S&Ls, Big Banks and Other Triumphs of Capitalism
THE DEREGULATION DECEPTION
Why weren't they closed? (We're speaking now from the depths of the 1980-83 recession.) For one thing, the F.S.L.I.C. was a farcical insurance program; it had only a measly $6 billion in the kitty to pay off depositors at what Kane says were "already understood to be $100 billion worth" of insolvent thrifts. Which meant that the F.S.L.I.C., if it wanted to dispose of dead thrifts, would have to get its money through rescue legislation. But Carter, running desperately behind in his re-election campaign, wasn't interested in such minor matters as the threatened collapse of a trillion-dollar industry. And then Ronald Reagan, being ideologically retarded, wasn't either.
Perhaps the most decisive reason the busted thrifts weren't shut down was that the U.S. League of Savings Institutions, the industry lobby, was against the government's taking any action that would result in a radical shrinking of its empire. If the league's membership (around 4,000 at that time) was reduced by the number of S&Ls then or soon-to-be insolvent, it would lose its powerhouse role. So the league, the F.H.L.B.B. (which it controlled), and Congress (key parts of which it also controlled) created the great deception that the industry wasn't really stinking from dead or dying thrifts and that nothing was wrong with it that fictional bookkeeping and freedom from regulations--in other words, fraud and anarchy--couldn't cure. The rationale was that if thrifts were allowed to run their affairs any way they wanted--even as floating crap games--they could "grow out" of their distressed condition. This was a nice way of saying that if they were allowed to do some double-or-nothing gambling on some very long shots in real estate, farming, energy, junk bonds and anything else under the sun, well, just maybe they might hit it lucky enough to get back in the black.
The industry got what it wanted through a variety of hocus-pocus techniques authorized by legislation and bureaucratic fiat between 1980 and 1983. These were the chief hustlers who created the rules of the new era:
The $100,000 Man
Representative Fernand St. Germain. Here we have a politician of infinite greed who became a multimillionaire by breaking many rules and possibly several laws over the years, but he was never punished and rose to a position of great influence. Former Speaker Tip O'Neill once said of St. Germain, "I don't know a man with fewer friends in the House." But his sleaze was so generic to the House that even when all sorts of conflicts of interest had become public, the Ethics Committee went out of its way to avoid chastising him. His colleagues knew of his honest graft; the press knew too, and the voters of Rhode Island were sometimes given evidence of his sleaze. But he lasted twenty-seven years in the House, and for the last seven years was in a position to do as much damage to the financial system as any one politician could.
In the perverse rating system of Washington, St. Germain was considered a liberal. He concocted a neopopulist mask for himself by talking tough about "big banks," and introducing marginal consumer legislation and supporting subsidized housing that benefited fat-cat developers more than it helped the poor. But apparently his main goal in Congress was to get rich. The first big money he made on the side was in secret partnership with "one of the biggest developers and managers of federally subsidized housing in the Northeast," Brooks Jackson reports.
St. Germain had an impressive talent for borrowing money in sweetheart deals. He bought restaurants worth $1.3 million without putting up any money of his own; banks were afraid not to give that kind of credit to the chair of the House banking subcommittee that handled their regulations. When St. Germain became chair of the House Banking Committee in 1981, he also became, in Jackson's phrase, "the undisputed godfather of the S&L industry." As such, he got waterfront condos at bargain prices and insider deals from S&Ls. But he was not without gratitude. When the chief executive of a Florida S&L who had done big favors for him sought federal permission to restructure the ownership of his thrift, Paul Nelson, St. Germain's banking committee chief of staff, nudged the regulators through repeated phone calls.
Besides being a tax dodger--he took about $400,000 in improper tax deductions--St. Germain was a leech. "He was seen night after night in Washington eating and drinking in the company of James (Snake) Freeman, lobbyist for the U.S. League of Savings Institutions," who, assigned specifically to keep St. Germain happy, always picked up the tab, which ran between $10,000 and $20,000 a year. It was only right and proper that a gent with those credentials should have had so much to do with two pieces of legislation that incited crooks within the industry to do their worst, and encouraged crooks outside the industry to join in.
The first piece was the Depository Institutions Deregulation and Monetary Control Act of 1980. Dreamed up by the Carter Administration, it was a lousy law that went a long way toward muddling the distinctions between banks and S&Ls and corrupting the character of the latter. For one thing, it destroyed the traditional community orientation of S&Ls by killing all geographic limitations on their lending. In the good old days, S&Ls were restricted to making mortgage loans only in their immediate vicinity. No more. Now they could lend money across the country, which is why, for example, you and I now own golf courses in Texas and Florida that S&Ls in Wisconsin and Kansas and Arkansas, before going down the tubes, spent millions of dollars to build.
