Hard Questions May Bring Reforms : S&L; Rescue Could Cost Average Taxpayer $450

This year American taxpayers are likely to get a big bill for the $100-billion mess in the savings and loan industry.

A new Congress will continue to fume and search for ways to get others to pay for salvaging bankrupt S&Ls;, and a new Administration will look for ways to lessen the impact on the budget deficit. This week, for example, the Treasury Department floated the idea of charging depositors up to 30 cents for every $100 they keep in banks and savings and loans, encountering a firestorm of criticism.

In the end, when all the maneuvering is over, the American taxpayer seems destined to pay the lion’s share of the cost.

“I see no alternative to a taxpayer bailout,” said William M. Isaac, a well-known Washington lawyer and banking consultant. “The problem has gotten too large to get the money from another source.”

Taxpayers are expected to complain angrily--some already are--that they did not create the problem.

“Why should Joe Blow taxpayer have to pay when he does not even have enough money to put into the bank?” asked James D. Davidson, chairman of the National Taxpayers Union in Washington.

“We’re being raked over the coals, but no one seems to care very much,” said David J. Thorne, a 40-year-old credit manager for a restaurant supply company in Culver City. “It infuriates me.”

Why are the nation’s 160 million taxpayers likely to end up paying an average of more than $450 apiece to clean up the savings and loan mess? Because other “solutions” appear either inadequate, unrealistic, create severe problems of their own or face powerful political opposition.

Lawmakers, for the first time in this decade, appear to be in a mood to solve the S&L; crisis after years of behaving as if the problem were not that severe. But taxpayers are not likely to pay without some tough questions: How could this happen, and how do we make sure it does not happen again?

The answers to those questions seem certain to lead to reforms: tougher oversight of those who run the nation’s financial institutions and tighter curbs on risky investments. Requirements on how much capital financial institutions must maintain probably also will be stiffened.

Meantime, officials in Washington are looking for an alternative to socking the taxpayer directly. These are among the most talked-about possibilities:

--Let the federal deposit insurance funds combine forces. Merge the insurance fund for deposits at savings and loans, the Federal Savings and Loan Insurance Corp., with the fund for banks, the Federal Deposit Insurance Corp. Proponents note that the FDIC, unlike the FSLIC, still has a positive net worth--now estimated between $15 billion and $16 billion.

The prospect appalls commercial bankers, who believe a merger would just spread ruin in the S&L; arena to their own insurance fund. They also argue that the resources of the FDIC are nowhere near large enough to handle the FSLIC’s problems. Others note that commercial banks have their own problem with failing institutions.

R. Dan Brumbaugh Jr., a banking consultant in San Francisco, said the cost of closing both failed banks and thrifts probably will cost well over $100 billion in the years ahead--several times what either industry can afford. “To merge the funds,” Brumbaugh said, “there is no there there.”

Isaac, himself a former chairman of the FDIC, likes the idea of a FSLIC-FDIC merger, but adds it must have a second step. Banks and S&Ls; now have $43 billion on deposit in non-interest-bearing reserve accounts at the Federal Reserve, the nation’s central bank. If the Fed were to pay interest on those accounts and that money went to bail out sick thrifts, it could raise between $2.5 billion and $5 billion annually between now and 2003, Isaac said.

However, Fed Chairman Alan Greenspan points out that this approach would aggravate the U.S. budget deficit--which is ultimately a liability of the nation’s taxpayers. The Fed makes money by investing those funds held in reserve, and those profits go to the U.S. Treasury. “If you pay interest on those reserves, it just increases the deficit,” a Fed spokesman said.

--Charge a fee on deposits at banks, thrifts and credit unions. Altogether, those institutions have more than $3 trillion in deposits. This fee is variously called a tax, a user fee and an insurance premium.

This proposal stirred immediate controversy Wednesday when the Treasury Department revealed it is considering a proposal to raise as much as $9 billion a year by imposing a fee of up to 30 cents for every $100 on deposit at federally insured financial institutions.

The proposal’s logic is that those who enjoy the fruits of deposit insurance should have to pay for it. It would be “a small price to pay to insure a savings account,” according to Rep. Gerald D. Klecza (D-Wis.), a member of the House Banking, Finance and Urban Affairs Committee.

