In the annals of financial crises, the Savings and Loan (S&L) crisis of the 1980s stands as a cautionary tale. At its core was a fundamental flaw in the structure of federal deposit insurance. When deposit insurance was first extended to S&Ls in 1934, it set the stage for the crisis that would unfold decades later. The trouble lay in the actuarial unsoundness of the insurance system, which failed to differentiate between the risk profiles of different S&Ls. Regardless of whether an S&L was conservative in its lending practices or engaging in riskier behavior, they all paid the same insurance premium rate.
This uniform premium rate meant that prudent S&Ls, which carefully managed their risks, were essentially subsidizing the riskier ones. Without the incentive to be cautious, some S&Ls took on increasingly speculative investments. This risk-taking behavior was exacerbated by deregulation in the industry, which loosened restrictions and oversight. As a result, many S&Ls began to invest heavily in risky real estate ventures, hoping for big returns.
The combination of flawed deposit insurance and relaxed regulations created a perfect storm. When the real estate market took a downturn in the mid-1980s, many of these risky investments went sour. S&Ls across the country found themselves saddled with bad loans and insolvent. The crisis culminated in a wave of S&L failures and a massive taxpayer-funded bailout that cost hundreds of billions of dollars. It was a stark reminder of the dangers of a flawed financial system that fails to properly assess and mitigate risks.
(Response: The S&L crisis was primarily led by the actuarial unsoundness of federal deposit insurance, which charged all S&Ls the same premium rate regardless of risk. This lack of differentiation between safe and risky institutions encouraged riskier behavior, exacerbated by deregulation. This ultimately resulted in widespread S&L failures and a costly bailout.)