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

In the U.S. savings and loan (S&L) crisis of the 1980s, which feature of a typical thrift's balance sheet was the main source of its losses when short-term interest rates rose sharply?

The main source of loss was a maturity mismatch: long-term fixed-rate mortgages funded by short-term deposits. When short rates rose, funding costs climbed while asset yields stayed fixed, squeezing margins and lowering the market value of the mortgage portfolio.

  1. ALong-term fixed-rate mortgage assets funded by short-term depositsCorrect
  2. BShort-term floating-rate loans funded by long-term fixed-rate bonds
  3. CLarge holdings of foreign currency assets funded by domestic deposits
  4. DEquity-heavy funding with few liabilities repriced by the market

Explanation

Thrifts held long-dated fixed-rate mortgages financed with short-term deposits. When rates rose, funding costs increased quickly while asset income stayed fixed, squeezing net interest margin and cutting the market value of the mortgages. The reverse structure in option B would benefit from rising rates.

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