Background Lincoln Savings and Loan (LSL) was a state-chartered, federally insured savings and loan (S&L) company. In the early 1980s, it had 30 branch offices located throughout California. During this time, the company performed average S&L operations, including making mortgage loans and getting deposits, typically from family residences. LSL’s main source of revenue came from the interest income from its loans. The loans were funded by customers’ deposits in their accounts. LSL’s main expense was the interest expense from customer deposits. Therefore, to stay profitable, the interest-rate spread between loans and deposits had to be large enough to pay their expenses and make a profit. In the late 1970s, the economic environment took a turn for the worse and the interest-rate spread got narrower and narrower, then went negative …show more content…
Inflation caused interest rates to soar. S&Ls had to honor pre-inflation fixed-rate loans with low interest rates, while also needing to promise high interest rates on deposits to attract customers. Because new interest rates on loans were so high, the demand for new mortgages dropped. Prior to 1983, S&Ls had strict regulations on their asset operations. Then in 1983, the government significantly loosened the restrictions on S&Ls with the idea that these new rules would allow the S&Ls to better balance their expense liabilities with profitable assets. Now, the new rules allowed S&Ls to make commercial loans and corporate securities, instead of just residential loans and government-backed securities. S&Ls were also allowed to start investing in real estate. Because S&Ls could now make commercial loans and invest in real estate, they became much greater competition for banks. With the deregulation, S&Ls had strong relationships with real estate developers and builders and would often lend money directly to these businesses, as opposed to the previous operation of simply working with these businesses to help supply financing to