President Bush’s plan to rescue the savings and loan industry will be debated in Congress next month, and the President’s men are rallying the financial industry to push for quick approval.
But S&L; executives and bankers aren’t willing to go along with every aspect of the comprehensive proposal, the biggest restructuring of the industry since the 1930s.
S&L; leaders dislike the loss of independence of the Federal Home Loan Bank Board and its deposit insurance arm, the Federal Savings and Loan Insurance Corp. Bankers complain about the Federal Deposit Insurance Corp.'s loss of independence.
And there are a host of other concerns, including higher premiums for deposit insurance and possible “fire sale” prices to liquidate properties.
Douglas McEachern knows the concerns well. As a partner in the Big 8 accounting firm of Touche, Ross & Co., he heads the firm’s national S&L; practice and works out of offices in Orange and Los Angeles counties. As an accounting fellow at the bank board from 1983 to 1985, he saw the problems in the industry cropping up.
McEachern recently spoke with Times staff writer James S. Granelli about the Bush proposal and the future of the savings and loan industry.
Q. The Administration is pushing for quick approval of its rescue plan for the nation’s savings and loans. What are the prospects that a law will be enacted quickly?
A. I don’t think it will happen as quickly as Bush would like. The key is getting the cash to pay off depositors at all these institutions that are going to be closed. I think the plan is a good one, but it’s subject to a lot of change as a lot of parties bring in their own ideas. I don’t think it’s the best possible plan yet, but it’s a major positive step.
Q. What are the major stumbling blocks to getting approval?
A. Resolving where the cash will come from and what controls exist on spending the money. Also, there is a lot of property that these institutions owned, and one of the major worries is how those assets will be liquidated or merged into healthy operations. If you get rid of that property too quickly, perhaps at fire-sale prices, you could create lower property values and have a great impact on the health of other companies, including financial institutions, in the area. So you have to liquidate and merge these assets while at the same time maintaining confidence in the system.
Q. The S&L; industry’s trade group, the U.S. League of Savings Institutions, has long had a great deal of influence in Congress. It plans to fight for changes in Bush’s proposal, but has its influence been diluted by the mess in the industry?
A. The U.S. league is struggling to have an impact on legislation. It’s been beat up by regulators and the Congress a lot lately. The problems facing a number of institutions have snowballed and brought the industry problems to a head. The league will try to have an impact through lobbying efforts, but I don’t know if it’ll be successful.
Q. Can the President’s plan work as is?
A. We’ve got to extend the June, 1991, deadline for S&Ls; to come up with more capital. The industry can’t raise the capital level (to 6% of assets from 3%) in that short a time. Everyone agrees you want higher capital. The issue is, it’s going to take a lot longer to get from where we are today to where we would like it to be. That’s not going to happen in 2 or 3 years. It’s just not realistic. Also, (under the proposal) we have to decide whether the S&L; industry should be devoted to housing. Personally, I think it’s something we, as a nation, need.
Q. How can S&Ls; raise capital?
A. There are only two ways--through investments or earnings. And one reason S&Ls; cannot attract investors is the lower return. Profit margins are thin, and right now the returns are very, very slim in the savings and loan business. S&Ls; have, as an industry, higher operating costs than banks. One way to enhance their earnings is to get costs down.
Q. Raising capital has been tough for both banks and S&Ls.; Is it tougher for S&Ls;?
A. If you compare the rates that banks pay for deposits versus the rate that savings and loans pay, the S&Ls; are being forced by the marketplace to pay higher interest rates. To tell an industry that’s having a real tough time competing right now and making profits, “Guys, you’re going to be paying a lot more in the future,” that poses a lot of problems on a long-term basis. How do you attract any capital into this business, especially when (regulators) are proposing an even tougher capital requirement that would hamstring the industry in comparison to other industries? And right now, you don’t see a whole lot of interest in buying S&Ls.; I do have a number of clients who have been looking to acquire savings and loans. They’ve backed off a bit now, the last couple of months, saying they’re not quite certain. The reason is this return on equity, along with some concerns about how to eke a profit out of this enterprise on a long-term basis.
