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CH 8] Business 101 8-15

Figure 8.5 Consumer Lending Promoted by a Savings Bank

Source: Courtesy of Great American Bank/Ad Agency: Franklin and Associates, San Diego, CA.

consumer loan business.
Traditionally, both S&Ls and savings banks earned money by attracting savings
deposits at interest rates of perhaps six percent and then making home mortgages at 10
percent, generating a four percentage point differential to use in covering operating
costs and earning a profit. As long as this spread existed between the cost of funds and
the interest earned on loans, the thrifts prospered.
Money institutions are for profit organizations, and the majority of their profit is
derived from interest earned, and their associated costs are interest paid. Rising interest
rates during the early 1980s devastated the S&Ls, whose mission was to use short-term
deposits to make long-term, fixed-rate mortgage loans. In 1982, for example, S&Ls
were paying an average of 11.5 percent interest on their deposits while earning only
10.4 percent on their loans.
In an attempt to correct the impending disaster, Congress and many state regulatory
bodies permitted S&Ls to engage in activities never before allowed. They were
permitted to make commercial loans, engage in consumer leasing, provide trust
services, and issue credit cards. This new freedom, combined with the removal of
maximum interest levels S&Ls could pay depositors, created a monster by allowing
S&Ls to raise endless amounts of money to fund disastrous investments. For example, 8
American Diversified of Costa Mesa, California, solicited deposits by telephone,
offering interest rates of more than 8.5 percent as a lure. The thrift, headed by Ranbir
Sahni, a former pilot in the Indian Air Force, funneled these deposits into such risky
investments as wind farms and ethanol plants. When Sahni's operation and nearby
North America Savings and Loan Association were closed by federal regulators in
1988, no depositors lost money, but the federal agency guaranteeing these accounts
had to come up with $1.35 billion—the largest cash payoff in U.S. banking history.
The point is that prudent investments are a requirement for sound banking practices credit union
and profitability. Member-owned financial
cooperative that pays
Credit Unions. The nation's 5,700 federally insured credit unions serve as sources interest to depositors,
of consumer loans at competitive rates for their members. A credit union is actually a offers share draft accounts,
form of savings cooperative and is typically sponsored by a company, union, or and makes short term
professional or religious group. The credit union pays interest to its member loans and some home
mortgage loans.

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