Insurance That Saved S&Ls; Facing Calls for Reforms
The panic that gripped the privately insured savings and loan industry in this Ohio River city last spring has been largely forgotten in most of the country. But the residents here are reminded daily of the worst depositor crisis in the United States in more than 50 years.
Signs and banners proclaiming “Federally Insured,” or “Member, FSLIC,” are still prominent at dozens of financial institutions throughout this city--a continuing reminder of how consumers here lost confidence in any savings and loan, no matter how healthy, if their savings weren’t backed by federal deposit insurance.
The federal insurance program played the role of savior during the Cincinnati crisis. Today, however, the federal system itself is coming under close examination.
A swelling chorus of politicians, bankers, economists, academics and regulators is calling for broad reforms to protect the financial health of the Federal Deposit Insurance Corp. and the Federal Savings and Loan Insurance Corp., which have guaranteed the savings of millions of Americans for more than five decades. The agencies insure accounts up to $100,000 should a financial institution fail.
The proposed reforms include a reduction in insurance protection and changing the way the deposit insurance pools are funded. Both the FDIC and FSLIC now raise their money by charging banks and savings and loans a flat fee based on the financial institution’s size.
An estimated 190 million people in the United States have money in insured savings or checking accounts. The insurance funds, with a maximum combined value of about $25 billion, back more than $2 trillion in deposits at the nation’s 18,000 banks and savings and loan associations.
The funds, forged in the fires of the Depression, have become linchpins of depositor confidence in the nation’s banking system. Fund managers and industry executives love to boast that no insured depositor has lost a penny in the funds’ history.
Today, though, these insurance funds are beset by a mid-life crisis. What has evolved, critics say, is an unfair, outmoded and underfunded system that encourages bankers to take excessive risk, allows hundreds of insolvent financial institutions that should be closed to remain open and cuts deeply into savings industry profits.
The distress is particularly evident at the FSLIC, the savings and loan insurance fund that would surely be bankrupted if regulators closed all the S&Ls; that are technically insolvent--that is, their debts exceed their assets--but still open for business.
The FDIC, while its balance sheet seems stronger, backs deposits at more than 1,100 institutions classified by federal regulators as “problem banks” because of poor management and bad loans.
“Both funds are inadequate by tough accounting standards,” said consultant William Ford, former president of First Nationwide Financial Corp. in San Francisco, one of the nation’s largest thrifts.
Ford’s point is that if all troubled banks and thrifts were required to put realistic market values on their loans, dozens of institutions would be forced to close. The result, he said, is that “the FDIC is broke, dead as a doornail, just like FSLIC would be.”
Congressional Action
No one really knows exactly what would happen if either fund were to fail. Though policy-makers universally assume that Congress would come to the rescue, it has no legal obligation to do so.
Contrary to widespread belief, no law places the credit of the U.S. Treasury behind the funds. A resolution adopted by Congress in 1982, as the thrift industry was in the midst of turmoil caused by high interest rates, affirmed that insured savings are backed by the “full faith and credit of the United States.” The resolution expired at the end of that session of Congress, however.
This year, about 120 banks have closed their doors, the highest total since the depths of the banking crisis of the 1930s. Most have been small agricultural banks in the Midwest.
In California, 10 savings and loans with assets exceeding a total of $12 billion have been taken over by federal regulators since April, largely because of imprudent real estate development and construction lending. However, the S&Ls; remain open for business today largely because the FSLIC doesn’t have the money or manpower to close them and pay off depositors.
When deposit insurance was established in the mid-1930s, the impact was dramatic. At a time when 10 banks a day were failing, federal guarantees of individual deposits put back into the banking system currency that had been buried in back yards, stuffed into mattresses or hidden in socks.
Achieved Sacred Status
Insured accounts have now achieved such a sacred status in American society that none of the dozens of experts interviewed by The Times believes that Congress would fail to act if either fund went broke.
“It’s God, motherhood and country, then comes the savings account,” said Ralph Rivet, retired spokesman for Great Western Financial Corp. in Beverly Hills.
Even though they have no legal obligation to pay off depositors if the deposit funds were to collapse, lawmakers apparently believe that failure to do so could spark a financial panic and surely end political careers.
“Any failure to meet that commitment (in protecting insured savings) and you have an instant run on all thrifts,” said Richard Pratt, a former chairman of the Federal Home Loan Bank Board. “It’s safe because there are not any alternatives.”
Despite the reassurances, the public is clearly concerned, particularly older depositors who remember how they or their parents lost their life savings during the thousands of bank failures during the Depression.
“You and I both know the deposit insurance is a drop in the bucket,” said retiree Ken McComb of Glendale. “Suppose several large S&Ls; failed at once. How on earth would FSLIC handle it?”
Opinion Survey Results
The concern shows up in opinion surveys as well. Although public confidence in the financial system remains relatively strong, recent studies indicate that it has been slipping.
In a study conducted in January by Cambridge Reports, based in Cambridge, Mass., 31% of the 1,430 respondents said they had less faith in the overall health and stability of the U.S. banking system than they had a few years ago. Only 21% said they were more confident.
A follow-up survey done three months later--after the Ohio crisis and a similar problem in Maryland--revealed that the proportion of those expressing lowered confidence rose to 37% while those professing greater confidence fell to 18%.
An American Bankers Assn. study attempted to measure public faith in America’s financial institutions through lengthy “focus-group” sessions with typical consumers.
“What has slipped is confidence in the entire banking system,” said ABA spokesman Fritz Elmendorf. “It’s not a precipitous drop, but it’s measurable.”
“The frightening question is: How much more bad news will the public stand?” R. G. Taylor, chairman of First Western Savings Assn. in Las Vegas, asked a gathering of savings bankers in San Francisco recently.
