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The Greatest American Shambles

There is an irony in the latter statistic. As has been pointed out by James Bennett in The Washington Monthly (September 1990), even as the S&Ls were bleeding, they continued to write fixedrate, low-rate mortgages to people who were busily moving their passbook savings into higher-yielding, shorter-term, money-market funds. Some feel that this “intergenerational opportunism” should be taken into account when it is reckoned who should bear what percentage of the cost of cleaning up the present fiasco.

Equally significantly, the way the nation saved had changed drastically in the course of the 1960s. People became more distant from their savings, as more and more working Americans became subject to benefit plans into which huge sums of “their” money were transferred without their ever having touched or seen it or had it recorded in a passbook. I make this point because it is my belief that financial chicanery is possible in inverse proportion to the visceral connection existing between a person and his or her savings.

Beginning in 1980, with the decision to squeeze inflation out of the economy by ratcheting the general level of interest rates to heights never before experienced by the American economy, the thrifts were put in peril of their very existence. They held vast portfolios of mortgages funded with deposits which it now took the interest-rate equivalent of an arm and a leg to keep from flowing to other money-market funds and suitors. What to do? All the commonsensical solutions—to rewrite existing mortgages, for instance, to reflect the thrifts’ drastically escalated cost of funds—were impossible because of one political pressure or another.

On the other hand, the thrifts were not about to roll over. Every congressional district was home to one or more thrift institution. The first American savings institution, after all, dated back to 1831, and the industry had grown side by side with the nation. The S&L lobby was among the most effective and influential in Washington. Repricing loans to reflect market realities was out of the question, although the industry fought with some success for an adjustable rate for new mortgages, and therefore other solutions would have to be found.

And found they were, in two pieces of legislation whose euphemism-swollen titles should forever ring in the ears of taxpayers: The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St. Germain Depository Institutions Act of 1982. Both are complex pieces of legislation, but their effects can be summed up by saying that, beginning in 1980, the thrift industry was turned loose to its own devices to find its own way out of its difficulties by taking in more high-priced deposits and lending them out at better than the historically high rates then prevailing. As an article of financial wisdom, this ranks with the notion, held by some, that it is possible to borrow one’s way out of debt.

Foremost among the privileges obtained by the thrift industry in 1980 was an increase in the amount of federal, that is, taxpayer insurance backing each deposit account. The upper limit was raised from $40,000 to $100,000 plus accrued interest per account—which is not the same as “per depositor.” At the time, the average thrift passbook (or equivalent) savings account amounted to $6,000.

Garn–St. Germain, named after a senator whose mental stability was often in question and a congressman whose cupidity never was, threw open the chicken-coop doors once and for all. It was, as Martin Mayer puts it, “the financial equivalent of a nuclear attack on the deposit insurance fund.” Signing it, President Reagan averred, “I think we hit a home run.” A month later, addressing the US League, the S&L trade and lobbying organization, the President declared Garn–St.Germain to be the “Emancipation Proclamation for America’s savings institutions.” The pens he handed around as he signed Garn–St. Germain into law would, metaphorically speaking, write the largest check in history, drawn on the collective bank account of the American taxpayer.

Now men who made much of quoting Adam Smith, who even wore neckties embroidered with the profile of the immortal Scot, felt the hardly invisible hand of government smite them companionably and encouragingly on their shoulder, urging them to go for it.

And they did so. The foxes—the crooks, fools, swindlers, and charlatans—took over the chicken house. Now began the era of brokered deposits, in which the big houses like Merrill Lynch and Paine Webber, for useful commissions, electronically broke down sums placed with them into $100,000 pieces and sent each piece zapping off along the money wire searching for the best interest rate being offered.

The irony was that now an institution chartered on Thursday, having no history and only negligible capital, could bid competitively for funds on Friday against institutions many times its size, with many years of history and community standing. These no longer mattered. Thanks to federal deposit insurance, all institutions were at a stroke rendered alike; the risks were the same; a deposit with an S&L engaged in the rankest speculations ran no more risk of ultimate loss than one which made only the most prudent, well-secured loans. Much of this brokered money may have been hot. The international drug trade was by 1982 counting its profits in the tens of billions, but it passed as respectably on the streets of the global electronic village as the stodgiest Yankee hoard.

