S&Ls, Big Banks and Other Triumphs of Capitalism
BROKERED AND JUNK GROWTH
So now all the ducks were in order. Twenty-five percent of the nation's thrifts were insolvent, but the new "regulatory accounting" that created funny money would cover that up and keep them in business. As for the rest of the industry, it was flying free and easy. Most regulations had been wiped out, and the regulators were disappearing too. There had been more than 700 federal examiners watching over the country's 4,002 thrifts in 1980; four years later, with twice as many insolvent thrifts to handle and with S&Ls now empowered to do the complex business of commercial banks, Reagan's budget cuts reduced the number to 679.
"As the industry deregulated," Inside Job tutors us, "inspectors accustomed to examining nearly identical sets of books at each thrift, books based on simple 30-year home mortgages, suddenly were expected to be able to follow the intricate machinations of highly speculative finance. Examining a $20,000 loan on a home was a far cry from trying to judge the quality or prudence of a $20 million loan on a shopping center or a multi-tiered master limited partnership."
The regulators got so far behind that they tried to do their supervision by mail: asking for data, challenging it and waiting months for an answer, which often never came. Generally speaking, the only restraint on S&L operations was whatever professional morality the managers might be imbued with.
Those who were unimbued could skim at will, dip into the till, make loans to themselves that they never intended to repay and make loans at usurious rates to other gamblers who proposed wild and hopeless projects from which the S&L owners could take kickbacks and enormous up-front payoffs. One developer went into Neil Bush's Silverado S&L, for example, and asked to borrow $10 million. The managers said to him, "We won't lend you $10 million. But we will lend you $15 million, if you will take that extra $5 million and buy some of our good stock." And with that concocted infusion of "new capital," the easygoing chaps at Silverado could launch another round of financial fun.
Who cared if they were never paid back? Who cared if the house went bust? The F.S.L.I.C. and the F.D.I.C. (the Foolish Dumb Innocent Citizens, as Jay Leno translated the initials) would pick up the tab. The only thing needed to complete their happiness was loads of money. By no accident, such money had been available since 1980, from deposit brokers.
Historically, as we have said, S&Ls got their money from wage earners, small depositors, people in the community. It was the kind of source that allowed only slow growth, but it was safe growth. Regulations forbade an S&L from taking more than 5 percent of its deposits from money brokers, those Wall Street hustlers who were hired by pension funds, insurance companies, credit unions and government trust funds to find the highest interest rates anywhere in the country. They moved billions of dollars every day, but these were transient, volatile funds--"hot money," it was called. The old 5 percent cap was to protect S&Ls from being lured too far down those dangerous billion-dollar paths.
In 1980 the bank board, pressured by the S&L lobby, killed the 5 percent rule and gave S&Ls the freedom to take all the brokered money they could get their hands on. Two years later, Garn-St. Germain made it easy to go after the brokered money by removing the last controls on interest rates.
Zombie thrifts, having nothing to lose, sought the brokered money by offering the highest, most unrealistic interest rates, thus forcing more conservative thrifts to follow, thereby endangering them, too. Using this hot money, some thrifts grew like cancers. In one year, forty thrifts grew 1,000 percent. Texas thrifts grew three times faster than the national average.
Naturally, as with every aspect of the S&L adventure, the brokering of funds attracted the seamier element of society, from Merrill Lynch to Mario Renda, the latter being one of Inside Job's most colorful villains. A former tap-dance teacher and Boy Scout executive, Renda was a clever dog who immediately saw the potential of the new spirit of S&L greed. His technique was to go to thrifts and say, "If you will make loans to certain borrowers that I send to you, I will supply the money to lend to them." Many of these pre-specified borrowers, it turned out, were members of the Mafia or kindred souls, and he was in effect laundering their money. But the S&Ls didn't care. They snapped up the offer. Before he was arrested in 1987, he had brokered $6 billion to 3,500 institutions (some of which were commercial banks).
One can't speak of brokered money without mentioning high-risk, high-interest "junk" bonds. Closely correlated with the fall of the S&L industry was the rise of the junk-bond industry, centered around the incredibly corrupt investment banking firm of Drexel Burnham Lambert, now in bankruptcy. It's doubtful that the S&L scandal would have grown beyond the size of a large bunion on the foot of Miss Liberty if brokered money hadn't been so available, and the same can be said of junk bonds, which the brokered money often went to purchase. As of last year, S&Ls owned $14 billion worth of junk bonds.
Investigators keep dropping their buckets into the Drexel cesspool and coming up with ties to some of the most notorious failures (Silverado, Lincoln, CenTrust, San Jacinto S&L) and with such corporate raiders as Ronald Perelman and the Belzberg family and the Bass brothers, all of whom, with the very questionable and secret assistance of the bank board, now own giant junk-bond-encrusted S&Ls, which they bought from the government during its infamous "fire sales" of 1988.
Two dozen of the largest thrifts went absolutely bonkers--each buying more than $100 million in junks. The ten largest gamblers in junks either went bust, had to be merged or are on the brink of insolvency.
