; 3 1 Γ««BUSINESS, Page 68Special Report: The Savings And Loan Crisis Finally, the Bill Has Come DueBush puts forth a thrift-industry bailout plan that couldcost $200 billion during the next three decades, but is itenough to solve the problem?By BARBARA RUDOLPH
"You know, George, I feel that in a small way we're doing
something important, satisfying a fundamental urge. It's deep in
the race for a man to want his own roof and walls and fireplace.
And we're helping him get these things . . ."
-- Peter Bailey to his son George in It's a Wonderful Life
In the 1946 film, George Bailey took that advice to heart and,
despite the requisite dramatic difficulties, made his family's
building and loan association a pillar of the community. But in
real life, the outcome has been much different. America's failed
savings and loans have become the country's biggest, most
scandalous financial mess. Devastated by a legacy of bad
management, rampant fraud and inept Government supervision, more
than 500 of the 3,150 federally insured thrifts had fallen into
insolvency as of the beginning of last year. Because the U.S.
failed to own up to the problem and launch a major rescue soon
enough, the cost has now grown higher than almost anyone had
imagined. Says Michigan Democrat Donald Riegle, chairman of the
Senate Banking Committee: "We've never faced a problem of this
scale. The answers aren't going to be happy ones."
Last week President Bush came forward with a long-awaited
bailout plan in which he sought to spread around the unhappiness
in an evenhanded way. Said Bush: "Nothing is without pain when you
come to solve a problem of this magnitude." His program will
require taxpayers and S & Ls to share the burden of a rescue that
will cost an estimated $126 billion during the next decade. The
taxpayer portion would amount to about $60 billion, which would be
contained in the federal budget over the next ten years. The
Government would borrow $50 billion by issuing 30-year bonds to be
repaid through revenues collected from S & Ls. Including the
interest expense, half of which will be borne by taxpayers, the
total package could cost $200 billion or more over the course of
three decades.
The Government is obliged to spend $40 billion to cover bailout
cases to which federal regulators are already committed, including
205 savings and loans that the Government closed or sold last year.
The $50 billion bond issue would be spent to liquidate or auction
off the remaining 300 or more insolvent savings and loans. Those
failing thrifts will be isolated from the rest of the industry by
bringing them under a new agency called the Resolution Trust Corp.,
which will oversee their cleanup.
Besides rounding up all that cash, Bush proposes to reform the
system that supervises the thrift industry and insures its
deposits. The main regulatory agency, the Federal Home Loan Bank
Board, which has been accused of being too chummy with
thrift-industry leaders, will be replaced by one chairman who will
answer to the Treasury Secretary. The exhausted Federal Savings and
Loan Insurance Corp., which guarantees deposits, will be overseen
by its healthier and better-staffed counterpart for the banking
industry, the Federal Deposit Insurance Corp. Banks and thrifts
have traditionally had separate regulators and roles: S & Ls
specialized in taking long-term savings deposits and issuing
residential mortgages, while banks typically held shorter-term
accounts and concentrated on making commercial loans.
In his budget speech on Thursday night, Bush called on Congress
to approve his proposal within 45 days. "We must not let this
situation fester," he said. "Any plan to refinance the system must
be accompanied by major reform." For the most part, his proposal
found bipartisan support. Said Iowa Republican Jim Leach, a member
of the House Banking Committee: "In his first inning, Bush has
stepped up and hit a home run." Another member of the committee,
New York Democrat Charles Schumer, said that Bush deserves "a heck
of a lot of credit for bellying up to the bar and putting a real
plan on the table." Most Washington insiders think the bill will
move quickly. "This package is a speeding bullet. The lobbyists
will try to put a few of their own nicks in it, but really it is
just a blur," said Kenneth Guenther, executive vice president of
the Independent Bankers Association of America.