A general air of unreality about money took hold, as it does when booms are rising toward their eventual heights. Theoretically, since the ultimate guarantor of all deposits was the same, the price paid for deposits should have been more or less the same around the country. But this was not so. The important thing was to get your hands on money, whatever it cost, so as to be able to play at the grownups’ table, to be known as “a player,” the loftiest sobriquet the age could bestow. Uncle Sam had put the cream out for skimming. Consider the following passage from James O’Shea’s Daisy Chain:

If a customer wanted a loan to buy a $100,000 house, an S&L specializing in home loans typically demanded a $10,000 to $20,000 down payment before the thrift would make a mortgage loan on the remaining $80,000 to $90,000…. If a developer, by contrast, walked into Vernon seeking a loan to build a $10-million office tower, he’d usually ask for a $12-million loan…. First the developer needed $10 million to acquire the land and the sticks and bricks…[then] $1.3 million to cover a year’s worth of interest at 13 percent…. Next Vernon allowed the developer to borrow his 2.5 to 4 percent development fee…. Then add the 4.5 points, or fees, that Vernon Savings gets for making the loan….

No wonder developers hastened to form or acquire federally insured thrifts, as Garn–St. Germain now permitted them to do, since they could then lend to themselves and pocket several sets of upfront fees. As O’Shea observes:

Why borrow money from a commercial bank at 2 or 3 percent over prime, which was then 15 percent? A developer who wanted to build a twelve-story hotel in Coconut Grove could simply have [his] S&L set up a development subsidiary and use [federally] insured deposits to fund the venture.

Emboldened and empowered, mostly under new management, the thrifts plunged into every game on offer, every form of three-card monte Wall Street could devise, including Michael Milken’s junk-bond manipulations. Drexel Burnham would broker deposits into selected thrifts, all of them now under criminal investigation, which would then buy Drexel’s junk-bond offerings, often with special incentives thrown in for thrift executives.

And then there were the mortgage-backed securities gambits devised and put over by the new crop of wizards at Salomon Brothers and other firms.2 Here is Martin Mayer on that subject:

This game was played by using brokered deposits to buy marketable instruments (usually mortgage-backed securities) that could be pledged [by the S&L] against a loan to the S&L to buy more securities with the same money, thus doubling the bet. The Wall Street houses made a commission or a markup on each and every one of these transactions.

Thus it was, as Mayer goes on to relate, that one S&L ran up losses totalling $417 million despite never having held deposits exceeding $277 million!

There was, quite simply, no limit to speculative effrontery, to disregard of law and public opinion, to contempt for history and economic truth. And why should there have been, when the notion of “risk,” that vexing side of market capitalism, had been eliminated.

3.

By 1986, many thrift institutions were insolvent and the federal insurance funds bankrupt in fact if not in decree. Indeed, one of the great mysteries which none of the books under consideration satisfactorily explains is the failure to keep the insurance fund in phase with the growth of the thrifts. Both the premiums charged for federal insurance and the capital requirements for being granted that insurance were wholly inadequate relics of more financially circumspect times. As Michael Robinson points out in Overdrawn, a judicious use of “accepted” thrift accounting principles enabled a thrift to raise $1 million of capital on $25,000 of deposits, a cushion of a mere 2.5 percent. Robinson then puts the matter pithily: “In other words, for the cost of a starter home in the San Francisco Bay Area, an S&L executive could buy an entire subdivision.” The metaphor is continued nicely in Mayer’s account of the rise and collapse of American Diversified Savings Bank of Lodi, California, which was taken over in 1983 by a former Air India pilot with no banking experience, and which collapsed in 1986:

A company with $11 million in assets lost $800 million…. With perhaps $500,000 in equity, it destroyed $800 million of insured deposits, a kill ration of 1,600 to 1…. This anecdote is tantamount to a news report that a drunken motorist has wiped out the entire city of Pittsburgh.

And so the problem metastasized but no one chose to notice. Why? Well, for one thing, this was still the blazing platinum high noon of the Reagan era. Donald Trump was a national hero and incipient best-selling author, and harsh financial actuality could not be permitted to interrupt the fantasies being spun from the White House. For those charged with dealing with the industry, I suspect that the sheer size and complexity of the deals that were made, let alone the unrelenting, multifaceted lobbying pressure (Jim Wright, “the Keating Five,” Tony Coelho), made it impossible to know where to turn or where to start. There must have been times, as the Eighties wore on, that the embattled folks at the Bank Board, the Federal agency responsible for overseeing the S&Ls, envied Custer his easy lot. Not to mention that there were by now simply too few bodies left to defend the fort. It is often overlooked that the essence of Reaganite deregulation consisted not merely in the elimination of notionally burdensome regulation, but in the wholesale elimination of regulators charged with the enforcement of what codes still remained in force. By 1986, the last year in which some semblance of rationality and control might have been restored to the industry, the regulatory hiring freeze laid down by David Stockman in 1981 had done its work.

  1. 2

    See Michael Lewis’s enjoyable chronicle, Liar’s Poker (Norton, 1989; Penguin, 1990).

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