Question

33. In the early 1980s, after the Federal Reserve engaged in very contractionary monetary policy and raised interest rates, Savings & Loan banks (S&Ls)

a. Became stronger since they correctly forecast that interest rates would rise

b. Were unaffected because their cost of borrowing did not change

c. Became largely insolvent due to prior maturity mismatching

d. Had not yet emerged as a prominent financial institution

Answer 1

(c)Became largely insolvent due to prior maturity mismatching.

In 1979 in an effort to curb inflation the Fedd reserve had raised the interest ates that it used to charge its member banks from 9.5 to 12%.Savings and Loans Banks(S&Ls) had already issued loans at a fixed rate which was lower than the new interest rate proposed by the Federal Reserve on top of that they had had interest liabilities on deposits that paid higher interest than the borrowing rate.This led to inadequate capital and subsequent insolvency.