One widespread early complaint was that Administration
officials, notably Budget Director Richard Darman, were using
sleight of hand to downplay the bailout's true cost. Darman
originally seemed to say that the cost to taxpayers would total
about $40 billion in the first decade, but that number in fact
described only how much the plan would aggravate budget deficits.
The actual spending from general revenues would be closer to $60
billion. But purely from an accounting standpoint, its impact will
be offset by $20 billion in increased insurance-premium fees to be
collected from the banking industry -- even though the funds will
be earmarked for future banking bailouts rather than for cleaning
up the thrifts.
Moreover, financial consultants pointed out that the
Administration was projecting the cost of the rescue based on the
rosy scenario of a robust economy, declining interest rates and
fast-growing thrift deposits. Over the next decade, taxpayers may
have to shoulder rescue costs that are tens of billions more
dollars than now expected. Yet even those who recognized the Bush
plan's shortcomings praised it as the best and boldest solution so
far.
A primary objective of such a sweeping rescue was to restore
the confidence of thrift depositors, some of whom have withdrawn
their savings in fear of the system's insolvency. In fact, the
Administration secretly feared a long-shot possibility that the
drama of its bailout might spark a run on S & L deposits. To
prepare for that dire prospect, senior White House officials and
Federal Reserve Board Chairman Alan Greenspan met in the Roosevelt
Room of the White House the night before Bush's plan was made
public. Greenspan agreed that the Fed would stand ready to pump
billions of dollars in emergency loans into threatened thrifts.
In the end, depositors stayed calm, even though some chafed at
the idea of the cost of the bailout. "Honestly, it's the stupidest
thing I've heard," said Leroy Scrues, a Detroit retiree. "Why
should the public be paying for these rich peoples' mistakes?" Yet
legislators and savers were relieved that Bush repudiated a
proposal that his Administration had floated two weeks earlier: to
levy a fee -- 25 cents for each $100 of deposits -- on all insured
accounts. That ploy was widely seen as a tax in everything but
name. The short-lived proposal was so distasteful that it made
Bush's new plan seem all the more palatable. Said Fred Dorey, a Los
Angeles medical statistician: "We were going to pay for it one way
or another. At least the banks have to pay some too. It's a fair
deal."
The healthy portion of the thrift industry will pay its share
through an increase in its insurance premiums. The rate would rise
from the current $2.08 per $1,000 of deposits to $2.30 from 1991
until 1994, after which it would decline to $1.80. The rate for
banks would increase too, from 83 cents per $1,000 to $1.20 in 1990
and $1.50 thereafter. Even though both industries' insurance funds
would be administered by the FDIC, their proceeds will be kept
separate.
One reason for raising the banking industry's fees as part of
the rescue package is to ensure that they do not obtain too much
of a competitive advantage over thrifts in terms of their costs of
doing business. Another reason is simply to bolster the banking
industry's reserve fund so that it does not run into the same
problems encountered by the FSLIC. In the end, at least some of the
increased costs will probably be passed along to consumers, since
thrift profits are already squeezed. Said Texas Democrat Henry
Gonzalez, chairman of the House Banking Committee: "The little
consumer will pay in the form of higher fees on checking accounts,
new fees for automatic tellers and a myriad of other charges."
The thrift industry seemed to meet the proposal with grudging
acceptance but a fair amount of grumbling. Healthy S & Ls object
philosophically to paying excessive cleanup costs for their
fraudulent and incompetent brethren. Says Adam Jahns, chairman of
Chicago's Craigin Federal Savings & Loan: "I don't think we should
have to pay for serious crimes committed by others." Another
complaint by S & Ls is that by combining thrift and banking
supervision, the Bush plan may blur the distinction between the two
and eventually remove any competitive advantage the thrifts still
have, principally the ability to borrow long-term funds from
federal Home Loan banks. Commercial banks are restricted to taking
shorter-term loans from Federal Reserve banks. Besides paying
higher premiums under the Bush plan, S & L owners would be required
to follow stricter accounting rules and to boost their reserve
capital from 3% of assets to 6%.