But the most treacherous and damaging part of the law was the provision that increased by 150 percent the F.S.L.I.C. insurance coverage of any single S&L savings deposit, moving the coverage to $100,000 from $40,000. It was a nuclear time bomb that, triggered by other rule changes in the next two years, would leave the thrift industry (and the national budget) looking like Hiroshima in 1945.
The provision, which avoided the close inspection of Congressional hearings, was sneaked in during the late-night write-up of the bill, stuck in "almost as an afterthought," one member of the House banking staff later said. More likely, suggest the authors of Inside Job, it was the long-plotted forethought of a league lobbyist, Glen Troop, who was, according to L.B.J.'s infamous aide Bobby Baker, a fast man with a bribe. Other writers lay the blame elsewhere. Martin Mayer tells us that Senator Alan Cranston, best known as Keating's highest-paid pal, cut the deal at the late-night session.
But Brooks Jackson argues persuasively that while the above rogues might have had their hands in it, the coup was St. Germain's. He writes: "The Senate had voted to raise the level only modestly, to $50,000, and the House hadn't approved any change at all. But with St. Germain taking the lead, the Senate-House conferees 'compromised' at $100,000....St. Germain slipped it into the large and complex banking bill."
Except for its placement of St. Getmain's sneak attack, Jackson's account jibes with Representative Henry Gonzalez's memory of the event. Gonzalez says there were only eleven other members on the House floor when St. Germain requested unanimous consent on several amendments to the pending banking bill. The House clerk had the only copy of St. Germain's provisions. As Gonzalez told Matthew Miller in The Washington Monthly, "There was never one minute's consideration or hearing on that increase. It took minutes--there was no debate."
Why such a radical increase? Nothing like it had ever happened before. The protection was set at $2,500 when the F.S.L.I.C. was fashioned in 1933 and raised to $5,000 in 1934. It stayed at this level until 1949, when it went to $10,000; it went to $15,000 in 1966, to $20,000 in 1969 and then to $40,000 in 1974.
Why in the world would the S&Ls want to increase coverage to $100,000? The average depositor's savings account was only $6,000 at that time. The 1980 increase was surely, as Jackson writes, "a perversion of the consumer-protection ethic that deposit insurance once embodied. At $40,000, insurance had been more than adequate to protect unsophisticated savers." St. Germain pushed it up not to protect them "but to aid S&L owners. With their deposits insured up to $100,000, the associations no longer had to rely on the savings of citizens in their own communities. A huge, unregulated national market in brokered deposits developed. Corporations [and pension funds and credit unions] and wealthy individuals found they could split up their spare millions into convenient $100,000 bundles and park them as federally insured certificates of deposit in S&Ls all over the country." It was as solid an investment as Treasury bills, for, with St. Germain guiding his gullible colleagues, Congress passed resolutions putting the full faith and credit of the United States government (you can translate that as "taxpayers") behind the rickety F.S.L.I.C. insurance funds.
This act, writes Edward Kane, was the lightning that turned insolvent thrifts into gambling monsters: "In effect, FSLIC's unconditional willingness to repay the zombie's depositors allows its managers to open up a line of credit in any financial casino they can enter. This line of credit permits the zombie to book high-stakes bets even though it has no funds of its own to risk."
But one should bear in mind that the increase to $100,000 coverage didn't benefit only S&Ls. It also applied to commercial banks. And that may explain why the banking committees were especially hospitable to the change. As Martin Mayer points out, "Insurance that went to $100,000 looked like a way to save not the depositor but the institution," and at the moment some of the biggest riskprone accounts were in commercial banking institutions. "We were on our way to the great scandal of the bailout of Continental Illinois, where in effect all the money expended by the FDIC went to giant foreign depositors and anonymous holders of Euronotes issued in tax-shelter locales like the Netherlands Antilles." An excellent marksman, Mayer squarely hits the central motivation of bureaucrats and legislators in all that was done for both banks and S&Ls in the 1980s: to help the big depositors and the big moneylenders.
So much for St. Germain's 1980 contribution to national disaster. His other contribution, which came in 1982, honored him by bearing his name: the Garn-St. Germain Depository Institutions Act, which will take its place in history alongside such names as the Teapot Dome. Which brings us to another key architect of disaster.
Hello Las Vegas
Senator Jake Garn. This Republican's home, Utah, should remind us that, for the most part, the S&L wrecking crew were from the West. That isn't surprising. In the last quarter-century, most of our worst headaches have been supplied by Presidents and other politicians from that region. Reformers might want to keep that in mind, in case they have the opportunity someday to expand vastly the Air Force's Western bombing ranges to include Salt Lake City, Phoenix, Denver, Los Angeles, any Texas city, et cetera, thereby removing the remnants of some of these crooked S&Ls as well as the people who created them.
