S&Ls, Big Banks and Other Triumphs of Capitalism
IT STARTED WITH CARTER
Keeping in mind Woodrow Wilson's remark, skip down eleven presidencies and we come to Jimmy Carter, the first in a series of betrayals, the fake populist who as much as any President in history put the government at the disposal of the first group on Wilson's list, the big bankers. As Michael Harrington later observed, Carter came to power with a background that shared "so many of the prejudices and premises of the corporate ideology" that he "could not, and would not, effectively oppose it when it became militantly conservative in the late seventies."
The nation had been given its first warning of what to expect from Carter when, during the 1976 campaign, Bert Lance, whose Georgia bank was a crucial financial backer of Carter, told the press his friend had proved in Georgia politics that "he campaigns liberal but he governs conservative." Sure enough, as a candidate he promised that unemployment would be his top priority, but as soon as he was elected he switched and said "winning business confidence" was more important. He vowed that he would immediately push for the deregulation of the banks.
To drive that point home, shortly after taking office he sent Lance to meet with twenty-eight representatives from some of the nation's largest financial institutions to promise that Carter would help them in any way he could. Columnists Evans and Novak reported that "Lance's rhetoric was as impeccably orthodox as William Simon's, if not Andrew Mellon's." But rhetoric was not enough for the bankers. A year later Walter Hoadley, chief economist for the Bank of America, said, "The fear across America--and it's just beneath the surface--is that there will be a redistribution of income and wealth. The Carter administration has become a symbol of that fear."
If such fear indeed existed among bankers, it was surely dispelled in 1979, when Carter, acting on the advice of David Rockefeller, appointed Paul Volcker to chair the Federal Reserve Board. It was a natural recommendation for Rockefeller to make. Volcker was a notoriously well-trained guard dog for the Eastern money establishment, having been a Chase Manhattan banker, a Treasury official in the Johnson and Nixon administrations and head of the Federal Reserve Bank of New York. Wall Street and the international banking fraternity loved him. They hated inflation--bankers don't like to be repaid in money that is softer than the money they lend, even if the softer money makes the economy hum--and they knew that Volcker was mean enough to destroy the economy to save the hardness of their dollars.
Because Carter had refused to use government controls, rising oil prices had helped drive inflation to uncomfortable heights (13 percent). Wall Street and the big banks were convinced, as financial writer Leonard Silk put it, that "nothing would be so good for the market and the economy as a minor recession--stiff enough to reduce inflation and the trade deficit, although not so steep as to disrupt business plans for new investment or to wreck prospects for strongly rising profits in the next expansion." The faith of Wall Street and the big banks was well placed. Only Volcker didn't stop with a nice little recession. He created a killer.
R. Dan Brumbaugh Jr., former deputy chief economist at the Federal Home Loan Bank Board, is among the many who trace the destruction of the S&Ls to Paul Volcker. "In October 1979," he writes, "the Federal Reserve made a decision with ruinous results for the thrift industry. The Federal Reserve changed from a policy of stabilizing interest rates to a policy of slowing money growth to combat inflation. This contributed to a spike in interest rates that led to an unprecedented increase in thrifts' cost of funds, which rose from under 9 percent in 1980 to more than 11 percent at the end of 1981, with almost no corresponding increase in revenues due to the preponderance of fixed-rate mortgages being held. This was the beginning of the modern thrift crisis."
Volcker tightened the money supply so much that the prime rate finally hit 20 percent. He had come into office stating flatly that "the standard of living of the average American [not the upper crust, mind you] has to decline." It did. With the high interest rates, the average American couldn't afford to buy a home or a car. Assembly lines closed down. When Volcker became chair of the Fed, unemployment was 5.7 percent; for nearly five years thereafter it averaged 8.2 percent, hitting nearly 11 percent at one time. Every percentage point stood for another million Americans out of work. In February 1982, a construction trade magazine turned its cover into a "Wanted" poster showing the faces of Volcker and the six other Fed members and charging them with "premeditated and coldblooded murder of millions of small businesses." Murdered with them were many of their creditors, hundreds of small banks. But nothing was hit harder than the savings and loan industry.
It Was a Wonderful Life
Established more than a century ago for the sole purpose of supplying home mortgages, the S&L industry had a reputation for restrained, sound management.
Although the old-fashioned S&Ls were bubbling with conflicts of interest--builders, developers, realtors, title insurance companies and all the others who would stand to benefit from home building usually had no trouble getting a seat on their boards of directors--community pressures usually maintained business decorum. Until the early 1930s, the industry got along perfectly well without any direction higher than the state governments, which chartered individual thrifts but pretty much left them to their own devices.
But when nearly 2,000 thrifts failed in the Great Depression and depositors lost $200 million, the industry, wanting to regain the public's confidence, asked the federal government to set up an agency that could hand out "seal of approval" charters. From that request came, as the authors of Inside Job write, "a federal S&L pyramid with the Federal Home Loan Bank Board in Washington at the top, twelve semi-independent regional federal home loan banks beneath it, and individual savings and loans at the base of the pyramid. Thrifts were given the option of being state or federally chartered, but those who chose a federal charter had to operate under strict federal regulations and examiners were sent to make sure they did."
