We Haven’t Seen the End of S&L; Crises

With remarkably little argument, the Senate last week overwhelmingly approved a bill committing $157 billion over the next 10 years to rescue and reform the savings and loan industry.

The House probably will pass similar legislation in the coming week, and President Bush is sure to sign it into law before the summer.

The purpose at least is noble. The government is hitting taxpayers directly with a bill for more than $100 billion--and raising $50 billion more by selling bonds in a new government agency--to ensure that S&L; depositors don’t lose money.

But will that do the job? As expensive as this is, taxpayers might ask, have we heard the last of savings and loan troubles? And, a related question, is this new law the best way to do it?

The answer to both is no. There will be more S&L; crises in the future because the present reform doesn’t go far enough. And this bill won’t do the job properly because it is flawed by the same fear, indecision and phony accounting that plague our whole economy.

But understanding is needed more than rhetoric. And a good way to begin is to keep in mind that the money has already been lost. The S&L; problem is like toxic waste, where the leak occurred years ago and the cleanup occurs today.

There are 3,092 savings and loan companies in the United States, and 497 of them are insolvent. But they cannot simply close their doors like any other bankrupt business, because the depositors’ money they lent out years ago to finance commercial and residential real estate was lost as the loans went bad. Then, as in a Ponzi scheme, old depositors were paid off by new deposits--with all deposits up to $100,000 insured by the federal government, of course.

In a sense, the money authorized by the new legislation is to pay off depositors and close or merge the insolvent S&Ls.;

But the government doesn’t have enough money or political will to address the problem directly. Even the $50 billion proposed in new legislation is being put up in a phony way. It is being borrowed through long-term bonds to set up Resolution Trust Corp., a government agency that will become a repository for bankrupt S&Ls; and foreclosed real estate. Yet Resolution is not being included in the federal budget, so the fiction can be maintained that the federal deficit is coming down.

Doors Left Open

And if the White House and Congress are afraid to add openly to the budget deficit, they are doubly afraid to force S&Ls; to close up shop. Why? Because they fear a collapse of real estate prices leading to a recession.

S&Ls; hold $26 billion in repossessed real estate, and there is probably more than that in unacknowledged bad loans, says Alex Sheshunoff, head of a bank and S&L; consulting firm in Austin, Tex. If the government pushed too hard on troubled S&Ls;, they might be forced to hold distress sales of foreclosed real estate and depress markets. So, notwithstanding the relatively few S&L; closures we see these days, regulators and lawmakers are leaving the doors open.

But there is a cost to doing nothing. Insolvent or marginal S&Ls; will continue to attract depositors by issuing high-interest certificates of deposit, and that will bring pressure on healthy S&Ls; to do likewise. The result is that everybody ends up paying higher interest rates--including house and apartment buyers.

There is an intelligent alternative if lawmakers had the political will to take it. Insolvent S&Ls; could be prohibited from paying more for deposits than healthy S&Ls.; That would cause marginal companies to lose deposits and to shrink. But, suggests Bert Ely of Ely & Co., an Alexandria, Va., consulting firm, the process could be gradual enough to avoid disaster while weeding out weak companies, just as the new legislation is supposed to do.

The new law proposes to reform the industry by requiring S&Ls; to increase their equity and other base capital to 6% of assets--meaning that, like banks, S&Ls; could take deposits and make loans equal to roughly 16 times their capital. S&Ls; have been running on 3% capital, and even that 3% often is not real cash equity but bookkeeping fictions. Fast money operators--like Charles Knapp, who took the old Financial Corp. of America to bankruptcy, and Charles Keating, the man behind the now failed Lincoln Savings--have been attracted to S&Ls; for years just because it was the only business anywhere in which you could put up no capital and yet attract the public’s money risk-free.

Now industry leaders want an end to that game. “Capital structure must be increased,” says Kenneth Thygerson, former head of the Federal Home Loan Mortgage Corp. and now president of Imperial Corp. of San Diego. Chairman James Montgomery, of Great Western Financial, sent a letter to the Senate Banking committee demanding that capital requirements be increased.

Yet the issue remains in doubt. The bills coming out of both Senate and House water down strict capital requirements by allowing accounting intangibles, such as premiums paid for acquisitions, to count as base capital.

And that practically ensures that the savings and loan business, which ought to be a public trust, will remain a public trough--and that we haven’t heard the last of the S&L; problem.