But most analysts in the private sector believe this approach could backfire and destabilize the financial system by driving deposits into foreign banks, money market funds and into Treasury bills and notes. Only a decade ago, many depositors were yanking their funds out of banks and S&Ls; and putting them in money market funds offering significantly higher rates. Today, savers are believed to be even more sophisticated about who is paying the highest rate.

“You’ve got to worry about competition,” said George Kaufman, a deposit-insurance expert and finance professor at Loyola University in Chicago. “You tax one group and you’re going to put them at a competitive disadvantage.”

--Have the U.S. Treasury raise money by issuing long-term bonds that rely on the resources of both government and the thrift industry. The bonds would be backed by thrift-industry capital but interest on the bonds would be paid by the U.S. Treasury. The chief virtue of this plan is that interest costs might be low enough (several billion dollars a year) to allow Congress to live within mandated Gramm-Rudman spending restraints.

The attraction of this approach is that presumably only interest payments on the bonds, and not the face value of the bonds, would show up in federal budget numbers. But the approach would be costly. Without the bonds having direct government backing, the government’s interest costs would be as much as $3 billion more over the year life of the bonds, according to Robert Litan, economist at the Brookings Institution, a Washington think tank.

“It could cost several stealth bombers to put this off budget,” said Litan, referring to the Air Force’s recently unveiled $500-million airplane.

--Continue a special assessment on the thrift industry to help the FSLIC pay the cost of increasingly expensive S&L; failures. This added levy has cost the industry almost $4.5 billion since it was enacted in 1985.

The nation’s chief S&L; regulator, M. Danny Wall, said last year that the special assessment may have to stay in place for 30 years to fund failure costs. Later, in the face of widespread industry anger, Wall said it was not realistic to expect the assessment to continue that long.

Officials at healthy and well-managed S&Ls; say they should not be forced to pay the price of irresponsible behavior by others in their industry. “We didn’t take those chances,” said Patrick H. Price, chief executive of San Francisco Federal Savings & Loan. “Most failures involved sheer dishonesty and stupidity.”

Thrift industry officials complain also that the extra insurance levy places them at a competitive disadvantage with commercial banks, which pay far less for their deposit insurance. Perhaps most important, industry executives and independent observers argue that the extra insurance costs will only worsen their financial condition, force more S&Ls; into insolvency and saddle the FSLIC with an even greater burden.

Although observers have warned for years of mounting problems in the savings and loan industry, many taxpayers continue to wonder how this crisis could develop and why they should pay the price.

Understanding the present problem starts with the FSLIC. In less than a decade, this government agency has gone from comfortable obscurity to front-page notoriety.

It is the FSLIC’s job to stand behind all deposits up to $100,000 per account, meaning savers will get their money even if the financial institution fails. The problem is that the FSLIC, because of hundreds of expensive failures in recent years, no longer has the financial resources to back up its commitments.

As much as one-quarter of the industry has run out of capital in the wake of mammoth losses. Capital is a measure of net worth--or assets minus liabilities. When capital vanishes, the thrift is termed insolvent--meaning the value of its assets, mostly loans and perhaps some real estate, are less than the sum of its debts, which include what it owes depositors. When an insolvent financial institution is closed and its assets sold off, there is still not enough money to give depositors their money back.

Serves as Reserve

Capital is a key measure of the health at any financial institution. It is supposed to serve as a reserve against losses. If a thrift’s capital is depleted, regulators have the power to close it and pay off depositors from funds in the FSLIC.

Therein lies the problem: although hundreds of thrifts have no capital, the FSLIC has nowhere near the resources to pay off its depositors.

Federal regulators generally have required thrifts to have capital equal to roughly 3% of their assets--a thin line of defense that could vanish overnight if loans do not hold their value.

Yet that is what has happened. Many thrifts saw their capital disappear because of loans and investments that did not pay off. These were commonly loans and direct investments for shopping centers that never rented any space, office buildings that never filled up, condominiums that never sold or vacant land that was never developed according to plan.

When a loan does not work out according to expectations, the lender is often forced to foreclose on the property and “write down” its value.

A thrift with $100 million in capital, for example, might lend $10 million for an office building in Texas. If the building does not rent well and the builder defaults on the loan, the thrift forecloses and slashes rents to attract tenants.

