of an ability to vary the return on assets with increases in the rate of interestrequired to be paid for deposits.

Increased competition on the deposit gathering and mortgage origination sides of thebusiness, with a sudden burst of new technology making possible a whole new way ofconducting financial institutions generally and the mortgage business specifically.

Savings and Loans gained a wide range of new investment powers with the passage ofthe Depository Institutions Deregulation and Monetary Control Act and the GarnSt.Germain Depository Institutions Act. A number of states also passed legislation thatsimilarly increased investment options. These introduced new risks and speculativeopportunities which were difficult to administer. In many instances managementlacked the ability or experience to evaluate them, or to administer large volumes of

nonresidential construction loans.

Elimination of regulations initially designed to prevent lending excesses and minimizefailures. Regulatory relaxation permitted lending, directly and through participations,in distant loan markets on the promise of high returns. Lenders, however, were notfamiliar with these distant markets. It also permitted associations to participateextensively in speculative construction activities with builders and developers who had

little or no financial stake in the projects.

Fraud and insider transaction abuses.

A new type and generation of opportunistic savings and loan executives and ownerssome of whom operated in a fraudulent manner whose takeover of many
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institutions was facilitated by a change in FSLIC rules reducing the minimum number

of stockholders of an insured association from 400 to one.

Dereliction of duty on the part of the board of directors of some savings associations.This permitted management to make uncontrolled use of some new operatingauthority, while directors failed to control expenses and prohibit obvious conflict ofinterest situations.

A virtual end of inflation in the American economy, together with overbuilding inmultifamily, condominium type residences and in commercial real estate in manycities. In addition, real estate values collapsed in the energy states Texas, Louisiana, and Oklahoma particularly due to falling oil prices and

weakness occurred in the mining and agricultural sectors of the economy.

Pressures felt by the management of many associations to restore net worth ratios.Anxious to improve earnings, they departed from their traditional lending practicesinto credits and markets involving higher risks, but with which they had little

experience.

The lack of appropriate, accurate, and effective evaluations of the savings and loan

business by public accounting firms, security analysts, and the financial community.

Organizational structure and supervisory laws, adequate for policing and controllingthe business in the protected environment of the 1960s and 1970s, resulted in fataldelays and indecision in the examination/supervision process in the 1980s.

Federal and state examination and supervisory staffs insufficient in number,experience, or ability to deal with the new world of savings and loan operations.

The inability or unwillingness of the Bank Board and its legal and supervisory staff todeal with problem institutions in a timely manner. Many institutions, which ultimatelyclosed with big losses, were known problem cases for a year or more. Often, it

appeared, political considerations delayed necessary supervisory action.

Major causes and lessons not learned

In 2005, Former bank regulator William K. Black listed a number of lessons thatshould have been learned from the S&L Crisis that have not been translated intoeffective governmental action:

Fraud matters, and control frauds pose unique risks.

It is important to understand fraud mechanisms. Economists grossly underestimateits prevalence and impact, and prosecutors have difficulties finding it, even without

the political pressure from politicians who receive campaign contributions from thebanking industry.
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Control fraud can occur in waves created by poorly designed deregulation that creates

a criminogenic environment.

Waves ofcontrol fraud cause immense damage.

Control frauds convert conventional restraints on abuse into aids to fraud.

Conflicts of interest matter.

Deposit insurance was not essential to S&L control frauds.

There are not enough trained investigators in the regulatory agencies to protectagainst control frauds.

Regulatory and presidential leadership is important.

Ethics and social forces are restraints on fraud and abuse.

Deregulation matters and assets matter.

The SEC should have a chief criminologist.

Control frauds defeat corporate governance protections and reforms.

Stock options increase looting by control frauds.

The "reinventing government" movement should deal effectively with control frauds

2.3.4.2) Failure

The United States Congress granted all thrifts in 1980, including savings and loanassociations, the power to make consumer and commercial loans and to issuetransaction accounts. Designed to help the thrift industry retain its deposit base andto improve its profitability, the Depository Institutions Deregulation and MonetaryControl Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20percent of their assets, issue credit cards, accept negotiable order of

withdrawal accounts from individuals and nonprofit organizations, and invest up to 20percent of their assets in commercial real estate loans.

The damage to S&L operations led Congress to act, passing the Economic RecoveryTax Act of 1981 (ERTA) in August 1981 and initiating the regulatory changes bythe Federal Home Loan Bank Board allowing S&Ls to sell their mortgage loans and usethe cash generated to seek better returns soon after enactment, the losses created bythe sales were to be amortized over the life of the loan, and any losses could also beoffset against taxes paid over the preceding 10 years. This all made S&Ls eager to sell

their loans. The buyersmajor Wall Street firmswere quick to take advantage of theS&Ls' lack of expertise, buying at 60%-90% of value and then transforming the loansby bundling them as, effectively, government-backed bonds (by virtue ofGinnie
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Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls were one group buying thesebonds, holding $150 billion by 1986, and being charged substantial fees for thetransactions.