Mayer writes that Garn has a "rather spacey manner (he was the Senator who went up in the space shuttle, and some staffers like to say he never came down)." As a former mayor of Salt Lake City, he is, needless to say, extremely conservative. A central figure in what some called "the Mormon Mafia," Gain was chair of the Senate Banking Committee for the six years following the Senate's change of party control in 1980; from that position of power he was able to foist on the government two other horrible mistakes: his protégé Richard Pratt (about whom we'll have more to say in a moment) and M. Danny Wall, who had served Garn in Salt Lake City and was now, though thoroughly unequipped for the job, chief of Garn's banking committee staff. Both Pratt and Wall would have catastrophic terms as the nation's top S&L regulator.
Garn, one of the Senate's leading defenders of the use of junk bonds by S&Ls, seems utterly devoid of any ability to measure conflict of interest. Apparently without any feeling of shame, he has openly received financial homage from many shady members of the thrift industry, and from the shadiest member of the junk-bond industry. "Three of the five savings and loans with the largest holdings of...junk bonds contributed $100,000 or more in recent years to help establish the nonprofit Garn Institute of Finance at the University of Utah," Kathleen Day reported last year in The Washington Post. "The S&Ls are Columbia Savings and Loan of Beverly Hills, Imperial Corp. of America in San Diego and CenTrust Savings Bank of Miami. Drexel Burnham Lambert Inc., the leading junk bond firm, also contributed $100,000 or more." Happily, bad management has driven most of those contributors into the ditch, as it earlier did another big giver, Charles Keating of Lincoln Savings and Loan.
With Garn-St. Germain, the character of federally chartered thrifts was changed completely (the act applied only to federal thrifts). It was goodbye Bedford Falls, hello Wall Street and hello Las Vegas. The act removed the last controls on interest rates; now an S&L could offer any amount, however ridiculously high, to attract funds.
No longer were thrifts chained to home mortgages, the anchor that had allowed them to ride out many a storm. Now they could hoist the Jolly Roger and sail off to make secured and unsecured loans for the new and unfamiliar lines of commercial, corporate, consumer or agricultural ventures--in fact, 90 percent of their assets could be invested there. The temptation to go that route--securities, land sales, real estate developments--was so great that, not surprisingly, home mortgage business at the S&Ls dropped nearly 50 percent.
But there were even more dangerous changes. Now thrifts needn't ask for the traditional down payments from borrowers but could provide 100 percent financing. That's right; to swing a deal, a borrower needn't put up a penny of his or her own money.
To complete the felonious scene, the new law (1) permitted developers to own S&Ls and (2) permitted the owners of S&Ls to lend to themselves. In short, the vault was not only opened to the crooks, it could be owned by them. No wonder, then, that at the Rose Garden signing of the bill, President Reagan, with his customary talent for unconscious confession, chortled, "All in all, I think we've hit the jackpot."
Savings and loan owners could now themselves buy land and build condos or anything else they wanted to throw up and not be limited to making loans to other developers. The owners could, in fact, borrow their depositors' money for any kind of harebrained personal scheme, which is why the government, thanks to bankrupt thrifts, now owns such weird items as a buffalo sperm bank, a racehorse with syphilis, a kittylitter mine, and "development" land so remote that it could be used only as a game preserve.
Brooks Jackson hardly needs to point out that "the Garn-St. Germain legislation created conditions in which speculation and swindles were sure to flourish." Outrageous as that criminal atmosphere would have been for healthy thrifts, it was even more outrageous--and dangerous--for the insolvent thrifts, for they had nothing to lose by performing in the most irresponsible fashion, investing in the wildest schemes. Which is why the Federal Home Loan Bank Board should have wiped them out. And it is also why making laws and regulations to keep them in business by pretending they were "solvent enough" should have been considered a criminal act in itself, which brings us to the most important mechanic for this deception.
Richard Pratt. In an Administration religiously committed to deregulation, nobody was more fanatical than Pratt. Many who have interviewed and written about him mention his physical presence: powerful, bull-necked, combative, blustering. He was a starting tackle on the University of Utah football team, and when he did his obligatory missionary work for the Mormon Church in New Zealand he became that country's heavyweight wrestling champion. In the late 1960s he was chief economist for the S&L lobby.
At the age of 44, in 1981, he became Reagan's first chair of the F.H.L.B.B.; the other two members were a Republican and a Reagan Democrat from Texas. Pratt stayed around the F.H.L.B.B. only a couple of years, but that gave him enough time to issue hell-for-leather rules that ruined whatever chance the industry might have had to recover. Not that everything he did was bad. He authorized federally insured S&Ls to issue adjustable-rate mortgages; if that change had been made five years earlier, the industry might have avoided the massacre of the Carter-Volcker years.