Prior to the 1980s, they were examined rather strictly. But the thrifts that chose to remain under state charter were never closely regulated. However, the danger of corruption was slight. High risk was not the game of thrifts, and home mortgages did not lend themselves to fancy manipulation (as recently as 1980, 80 percent of S&L assets were in home mortgages). Hedged in by tradition and regulation, the people who ran the thrifts, whatever their ambitions, were in no position to compete with the big dogs of finance.
During the early years of the Depression the S&Ls and commercial banks received another federal crutch that increased public confidence in their stability. For the banks this was the Federal Deposit Insurance Corporation (F.D.I.C.), and for the S&Ls it was the Federal Savings and Loan Insurance Corporation (F.S.L.l.C.). Both were funded by dues paid on deposits. (State-chartered thrifts could pay their way into the F.S.L.I.C. coverage.)
But for neither thrifts nor banks was the plan supposed to do more than comfort the small investor; the insurance--which started off covering up to $5,000 per depositor and stayed at that level until well after World War II--was not aimed at protecting the high-rolling, sophisticated investor. But that suited the S&Ls just fine, before the 1980s. Their traditional customers were wage earners, not high rollers. The thrifts gave modest interest rates to depositors and charged borrowers modest interest rates. And because S&Ls seemed so bland of purpose, they never had the hard reputation of commercial banks. "Banking establishments are more dangerous than standing armies," wrote Thomas Jefferson, but thrifts never aroused that kind of fear. Indeed, until lately they have been swaddled and protected by grassroots myths of honesty.
That's why, when evidence of vast corruption in the industry began to surface in the 1980s, some members of Congress, particularly those from the hayseed regions, refused to believe that good ol' boys would do such things. As Senator David Pryor, the Arkansas Democrat, explained to New York Times reporter David Rosenbaum, "You've got to remember that each community has a savings and loan. Some have two, some have four, some have five, and each of them has seven or eight board members. They own the Chevy dealership and the shoe store. And when we saw these people, we said, gosh, these are the people who represent a dream that has worked in this country." That only shows how unobservant, if not downright stupid, members of Congress can be. At the moment Pryor was spinning that homespun story, Arkansas thrifts were trying to recover from the bad management and corruption that had given them the highest percentage of insolvencies in the nation.
Night of the Living Debt
The thrifts' solid, relatively untroubled way of life came to an end with Volcker. By cutting the supply and thereby driving up the price of money, Volcker simply paralyzed most S&Ls. Before they could lend money for mortgages, they had to have it--and they were rapidly running out of money as tens of billions of dollars were withdrawn by their customers and placed in the much-higher-yielding money market funds or government securities. Of course, the S&Ls could always borrow working capital from banks, but it was available only at enormously high rates and for short terms. To take that kind of money and lend it out at lower rates for long terms would be madness and virtually guarantee bankruptcy.
Many S&L managers were crazed enough to go that route, with the inevitable result. Others went bankrupt when the Carter-Volcker recession resulted in mortgage foreclosures. And other S&Ls, still solvent but nearly out of money, became hardly more than caretakers for old accounts. By the time Carter had finished his part in Wall Street's scorched-earth policy and retired to Plains, Georgia, two-thirds of the nation's S&Ls were losing money, and many were insolvent. A thrift is considered insolvent when losses eat up all its capital. To put it another way, for a savings and loan to be healthy, the loans and other assets on its books have to be worth more than what it owes depositors. But if an S&L makes a lot of risky loans that go bad, there may not be enough good ones left to cover all those CDs and savings accounts, and the S&L becomes technically insolvent.
Edward Kane calls these insolvent thrifts "institutional zombies" because each has "transcended its natural death from accumulated losses by the black magic of federal guarantees." These busted thrifts should have been shut down by the government and their depositors paid off without further ado. If they had been buried at the moment they stopped breathing, we would now be facing no S&L debt whatsoever. Brumbaugh argues that "if thrifts could be closed at the exact moment" they hit bottom, government "would incur only administrative costs."
William Black, the San Francisco federal home loan bank office general counsel, agrees in his own way: "If you were acting in a timely fashion from the beginning, this whole thing would never have gotten so out of hand. If you act when there's enough of a cushion, it costs the insurer nothing, because you can sell the thrift for market value."
Federal regulators sometimes waited as long as seven years before closing hopelessly insolvent S&Ls. A recent study by James Barth, another former chief economist at the F.H.L.B.B., showed that from 1980 to 1988 regulators delayed an average of two years before shutting down insolvent thrifts, although they knew that such delays allowed the busted thrifts to go on losing billions of dollars, which taxpayers would probably have to pay down the line.
Political/bureaucratic delay in closing bankrupt thrifts has been the greatest sin of the S&L scandal; allowing them to stay in business virtually gave them a mandate to operate like Charles Ponzi, the notorious swindler of the 1920s who perfected the pyramid scheme of paying interest to depositors (or investors) not from profits, since there were none, but from new deposits. To succeed, the scheme must have a steady stream of new cash, lured by "seductive promises of high returns." This is exactly what the insolvent thrifts relied on in the 1980s. And by doing so they endangered healthy thrifts by forcing them to compete with unrealistically high interest rates.