Q. Most S&L; experts, including yourself, believe that the need for more capital will force sales and mergers. But merging two S&Ls; with low capital doesn’t give you an S&L; with proportionately higher capital.
A. There is not enough capital out there, and the Bush plan doesn’t encourage investors to bring capital into the industry. What the Bush proposal needs to do is to attract investors who can get a good return for their investment over the long haul. You’ve got to have capital, and it doesn’t look like it’s there now.
Q. Regulators merged or closed more than 200 S&Ls; last year. About 350 are still basket cases, and more are being put into that category. Are we looking at the death of an industry?
A. I hope not. There’s a reason this industry was created. It’s because home ownership was deemed to be an important part of the American fabric. And the delivery of that service to the marketplace is very important. There’s an established facility or network for delivering that service to the marketplace, which also encourages savings.
Q. So you don’t like the new investment powers S&Ls; were given in deregulation?
A. I don’t question the powers, but I think some of the owners didn’t have the management capability to take on those powers. If we continue down a path that says that real estate development activities are fine, that investing in commercial loans like high-yielding junk bonds or commercial loans to business is fine, that making consumer loans is fine, we’ll confuse the issue of what we want those institutions to focus on. If they have a focus, I think they’ll do all right. If we don’t give them that focus and they get lost in the financial intermediary process, I don’t think they will survive.
Q. Do we still need S&Ls; to encourage savings?
A. We need more savings as a country. I think S&Ls; have a marvelous franchise with their customers, and they should continue to play a major role in savings. If we had a nationwide policy to encourage savings, that would help. But there’s no such policy yet. I’d like to see some sort of tax incentive for savings. Indirectly, we’re encouraging savings through our tax laws, which are eliminating the consumer interest deduction and saying, in effect, “Don’t borrow. Save up to buy something.” I think that is slowing up spending.
Q. Are there some other methods to get out of the S&L; mess? Besides spending tax dollars, should we foster sales to foreign investors?
A. The regulators have been selling a lot of the savings and loans. But with the tax benefits that acquirers receive in acquisitions in 1988, the taxpayers are underwriting, to a degree, some of these transactions. Foreign investors is an idea. Foreign investors are starting to show some interest in savings and loans, as well as real estate, in the United States. But it’s going to take a lot longer to work on sales. The Japanese, for instance, aren’t comfortable yet with the savings and loan business. They’re familiar with banks and they understand that, but not S&Ls; at this point.
Q. Healthy S&Ls; complain that they shouldn’t be assessed higher deposit insurance premiums than banks because the fiasco in the savings business wasn’t their fault any more than it was the banking industry’s fault. Can they afford to pay more to pull the industry up?
A. Not for them to continue to be competitive with banks. Great Western is paying 50 or 60 basis points (0.5 to 0.6 of 1 percentage point) more to attract similar types of deposit accounts that Bank of America gets. Now, Great Western is very, very strong, maybe stronger than Bank of America financially, and it’s already paying an extra amount for deposit insurance. I don’t think it is fair for the healthy S&Ls; in the industry to continue to pay that extra amount. It puts them at a very big competitive disadvantage with the banking industry.
Q. The President’s proposal goes a long way toward turning banks and S&Ls; into one industry. For insurance purposes, at least, you would go further by merging the FDIC and FSLIC completely.
A. I think it’s inevitable. I personally think that we should have one entity that does all the insurance for all financial intermediaries. Whether that’s the securities industry, the credit union fund, the FDIC or FSLIC. Maybe they should all be done or handled out of the Treasury and have everyone pay the same premium fee. I haven’t seen a whole lot of debate about why you’d have different entities out there, but at least, in my own mind, I can see a reason for making it all centralized, especially if we as taxpayers are funding everything and standing behind all the insurance funds as it is.
Q. The FSLIC is using promissory notes to wipe out the red ink at failed S&Ls; that it sells. Some industry leaders, including FDIC Chairman L. William Seidman, question the value of the notes. What’s really the concern behind the use of FSLIC notes?