In 1982, the Garn-St Germain Depository Institutions Act was passed and increased

the proportion of assets that thrifts could hold in consumer and commercial real estateloans and allowed thrifts to invest 5 percent of their assets in commercial loans untilJanuary 1, 1984, when this percentage increased to 10 percent. (Pub.L. 9734,Economic Recovery Tax Act of 1981, 95 Stat. 172, H.R. 4242, 13 August 1981, Title II,97th Congress)

A large number of S&L customers' defaults and bankruptcies ensued, and the S&Lsthat had overextended themselves were forced into insolvency proceedings themselves.

The Federal Savings and Loan Insurance Corporation (FSLIC), a federal government

agency that insured S&L accounts in the same way the Federal Deposit InsuranceCorporation insures commercial bank accounts, then had to repay all the depositorswhose money was lost. From 1986 to 1989, FSLIC closed or otherwise resolved 296institutions with total assets of $125 billion. An even more traumatic period followed,with the creation of the Resolution Trust Corporation in 1989 and that agencysresolution by mid-1995 of an additional 747 thrifts.

A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up beingeven larger than it would have been because moral hazard and adverse

selection incentives that compounded the systems losses.

There also were state-chartered S&Ls that failed. Some state insurance funds failed,requiring state taxpayer bailouts.

Home State Savings Bank of Cincinnati

In March 1985, it came to public knowledge that the large Cincinnati, Ohio-based Home State Savings Bank was about to collapse. Ohio Gov. DickCeleste declared a bank holiday in the state as Home State depositors lined up in a

"run" on the bank's branches to withdraw their deposits. Celeste ordered the closure ofall the state's S&Ls. Only those that were able to qualify for membership in the FederalDeposit Insurance Corporation were allowed to reopen.Claims by Ohio S&L depositorsdrained the state's deposit insurance funds. A similar event involving Old CourtSavings and Loans took place in Maryland.

Midwest Federal Savings & Loan of Minneapolis, Minnesota

Midwest Federal Savings & Loan was a federally chartered savings and loan based in

Minneapolis, Minnesota until its failure in 1990. TheSt. Paul Pioneer Presscalled thebank's failure the "largest financial disaster in Minnesota history.
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The chairman, Hal Greenwood Jr., his daughter, Susan Greenwood Olson, and twoformer executives, Robert A. Mampel, and Charlotte E. Masica, were convicted ofracketeering that led to the institution's collapse. The failure cost taxpayers $1.2billion.

Presumably the Megadeth song "Foreclosure of a Dream" was written about thisparticular failure. Megadeth's then bassist Dave Ellefson contributed lyrics to the songafter his family's farm in Minnesota was in jeopardy of being lost as a result of the S&Lfinancial crisis.

Lincoln Savings and Loan

The Lincoln Savings led to the Keating five political scandal, in which five U.S.senators were implicated in an influence-peddling scheme. It was named for CharlesKeating, who headed Lincoln Savings and made $300,000 as political contributions to

them in the 1980s. Three of those senatorsAlan Cranston (D-CA), Don Riegle (D-MI),and Dennis DeConcini (D-AZ)found their political careers cut short as a result. TwoothersJohn Glenn (D-OH) and John McCain (R-AZ)were rebuked by the SenateEthics Committee for exercising "poor judgment" for intervening with the federalregulators on behalf of Keating.

Silverado Savings and Loan

Silverado Savings and Loan collapsed in 1988, costing taxpayers $1.3 billion. Neil

Bush, son of then Vice President of the United States George H. W. Bush, was on theBoard of Directors of Silverado at the time. Neil Bush was accused of giving himself aloan from Silverado, but he denied all wrongdoing.

The U.S. Office of Thrift Supervision investigated Silverado's failure and determinedthat Neil Bush had engaged in numerous "breaches of his fiduciary duties involvingmultiple conflicts of interest." Although Bush was not indicted on criminal charges, acivil action was brought against him and the other Silverado directors by the FederalDeposit Insurance Corporation; it was eventually settled out of court, with Bushpaying $50,000 as part of the settlement, theWashington Postreported.

As a director of a failing thrift, Bush voted to approve $100 million in what wereultimately bad loans to two of his business partners. And in voting for the loans, hefailed to inform fellow board members at Silverado Savings & Loan that the loanapplicants were his business partners.

