A Message for S&L; Lobby, Congress
As you may have noticed from the business pages, savings and loan institutions--thrifts, for short--have been going bankrupt at an alarming rate during the past few years. Because the deposits at these institutions are insured against loss by a federal government agency, the Federal Savings and Loan Insurance Corp., depositors’ money is not at risk.
But the record number of bankruptcies long ago exhausted the FSLIC’s reserves, so the government must provide funds to make good on the deposit insurance. Doing so is the first objective of legislation before Congress, and it is generally agreed that, if the problem does not worsen, it will cost $100 billion to $150 billion.
The second objective of the legislation is to change the rules governing thrifts to avoid repeating the present crisis in the future or having the present crisis spread much further and cost much more than is now projected.
One might have thought that, in a demonstrable crisis that already is costing taxpayers megabucks, business in Washington as usual might be suspended. Yet the lobby for the thrift industry continues on its narrowly self-serving way, and many in Congress, despite all that has happened, seem unwilling to resist that pressure. Unless it changes direction soon, Congress will have weakened the legislation originally offered by the Administration and so will have increased the likelihood of a renewed thrift crisis in the future and increased the cost that taxpayers will eventually bear.
Mutual Savings & Loan Assn. of Pasadena recently reacted to all this in a refreshing way. The institution, controlled by the fabled investor Warren E. Buffett and chaired by Charles T. Munger, resigned in disgust from the U.S. League of Savings Institutions, the industry’s main lobbying group.
In pulling out of the league, Munger offered a remarkably salty assessment of its actions to date. “The league responds to the savings and loan mess as Exxon would have responded to the oil spill from the Valdez if it had insisted thereafter on liberal use of whiskey by tanker captains,” he said. For good measure, he added, “It is not unfair to liken the situation now facing Congress to cancer and to liken the league to a significant carcinogenic agent.”
We can applaud Buffet and Munger for calling attention to the harm being done by the S&L; lobby. But they should have directed some of their attention to Congress itself, whose members should understand the problem and the harm they can do.
Underlying the problems of the thrift industry and the risk of huge additional costs to taxpayers from future insolvencies is the perverse incentive structure that exists for insured depository institutions. Because deposits are insured, depositors have little concern for how safely management invests their money. Depositors mainly go where they get the highest interest rate. A thrift can take exceptional risks, and its depositors are unlikely to know--let alone care. If the big risk succeeds, the thrift makes a lot of money. If it fails, the depositors are insured.
Of course, there are still losses to the owners if the thrift fails. But the amount of owners’ capital at risk is very small relative to the total of deposits and investments, so any major gains accrue to the owners, while any major losses are borne mainly by the insurance system. This asymmetry between possible gain and loss can and has been used to advantage by unscrupulous owners.
But even honorably run institutions can be driven to take excessive risk if doing so offers a chance to save the institution from insolvency. If an institution initially gets into trouble because economic conditions turn some of its loans and investments sour, losses can erode its capital to the point at which it amounts to, say, less than 1% of its assets. The owners have little or nothing left to lose. Yet taking risks with the assets offers the chance for profits that could rescue the institution from insolvency. In effect, the owner is invited to gamble--with a chance of winning big and with the insurance fund’s money available to cover losses.
It is evident that the insurance system needs some greater discipline to neutralize the incentives for excessive risk taking that otherwise exist. One kind of proposal would tighten restrictions on what investments an institution is allowed to make. The usual proposal would restrict thrifts more closely to mortgage lending, which historically was their main activity. However, the net effect of such restrictions is uncertain because a more diversified portfolio should reduce the risk associated with economic fluctuations.
That leaves stiffer capital requirements, which would put more of the owners’ money at risk, as the main discipline that is available and that is widely agreed to be necessary. The Administration had proposed gradually bringing the capital requirements of thrifts up to the 6% capital requirement of banks.
The powerful thrift lobby has been pressuring Congress not only to settle for a capital requirement only half that large but to allow “good will”--the value of a company in excess of its tangible assets--to count as capital for purposes of meeting the requirement. The Congress might remember that taxpayers, who will have to pick up the tab for thrift failures, cannot meet their tax obligations with “good will.”