But otherwise, Pratt did nothing right. Martin Mayer, who, oddly enough, claims to like Pratt, summarized his F.H.L.B.B. tenure this way:
It was during Pratt's two years as chairman of the Bank Board that the road to hell was paved and polished. He wrote the worst of the regs, and more than any other single person he wrote the Garn-St. Germain bill of 1982 that codified the perverse incentives the government gave the industry. (On its introduction in the fall of 1981, it was known as "the Pratt bill"; it went through Congress like a dose of salts, with virtually no hearings in either Senate or House Banking committees.)... If you had to pick one individual to blame for what happened to the S&Ls and to some hundreds of billions of dollars of taxpayer money, Dick would get the honor without even campaigning.
The basic goal of Pratt's bank board was to keep zombies in business by making them appear to have some net worth when in fact they had none or had less than the law required. About 800 thrifts failed to meet the net-worth requirement in 1982. The bank board could have put them out of business, but instead it simply changed the accounting practices to falsify their net worth or, as Mayer puts it, the board "designed a program that permitted decapitalized thrifts to pretend they still had some of their own money in the game."
Among the clever techniques were the following:
(1) The "net worth certificate" program. In effect, as Mayer says, this allowed the S&Ls to print their own capital. How? By swapping paper with the F.S.L.I.C. The S&Ls gave the F.S.L.I.C. worthless notes, and in return the F.S.L.I.C. gave the S&Ls notes as good as money, which could be considered part of the S&Ls' net worth.
(2) "Good will." It worked like this: The F.H.L.B.B. announced that instead of closing the insolvent thrifts, it would make them whole through mergers. It would merge healthy thrifts with failing thrifts, merge marginal thrifts with stone-broke thrifts or, yes, it would perform the greatest miracle of all by blending several insolvent thrifts.
How could they make one healthy thrift out of several deathly sick ones? Easy. The bank board simply credited the broke thrifts with enormous amounts of "supervisory good will"--customer loyalty, share of market and other voodoo trinkets--and allowed the thrifts to count this as part of their capital base. It was a shell game. The good will was an ersatz asset, totally meaningless and worthless--except as a bookkeeping device to keep the broke thrifts in business. By 1987, nearly 45 percent of the thrift industry's net worth was "good will." Many thrifts are operating today, some profitably, some not, that could never meet federal standards for capitalization if "good will" were deducted from their books. Talman Home Federal Savings and Loan, the largest thrift in Illinois, has half a billion dollars' worth of good will on its books.
(3) Another scam was the bank board rule that S&Ls could add "appraised equity capital" to their books. Let's say a Dallas S&L came to own, through foreclosure or purchase, an abandoned airport out in the West Texas desert that was worth, at most, $20,000. The new rule allowed the S&L to count that commercial property as capital. But wait! If it got a crooked appraiser to jack up the value to outlandish heights, or if it teamed up with other crooked S&Ls to trade commercial property back and forth at fraudulently inflated prices, the Dallas S&L could transform a nearly worthless airport that was nothing but a tin building and a pasture of tumbleweeds into a half-million in "capital." For each new dollar of capital created by reappraising owned property, bank board rules allowed an S&L to raise from the public $33 in deposits.
So, with its artificially created half million on the books, the Dallas S&L could call up Wall Street money brokers and offer an exorbitant interest rate that would persuade the brokers to deposit $16.5 million in hot money--all insured by you and me--which the Dallas S&L could then turn around and spend any way it wanted, ad infinitum, or at least ad bankruptcy.
It becomes clear that subordinate professionals--particularly appraisers and public accounting firms--played a key role in creating these frauds. Their presence is everywhere in this sordid history. With only slight exaggeration, William Greider says of the public accountants and auditors, "They were on the take, every one of them. Without exception." And Stephen Pizzo, one of the Inside Job authors, adds: "I'll tell you this--deregulation unleashed a tidal wave of corruption across the country....Appraisers, for example, figured out they could raise their standard of living just by raising their opinion of value. Slip the guy another $25,000 and suddenly a $200,000 piece of property is worth $20 million. It's very simple."
A purple example of the part played by appraisers: In 1977 J. William Oldenburg, with a down payment of $80,000, bought 363 acres of land in Richmond, California, for $874,000. Two years later he hired the "right" appraiser, who certified that the land was now worth $32.5 million. That was the first step. The second step was to rehire the same appraiser in 1982 and get an update. This time, sure enough, the appraised value had soared--to $83.5 million. But who in the world would buy it for even a large fraction of that inflated price? Oldenburg supplied the answer by purchasing the State Savings of Salt Lake City, for $10.5 million, which in 1984 bought the land for $55 million. Only in America.