Ohio Case Instructive
The case in Ohio is instructive because it vividly illustrates what can happen when customer confidence vanishes.
The chain reaction of events began in early March when the collapse of a Florida securities dealer led to the bankruptcy of Home State Savings Bank, the largest of 70 thrifts whose deposits were insured by the Ohio Deposit Guarantee Fund, a state-sanctioned private insurance agency.
Home State’s closure set off a run at the other privately insured institutions, stemmed only by Ohio Gov. Richard F. Celeste’s edict closing the 70 S&Ls; in the nation’s first major government-ordered bank holiday since the Depression.
Depositors who were only vaguely aware that some Ohio savings and loans were state insured and others were backed by the federal fund learned the difference overnight.
One suburban branch of the state-insured Charter Oak Savings, for example, was besieged by 1,000 angry depositors seeking their money at the height of the Ohio panic. Two hundred yards away, at the federally insured Gateway Federal Savings & Loan Assn., there were orderly lines of customers waiting to make deposits. Gateway grew with the accounts of those who fled Charter Oak.
Bill Dempster, 59, a retired electrician who kept an account at Charter Oak, didn’t panic when the governor ordered the S&L; temporarily closed. He had faith that the crisis would subside and he’d soon have access to his money.
Safe Deposit Boxes
But his 80-year-old mother-in-law, a survivor of the U.S. banking disaster of 1933, converted her savings to cash and stashed it in safe deposit boxes at several banks around Cincinnati.
Critics of the system contend some of the problems arise because the FDIC and FSLIC are attempting to cope in a period of rapid financial deregulation using supervisory methods that are outdated.
George G. Kaufman, professor of finance at Loyola University of Chicago, said deposit insurance today actually leads to the kind of risky lending it was designed to prevent.
“Deposit insurance has both good and bad aspects,” he said. “The good is that it has immunized healthy banks from sick banks. The contagiousness we worried about in the 1930s is unlikely to happen.
“But, like other insurance, it’s made us more prone to take risks. If we win, we regain profitability and get all the rewards. If we lose, the insurance company picks up the tab.”
Ill-Advised Ventures
Indeed, many experts argue that deposit insurance allows institutions in trouble to gamble on highly questionable investments at no risk to depositors. These financial institutions have typically attracted deposits by offering high interest rates, then invested the money in a host of ill-advised ventures, particularly real estate development loans.
If the investments pay off, the bank or thrift meets its obligations to depositors. If not, the FDIC or FSLIC gets stuck with the bill after the financial institution fails.
“The incentives for managers to make dumb decisions are immense,” USC finance professor Tim Campbell said. “Companies are operating under a go-for-broke mentality.”
The system is seen as unfair by executives of healthy banks and thrifts, who complain that they’re being forced to pay for the sins of their high-flying colleagues because their FDIC or FSLIC dues are based only on size, not risk. Charges of discrimination also come from representatives of small banks, who complain they’re being treated unfairly by regulators, who are quick to close a small insolvent bank in, say, Nebraska, but risk billions of government funds to keep Continental Illinois afloat.
One widely advocated solution is to set up a system in which financial institutions pay different insurance premiums depending on how risky their operations are. It is usually referred to as risk-based deposit insurance. Another proposed reform would force banks and thrifts with unusually large problem loan portfolios to keep larger pools of capital on hand.
In either case, the public would receive more information about the financial health of their bank or savings and loan, perhaps employing a rating system such as the Michelin Guide uses for hotels and restaurants. That in turn would supposedly encourage depositors to channel their money into better-run institutions.
“Under the current system, the insured depositors don’t give a damn,” Kaufman said. “They don’t look over their bankers’ shoulders. That’s badly in need of reform. Something needs to be done to reimpose market discipline and reduce the risk-taking by banks.”
Objections to Plans
Many financial executives object to both plans because they would give regulators too much discretionary power. Another objection is that the cost of the additional premiums or added capital could in itself force scores of troubled institutions into insolvency.
This year, all S&Ls; that belong to FSLIC have been forced to pay an extra premium to bolster the fund’s reserves. The assessment, totaling $1 billion, has weakened ailing thrifts and eroded profits industry-wide.
Another plan calls for reducing the level of deposit insurance, perhaps by half. Even accounting for inflation, $50,000 is far more than the original $2,500 in protection offered in 1934, consultant Ford said.
“The original idea (of deposit insurance) was to protect a person’s life savings,” Ford said, noting that the fund was designed to protect small depositors, not millionaires who split their savings into multiple insured accounts.
Still another proposal for reform calls for the merger of the FDIC and FSLIC as a means of rescuing the weaker S&L; fund. The idea faces stiff opposition from both bankers and thrift executives.
Bankers don’t want to take on FSLIC’s problems without imposing on thrifts the stricter regulations under which banks operate, while thrift industry officials prize their independence and bridle at the thought of a rescue by the bankers or government.
‘Can Solve Problems’
“FSLIC doesn’t need a bail-out,” Donald Hovde, a member of the Federal Home Loan Bank Board, which regulates most of the thrift industry, said at a recent bankers conference in Dallas. “The S&L; industry does not want to become a ward of the government. It can solve its own problems.”
He added: “The FDIC is not that healthy and the FSLIC is nowhere near that sick.” Whatever happens, government regulators have displayed considerable ingenuity in managing the country’s major banking crises--Ohio and Maryland, Penn Square Bank and Continental Illinois--over the past five years. What has emerged from the turbulence is a battle-tested feeling that somehow, some way the system will muddle through.
As Washington lawyer Thomas Vartanian, former head attorney for the Federal Home Loan Bank Board, put it, “One thing you learn as a regulator is that if the worst happens, you just change the rules.”
