REFERENCE – GARN ST. GERMAIN ACT

As of 1982, Congress had passed the Garn-St. Germain Depository Institutions Act. The major goal was to relieve strains on financial institutions caused by the Federal Reserve’s decision to boost interest rates to combat inflation. When the Federal Reserve began to raise deposit interest rates in the early 1980s, financial firms that had previously taken on interest rate risk by lending at low rates were hit with negative spreads.

The Monetary Control Act (MCA) had already begun the process of removing interest rate caps on bank deposit accounts when this law was passed. Today, it is generally accepted that these actions, taken together, exacerbated the Savings and Loan Crisis that hit the United States in the 1980s and 1990s.

After the Nixon government cut the final ties between the U.S. dollar and gold in the mid-1970s, inflation in the United States skyrocketed, eventually surpassing 10% by early 1980.

The pattern finally reversed in the 1980s, when interest rates were being steadily raised by the Federal Reserve under Chairman Paul Volcker. Since they were losing money on mortgage loans made in previous years when interest rates were significantly lower, traditional banks were stuck in the middle. Due to maturity mismatching—lending for the long term at low rates for mortgages and borrowing for the short term at variable rates on bank deposits—they had taken on tremendous interest rate risk. Since banks were unable to sell their fixed-rate, long-term holdings at a profit, they became illiquid.

Alongside this, the MCA phased down Fed Regulation Q for non-checking deposit accounts, which had previously prevented banks and savings and loans (S&L or thrifts) from increasing their deposit interest rates. Money market mutual fund accounts, certificates of deposit, and savings accounts saw a surge in popularity as investors and savers sought greater interest rates, while corporations devised alternatives including repurchase agreements. Banks were in a bind as the interest they paid out on deposits grew while the income they earned on existing mortgages stayed the same.

Title VIII, “Alternative Mortgage Transactions,” of the Garn-St. Germain Depository Act legalized banks’ provision of adjustable-rate mortgages. However, the act also had significant advantages for consumer real estate owners, as it enabled consumers to place mortgaged real estate in inter-vivos trusts without triggering the due-on-sale clause that permits loaners to close and accumulate the balance due on a mortgaged property when ownership of that property is conveyed. This facilitated the transfer of property to minors and heirs and permitted the wealthy to shield their assets from potential losses due to lawsuits or creditor claims.