Bankers were miffed too about being tied up with the S & Ls.
The symbolic point of contention was the trusted FDIC decal that
banks display prominently on their premises and in their
advertising. The Administration at first told thrift owners that
they would be able to display the symbol under the new plan. To
many depositors, the seal represents greater safety and security
than the thrift industry's own logo. Bankers therefore vociferously
oppose sharing the FDIC seal, maintaining that it would be
effectively tarnished if given to the thrifts and would lead to the
complete merging of the two insurance funds. By week's end, the
Administration had backed away from its promise of the seal to the
S & L industry.
The FDIC wasted no time in wielding its new authority over the
thrifts. Within a day after the Bush announcement, the Government
agency took charge of four insolvent S & Ls and three days later
assumed control of six more. The agency intends to take over the
224 most hopelessly insolvent S & Ls within the next month. The
FDIC also decided to freeze temporarily all negotiations for the
sale of ailing thrifts. Last year the FSLIC completed a flurry of
deals -- 34 in December alone -- in an effort to offer investors
tax breaks that expired on Dec. 31. Because of the rich payoffs
guaranteed to investors in those deals, they were highly
controversial. Said L. William Seidman, chairman of the FDIC:
"Before we go forward, we are going to evaluate, along with the
FSLIC, where we stand."
Seidman said talks with investors will resume after the FDIC
takes control of the remaining insolvent S & Ls. But since the FDIC
said it would then allow only deals that were supported by the cash
of the FSLIC -- a fund that is currently bankrupt -- more
Government-assisted sales would seem unlikely. The FDIC might also
try to renegotiate some of last year's sweet deals.
When the huge cost of the cleanup hit home last week, so did
a strong sentiment in favor of pursuing the fraudulent thrift
owners who made off with the loot. Regulators have estimated that
at least one in every four S & L failures has been the result of
fraud. In fact, the Bush rescue plan proposes to give the Justice
Department an additional $50 million a year for probing S & L
fraud, a sum that would pay for 200 new investigators and 100 more
prosecutors.
Even so, in testimony before the Senate Banking Committee last
week, Attorney General Richard Thornburgh said most of the lost
money is long gone. "In many cases, the assets have been dissipated
through laundering schemes or taken out of the country, and are
beyond the reach of federal authorities," he said. "We'd be fooling
ourselves to think that any substantial portion of these assets is
going to be recovered." Besides the money that was simply stolen,
billions of dollars were lost on high-risk investments and
frittered away by paying excessively high interest rates to attract
depositors.
How did the S & Ls arrive at such a sorry state? Traditionally,
running a thrift was a relatively tranquil business. S & L managers
used to follow what was known as the 3-6-3 rule: pay depositors 3%,
lend money at 6% and tee up at the golf course by 3 p.m. When
interest rates remained stable, the strategy worked well. But by
the late 1970s, thrifts began steadily losing depositors to the new
money-market funds, which were not covered by deposit insurance and
paid higher interest rates.
Thrift executives pressured Congress to let them fight back.
In 1980 Congress lifted restrictions on interest rates that S & Ls
could pay. But regulators waited a year before freeing the other
side of the balance sheet by allowing S & Ls to grant
adjustable-rate mortgages. The delay left the thrifts in a bind,
because interest rates had rocketed from 13% at the end of 1979 to
more than 20% a year later. Thrifts were collecting interest rates
of around 8% or less on their 30-year mortgages, while paying
double-digit interest to new depositors. During 1981 some 85% of
all S & Ls were losing money.
Interest rates eventually eased, but other problems arose.
Congress passed a sweeping deregulatory law in 1982 that permitted
S & Ls to make loans for a raft of new businesses. At the same
time, some states allowed their locally chartered thrifts to run
wild. Suddenly no venture was too farfetched: ethanol plants, wind
farms, Las Vegas casinos and commuter airlines. S & L managers who
were accustomed to making simple residential mortgages were ill
prepared to evaluate the new kinds of credit risks. The great
mistake in deregulation was not so much the easing of rules but the
failure of the federal and state governments to boost supervision
at the same time.