Neil Bush paid a $50,000 fine, paid for him by Republican supporters, and wasbanned from banking activities for his role in taking down Silverado, which costtaxpayers $1.3 billion. A Resolution Trust Corporation Suit against Bush and other

officers of Silverado was settled in 1991 for $26.5 million.
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2.3.4.3) Financial Institutions Reform, Recovery and Enforcement Act of 1989

As a result of the savings and loan crisis, Congress passed the Financial InstitutionsReform, Recovery and Enforcement Act of 1989 (FIRREA) which dramatically changedthe savings and loan industry and its federal regulation. The highlights of the

legislation, signed into law August 9, 1989, were:

The Federal Home Loan Bank Board (FHLBB) and the Federal Savings and LoanInsurance Corporation (FSLIC) were abolished.

The Office of Thrift Supervision (OTS), a bureau of the United States TreasuryDepartment, was created to charter, regulate, examine, and supervise savings

institutions.

The Federal Housing Finance Board (FHFB) was created as an independent agency to

replace the FHLBB, i.e. to oversee the 12 Federal Home Loan Banks (also calleddistrict banks) that represent the largest collective source of home mortgage andcommunity credit in the United States.

The Savings Association Insurance Fund (SAIF) replaced the FSLIC as an ongoinginsurance fund for thrift institutions (like the FDIC, the FSLIC was a permanentcorporation that insured savings and loan accounts up to $100,000). SAIF is

administered by the Federal Deposit Insurance Corp.

The Resolution Trust Corporation (RTC) was established to dispose of failed thrift

institutions taken over by regulators after January 1, 1989. The RTC will makeinsured deposits at those institutions available to their customers.

FIRREA gives both Freddie Mac and Fannie Mae additional responsibility to supportmortgages for low- and moderate-income families.

2.3.4.4) Consequences

While not part of the savings and loan crisis, many other banks failed. Between 1980and 1994 more than 1,600 banks insured by the Federal Deposit Insurance

Corporation (FDIC) were closed or received FDIC financial assistance.

From 1986 to 1995, the number of federally insured savings and loans in the UnitedStates declined from 3,234 to 1,645. This was primarily, but not exclusively, due tounsound real estate lending.

The market share of S&Ls for single family mortgage loans went from 53% in 1975 to30% in 1990. U.S. General Accounting Office estimated cost of the crisis to aroundUSD $160.1 billion, about $124.6 billion of which was directly paid for by the U.S.government from 1986 to 1996. That figure does not include thrift insurance fundsused before 1986 or after 1996. It also does not include state run thrift insurancefunds or state bailouts.
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The federal government ultimately appropriated $105 billion to resolve the crisis. Afterbanks repaid loans through various procedures, there was a net loss to taxpayers ofapproximately $124 billion by the end of 1999.

The concomitant slowdown in the finance industry and the real estate market may

have been a contributing cause of the 19901991 economic recession. Between 1986and 1991, the number of new homes constructed dropped from 1.8 to 1 million, thelowest rate since World War II.

Some commentators believe that a taxpayer-funded government bailout related tomortgages during the savings and loan crisis may have created a moral hazard andacted as encouragement to lenders to make similar higher risk loans during the 2007subprime mortgage financial crisis.

2.3.5)Japanese Asset Price Bubble Collapsed

The Japanese asset price bubble was an economic bubble in Japan from 1986 to1991, in which real estate and stock prices were greatly inflated.The bubble'ssubsequent collapse lasted for more than a decade with stock prices initially bottomingin 2003, although they would descend even further amidst the global crisis in 2008.The Japanese asset price bubble contributed to what some refer to as the Lost Decade.Some economists, such as Paul Krugman, have argued that Japan fell into a liquiditytrap during these years.(http://fhayashi.fc2web.com/Prescott1/Postscript_2003/hayashi-prescott.pdf).

2.3.5.1) History

In the decades following the Second World War, Japan implemented stringent tariffsand policies to encourage people to save their income. With more money in banks,loans and credit became easier to obtain, and with Japan running large tradesurpluses, the yen appreciated against foreign currencies. This allowed localcompanies to invest in capital resources much more easily than their competitorsoverseas, which reduced the price of Japanese-made goods and widened the tradesurplus further. And, with the yen appreciating, financial assets became very lucrative.One of the major reasons for the sudden appreciation of the yen was the Plaza Accord.(Saxonhouse, Gary and Stern, Robert (Eds) (2004) Japan's Lost Decade: Origins,Consequences and Prospects for Recovery (World Economy Special Issues), Wiley-Blackwell)

So much money readily available for investment, combined with financial deregulation,overconfidence and euphoria about the economic prospects, and monetary easingimplemented by the Bank of Japan in late 1980s resulted in aggressive speculation,particularly in the Tokyo Stock Exchange and the real estate market. The Nikkei stock

index hit its all-time high on December 29, 1989 when it reached an intra-day high of
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