Garn-St. Germain Depository Institutions Act

Introduction

The Garn-St. Germain Depository Institutions Act of 1982 is a United States federal law that significantly deregulated the savings and loan industry and allowed banks to offer adjustable-rate mortgage loans. Signed into law by President Ronald Reagan on October 15, 1982, this act was designed to ease the financial difficulties of the savings and loan industry while promoting a more competitive and resilient financial system.

Background

In the late 1970s and early 1980s, the savings and loan industry in the United States faced a series of economic difficulties. High inflation rates and prolonged periods of low-interest rates squeezed profit margins, causing severe financial strain. Traditional savings and loan institutions, which primarily issued fixed-rate mortgages funded by short-term deposits, found it exceedingly difficult to remain profitable under these conditions.

Key Provisions

Adjustable-Rate Mortgages (ARMs): One of the most significant provisions of the Garn-St. Germain Act was the authorization of adjustable-rate mortgages, providing more flexibility to savings and loans institutions. ARMs allow the interest rate on a mortgage to fluctuate periodically based on a specified index, thereby aligning the interest income on loans more closely with the market rate.
Residential Mortgage Lending: The Act allowed more lenient lending practices for residential mortgages, enabling institutions to extend terms and conditions that were previously restricted.

Title II: Deregulation of Savings Institutions

Expanding Permissible Activities: Savings institutions were allowed to diversify their services and investments, including holding commercial loans up to 10% of their assets, holding up to 40% of their assets in consumer loans or commercial paper, and investing up to 30% of their assets in activities related to real estate development and leasing.
Deposit Insurance Flexibility: Federal deposit insurance was extended to include money market deposit accounts (MMDAs) up to $2,500, which were previously not insurable.

Title III: Net Worth Certificate Program

Government Backing: The Act introduced the “Net Worth Certificate Program”, allowing federal institutions to provide capital assistance to savings and loans experiencing net worth deficiencies. This was designed to restore public confidence and prevent widespread bank failures.

Title IV: Federal Home Loan Bank Board Provisions

Supervisory Authority: Consolidated supervisory responsibilities for thrifts under the Federal Home Loan Bank Board, giving the board increased authority to intervene and manage failing institutions more effectively.

Title V: Miscellaneous Provisions

Pre-emption of Due-on-Sale Clauses: This section preempts state laws regarding due-on-sale clauses, allowing lenders the right to demand full repayment of the loan if the property securing the mortgage is sold or transferred without the lender’s consent.
Deposit Accounts: Authorized the creation of new deposit accounts that would compete with money market mutual funds - the Money Market Deposit Accounts (MMDAs).

Economic Impact

The Garn-St. Germain Act had a profound impact on the U.S. financial landscape. By deregulating significant facets of the savings and loan industry, the Act provided immediate financial relief to many institutions struggling to maintain profitability. Adjustable-rate mortgages, in particular, offered more flexible lending and borrowing terms, which were positively received by the market.

However, the increased freedom also led to riskier behavior from financial institutions, as some took advantage of the new law to engage in speculative real estate ventures and high-risk commercial loans. This activity contributed to the eventual savings and loan crisis of the late 1980s and early 1990s, where numerous institutions failed due to overleveraging and exposure to unsustainable real estate loans.

Long-Term Consequences

The advantages initially garnered by the Garn-St. Germain Act were, in many ways, overshadowed by the ensuing crisis. The explosive growth in high-risk lending and speculative investments led to increased defaults, financial instability, and, ultimately, the collapse of many savings and loan institutions. The Federal Savings and Loan Insurance Corporation (FSLIC), the body responsible for insuring savings and loans deposits, faced insurmountable liabilities, leading to its insolvency in 1989.

In response, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was enacted to address the failures and restructure the regulatory framework surrounding thrifts. FIRREA transferred regulatory authority from the Federal Home Loan Bank Board to the newly formed Office of Thrift Supervision (OTS), increased capital requirements for thrifts, and established the Resolution Trust Corporation (RTC) to manage and liquidate insolvent institutions.

Conclusion

The Garn-St. Germain Depository Institutions Act of 1982 remains a landmark piece of financial legislation. While it achieved its goals of deregulating the savings and loan industry and allowing more flexible lending practices, it inadvertently set the stage for widespread risk-taking and ultimately contributed to the financial turmoil of the late 1980s. The lessons learned from this episode continue to inform regulatory policies and underscore the delicate balance between deregulation and maintaining financial stability.