An appraiser is hired to give the project a more realistic resale value, perhaps only $5 million based on the income generated by reduced rents. The lender is then forced to take a loss, or writedown, of $5 million on the loan. That loss, in turn, diminishes the thrift’s capital 5% to $95 million--because of just one loan.

These kinds of writedowns have been the bane of the thrift industry since 1985 and have led to literally billions of dollars in red ink. Such loan losses, for example, eroded the capital of Stockton-based American Savings & Loan Assn., which failed last September and was sold to Texas billionaire Robert M. Bass.

A look at the whole industry on Sept. 30, the latest date for which figures are available, shows how the losses added up in just one three-month period.

Of 3,046 thrifts insured by the FSLIC, 837 lost a total of $3.07 billion in the year’s third quarter, according to Veribanc, a financial consulting company in Woburn, Mass. Although 2,209 made money, the consulting firm said, the industry as a whole lost $1.54 billion.

Depending on the toughness of the accounting system used, anywhere from 315 to 735 thrifts were insolvent on Sept. 30, Veribanc calculated.

The problem has gotten worse with time, and the crisis proportions of the problem today have created a sense of urgency. What was a $15-billion problem in 1983, Isaac said, is generally regarded as a $100-billion problem today.

The cost is growing at a rate of $1 billion or more a month because the insolvent thrifts--ones that the FSLIC cannot afford to close--still have bills to pay and payrolls to meet. So usually they raise interest rates on deposits to keep cash flowing in.

That, in turn, sharply boosts their costs, deepens their losses, and gives them an even bigger negative net worth. Meanwhile, properties taken over through foreclosure often generate no income and rapidly drop in resale value as inevitable neglect sets in.

Before long, such thrifts are hopelessly unsound and unstable, and they are left facing two choices: liquidation, which the FSLIC usually cannot afford, or a forced merger with an acquirer willing to inject new capital into the company.

Last year, more than 200 failed thrifts were rescued, merged, liquidated or consolidated by the Federal Home Loan Bank Board, of which the FSLIC is a part, at a cost of more than $37 billion. Veribanc calculated that these thrifts lost more than $17 billion from 1986 to 1988.

To finance the rescues, the FSLIC issued notes and IOUs that must be honored during the next 10 years. It is these pledges--coupled with hundreds more rescues that are still necessary--that likely will require taxpayer assistance.

Blame for the savings and loan crisis, experts say, belongs to regulators, lawmakers and the industry itself.

Became Loan-Quality Worries

It started with the high interest rates of the early 1980s that led to heavy losses and, eventually, to the loan-quality problems of the mid-to-late 1980s. As Isaac summed up the problem: “A manageable interest-rate . . . problem became an asset-quality problem of almost mind-boggling proportions.”

Contributing to the mess were: lax supervision by regulators, permissive new federal and state investment laws that led to questionable lending and heavy losses, widespread fraud by savings and loan executives and depressed regional economies, such as in Texas where the real estate market collapsed when crude-oil prices plunged in 1986.

The healthy segment of the industry has not escaped blame. For years, through their powerful trade groups, industry spokesmen downplayed the depth of the problem and fought regulatory efforts to change the system. They lobbied hard in Congress against reforms proposed by Edwin J. Gray, chairman of the Federal Home Loan Bank Board from 1983 to 1987.

“Much of the reason for today’s disaster at the FSLIC is that the thrift industry trade associations were able to convince Congress . . . that the regulatory concerns about the FSLIC were nothing more than exaggerations and the Congress need not worry,” Gray told a congressional hearing in San Francisco recently.

Problem Traced to Early ‘80s

The original seeds for this disaster, though, were planted in the early 1980s when skyrocketing interest rates drove up deposit costs and drenched thrifts in red ink because most of their assets were in fixed-rate mortgage loans. The result was a total of nearly $9 billion in losses in 1981 and 1982.

The thrift industry emerged from the experience severely shaken and its capital badly eroded. But thanks to new state and federal deregulation legislation, they also emerged from the debacle with vastly expanded investment powers that took them far afield of mortgage lending, their traditional expertise.

Deregulation was supposed to give thrifts other ways of earning money. Instead, for many, it just gave them more ways to lose money at a time when they needed to raise capital.

Staff writer Robert A. Rosenblatt in Washington contributed to this story.