When Charles Keating, for example, wanted to buy Lincoln Savings and Loan, he simply solicited Drexel's evil genius, Michael Milken, to market $50 million in junk bonds. "By the time Lincoln went broke six years later," writes Jerry Knight in The Washington Post, "Keating had leveraged the original $50 million from Drexel into $454 million worth of junk bonds--$374 million of them bought from Drexel and Drexel clients." Among the junk bonds Lincoln dealt in were those financing Robert Campeau's purchase of Allied Stores and Federated Department Stores and the buyout of Eastern Air Lines, which, one and all, like their patron, went bankrupt.
It was, you see, an incestuous affair. Drexel had an intimate relationship with both sides of the ledger. The S&L crooks sold junks through Drexel to get the money to go into business, and then they gorged on junks bought through Drexel to get the high interest they needed for their Ponzi-like growth. Nowhere was this technique more dramatically used than in the founding and foundering of CenTrust Savings Bank of Miami, Florida.
Six years ago David Paul bought a dying thrift and turned it into the nation's twenty-third largest, with Drexel offering as many services as The Mikado's Pooh-Bah. Knight reports: "As CenTrust's investment banker, Drexel raised $150 million of the thrift's capital by selling junk bonds. As CenTrust's bond broker, Drexel sold the thrift almost $1 billion worth of junk bonds. And as a customer, Drexel borrowed $15 million on an unsecured loan."
You and I are paying for all that hocus-pocus. And what did we get for our millions? A little soap opera starring Paul, who was such a pretentious, phony bastard that it was only natural for him to select glitzy Miami as the place to do his business. He fitted right in and was embraced by The Miami Herald and by the highest level of the city's moneyed establishment even after a local business daily, the Miami Review, pointed out that his reputation had been built on strange fictions. Paul had falsely claimed to have a Ph.D. from Harvard and an M.B.A. from Columbia. He had falsely claimed that the Citicorp and American Express buildings in New York City were among his "most successful real estate projects." He had claimed that his mother, a Jew, was really a Catholic.
But if it was offended, Miami's upper crust nevertheless went right on attending his princely galas, such as a party for the New World Symphony at which guests chomped on 1,800 stone crab claws, 1,500 lobster tails and 150 Peking ducks. When Elizabeth Taylor came to Miami for an AIDS fundraiser, CenTrust contributed $50,000 and Paul gave Liz a party on his $7 million, ninety-six-foot yacht.
With CenTrust gone belly up, you are now helping to pay for the yacht, for the 24-karat gold-leaf ceilings and gold-plated toilet pipes in Paul's office building and for all of Paul's good times.
Meanwhile, State Thrifts Go Mad
While the bank board and Congress were deregulating the federally chartered S&Ls, some of the states were just as busy doing the same. None did it more recklessly than Texas and California. Bear in mind that while state-chartered S&Ls may for a fee enjoy the safeguard of federal deposit insurance, they get to enjoy the freedom, or anarchy, of state regulation. State regulators are usually hacks and are often bought off. Like many of their federal counterparts, they are underpaid, undertrained, demoralized, confused. They did their jobs poorly before the 1980s deregulations, but they had impossible jobs thereafter.
It had always been easy to buy a Texas S&L; all you had to do to get a state charter was prove that you weren't in prison at the moment you applied. In the new deregulated environment, it was even easier. Now everyone was buying into the game, particularly real estate developers, who brought to the industry the strong sense of social morality for which they are celebrated. By 1987, 80 percent of Texas thrifts were run by former real estate developers.
By the mid-1980s, the adventures of Texas S&L operators were becoming legendary. As Inside Job tells it, there were stories "about thrift board meetings attended by hookers whose services were paid for by the thrift, chartered jet-set parties to Las Vegas, gala excursions to Europe, luxurious yachts, ocean-front mansions, and Rolls-Royces--princely life-styles built on mountains of bad loans and bad investments.... In the newly deregulated environment new thrifts had sprouted throughout Texas like rye grass after a spring rain. Old, long-established thrifts were snatched up by young speculators eager for the opportunity to wheel and deal with insured deposits." They weren't interested in giving the traditional single-family housing loans. Hell no. It was skyscrapers--office buildings and condos--they were interested in.
If possible, California became even more of a wildcat state, especially after 1983, when the California legislature passed the Nolan Act, with only one politician in each house in opposition, a proportion that hinted at wholesale bribery. The act (sponsored by Republican caucus chair Pat Nolan, who later resigned when the F.B.I. released a film showing someone taking money on his behalf in a sting operation) made California as freewheeling as Texas, with just about anyone eligible to buy an S&L, lure deposits any way possible and blow the deposits on any whim, comforted by the knowledge that this marvelous adventure in Reaganesque capitalism would be insured by the full faith and credit of the United States government.
Leading the California orgy was Lawrence Taggart, who had been a vice president of Great American First Savings Bank in San Diego (the thrift that so generously overlooked Edwin Meese's mortgage debts) and who in 1983 became the new state Republican administration's Savings and Loan Commissioner. By the time he took office the California industry was well down the road to boom/chaos. With virtually no regulation, some thrifts leaped from the minimum required starting fund of $2 million to a couple hundred million bucks overnight and to more than $1 billion in deposits within five years, much of it floating on some extremely leaky deals.
Far from being worried, Taggart ("I was pro-business," he says with the magnificient understatement) encouraged the industry expansion. In his first six months in office, he approved sixty charters, 210 in a year and a half. Last year, testifying before the House Banking Committee, Taggart was asked how many of the thrifts he had chartered later failed. His response: "Take your pick, Congressman."