A perverse trait among shaky S & Ls has been their tendency to
get further and further into what one bank regulator
euphemistically calls "deep yogurt," in part because they must
offer higher interest rates than their competitors to keep
attracting savings. Big-time depositors flock to these S & Ls,
knowing that they cannot lose because the Government will guarantee
deposits up to $100,000. In that sense, Congress contributed to the
FSLIC's liability in 1980, when it raised the coverage limit from
$40,000.
Troubled S & Ls are heavily concentrated in Texas and
California, where state thrift regulations were loose and local
economies had booms and busts. Many Texas thrift owners who pumped
money into energy ventures when oil sold for $29 per bbl. in 1983
saw their collateral collapse in value when prices plummeted below
$10 in 1986. In California some thrifts invested in real estate
markets that became glutted, including Los Angeles office towers
and Beverly Hills condominiums.
The overall losses would have been vastly smaller if Government
regulators had seized control of insolvent S & Ls years ago. In
1983 the cost of the bailouts was estimated at only $10 billion.
But the FSLIC never had enough cash simply to close down the
thrifts and pay off the depositors. The Bank Board lobbied Congress
for more money, but the politically powerful thrift industry
consistently opposed such requests, along with almost any proposal
to rein in the S & Ls.
Edwin Gray, chairman of the Bank Board from 1983 to 1987,
bitterly accuses congressional leaders of bowing to industry
pressure. He claims that S & L lobbyists tried to coerce him by
warning that his future career in the business would be ruined if
he opposed them. One of the biggest defenders of S & L liberties
was Texan Jim Wright, now Speaker of the House. Wright has been
under investigation by the House Ethics Committee, which has been
trying to determine whether he used "undue influence" in dealing
with officials of the Bank Board.
Instead of liquidating insolvent S & Ls, regulators decided it
would be cheaper and more expedient to sell them to private
investors or merge them with healthy thrifts. Bank Board Chairman
M. Danny Wall sharply stepped up the tempo of such sales last year,
selling or liquidating more than 200 thrifts at an estimated cost
to the Government of $39 billion in tax breaks and other incentives
extended to the buyers. Critics contend that the regulators were
taken for a ride. Fumed Iowa's Leach: "The dealmakers are laughing
all the way to the piggy bank." But Wall staunchly defends his
deals as the lesser of evils. "I much prefer to be damned for
having done something than to be damned for doing nothing," he
says. In fact, the cleanup is showing some results. The thrift
industry's 1988 third-quarter loss of $1.6 billion was down from
$3.9 billion in each of the previous two quarters.
Will thrifts ever thrive again? By blurring the distinction
between banks and thrifts, the President's rescue plan prompts many
banking experts to wonder whether the U.S. needs a separate S & L
industry anymore. Thrifts hold about one-third of all U.S.
mortgages, down from nearly 60% some 20 years ago. Says Laurence
Fink, a partner in the Blackstone Group, an investment firm that
is acquiring several S & Ls: "The average homeowner can get a
mortgage without stepping inside an S & L. Maybe the thrifts have
outlived their usefulness."
The thrift industry that survives the coming decade will
probably look very different from what it is today. Says Jonathan
Gray, who follows the industry for the Sanford C. Bernstein
investment firm: "If there's one word to describe the industry's
future, it's turmoil." Gray envisions a severe industry shake-out.
In just a decade, he points out, the number of U.S. thrifts has
already fallen from 4,200 to less than 3,000. By the late 1990s,
he predicts, there will be just 1,000 left.
The S & L business will never be as peaceful as it once was.
Surviving thrifts will have to compete with powerful rivals and
satisfy a far more sophisticated customer than they did in the
past. But if the industry shakes off its con artists and recaptures
its basic prudence, those thrifts that remain might still do George
