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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

In the US savings and loan (S&L) crisis of the 1980s, thrifts held mostly long-term fixed-rate mortgages funded by short-term deposits. Which development was the immediate trigger for their widespread losses?

The trigger was a sharp rise in short-term interest rates. Thrifts funded long-term fixed-rate mortgages with short-term deposits, so their funding costs rose above asset yields, compressing margins and wiping out equity. This maturity mismatch, not a rate fall or currency issue, caused the losses.

  1. AA sharp rise in short-term interest rates that raised funding costs above the yield on their fixed-rate assetsCorrect
  2. BA sharp fall in short-term interest rates that caused mass mortgage prepayments
  3. CA collapse in credit card receivables
  4. DA currency devaluation that raised the cost of foreign deposits

Explanation

Thrifts had a duration mismatch: long-term fixed-rate assets funded by short-term liabilities. When short-term rates rose in the early 1980s, deposit costs exceeded mortgage yields, squeezing net interest margin and eroding equity. A rate fall would have helped, not hurt, such a funding structure.

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