A. The concern is that FSLIC is very much strapped for resources. How is it going to pay off these notes when they come due? FSLIC would say that’s not an issue, they’re backed by the full faith and credit of the U.S. government. Well, that’s fine, but then you read the newspaper articles where Congress is saying, “We didn’t give full faith and credit. FSLIC is out spending money that we didn’t authorize.” And then you have Bill Seidman of the FDIC saying he thinks maybe we should take back the full faith and credit behind some of the deals that were done last year. So the issue is that inherently everybody believes that the U.S. Treasury is standing behind these things. I personally do. But it’s hard to sit there and sort through how those notes are going to be repaid by an agency that is strapped right now.
Q. Some people blame deregulation of the early 1980s for letting in new players, some of whom were greedy and unscrupulous and caused much of the problems in the S&L; industry. But will the industry fare any better with the latest round of players that have been brought in through these mergers?
A. No one anticipated what was going to happen when the first group was allowed to buy institutions and take over and do things. When I was at the bank board, we were absolutely incredulous about what occurred. I think that the big test is what is the quality of the management group and can they handle the environment in which they’re put. If the management group is on top of things, does a lot of blocking and tackling in their industry right, they’ll succeed. And are they qualified for the industry in which they’re in?
Q. Orange County has been home to more S&L; failures than any other county in the state. Why is that?
A. You have a lot of entrepreneurial activity taking place in Orange County. You had a combination of things. A lot of real estate developers acquired institutions and they grew the institutions because they had fairly easy access to money. And Congress, in late 1979 or early 1980, increased the insurance limit on deposits from $40,000 to $100,000. And we had lots of money flow into these institutions very quickly because we taxpayers stood behind it. Orange County had North America Savings, Ramona Savings, American Diversified--everyone knows the names of all these institutions because they’ve been reported quite roundly in the news. You had a group of people who didn’t have the management talent for the industry in which they were in. And they were risk-takers, big risk-takers with deposits. In their own industries, they were probably good managers. But I think that they were probably using insured deposits in a way in which they were never intended by us as a public to be used--to speculate in real estate. And things didn’t turn out as well as they thought. It wasn’t quite as easy to manage these companies. They’re very complicated entities. And you’ve got to control operating expenses. One of the things that’s a real danger sign is high operating expenses for luxuries they couldn’t afford.
Q. Regulators sued Touche Ross over its audit of Beverly Hills Savings and said most Big 8 accounting firms will end up being sued over audits of other failed S&Ls.; Is this an effort to go after money wherever they can?
A. They’re not suing just accounting firms. They’re suing the lawyers. They’re suing appraisers. They’re suing management groups. They’re suing insurance companies. Regulators are looking at the hole they’re facing, and they’re trying to look for where they can get some money. Courts will tell who’s responsible and how we divvy up the responsibility in this process. But I think the initial thrust is to try to get money back. Plus, I think in some cases, we’re seeing a response to pressures from outside forces, like Congress and others who want to see that people are held accountable for problems that occur.
Q. While you were with the bank board, did regulators see these problems coming up? Did they understand what was going on?
A. I think the regulators understood the problems that were coming up. Some of the problems were delayed by using some of the accounting that you alluded to earlier. That accounting was put in place, a lot of it with good intentions, to help people restructure their S&Ls.; Some of the other things were done to prop up the industry on a short-term basis without a focus of what the heck happens on a long-term basis. “We’re going to take care of today’s problem and then maybe it’s going to be somebody else’s problem to worry about later on their watch.”
Q. Such as the accounting methods that were used to prop up the financial condition of S&Ls;?
A. Sure. They allowed institutions to double the amount of loan fees that they were recognizing as current income in late 1979, retroactive to the beginning of 1979. The sole reason was that earnings and net worth were down, and this was a way of propping that up. That caused a lot of furor at the time. And you had the ability to acquire an institution or charter an institution with very little capital. And the capital regulation requirement that allowed exponential growth very, very quickly. It was very attractive for an entrepreneur to come in and acquire a thrift charter and do things.