Bailout Seen as Eliminating Many S&Ls;, Inviting Abuse

The thrift bailout bill approved by a joint congressional committee is a landmark piece of legislation that will drastically shrink the nation’s savings and loan industry and make it far more conservative in its investments, lending experts believe.

At the same time, the proposed legislation contains important flaws and does not provide nearly enough money to solve the industry’s problems once and for all, critics say. If they are right, taxpayers may have to open their wallets again for what is already the most expensive bailout in U.S. government history.

The legislation--if it is given final congressional approval and is signed by President Bush--will probably put at least 1,000 savings and loan firms--one-third of the industry--out of business through closures and mergers in the years ahead, lending specialists believe.

Most experts predict that the number of thrifts nationwide will fall from around 2,950 today to fewer than 2,000 by the mid-1990s, but it may drop as low as 1,000, some believe. There were more than 4,000 thrifts in the United States when the decade began.

Despite approval by the conference committee Thursday, the bailout bill is not out of the woods. After days of negotiating, the Senate’s conferees bowed to House demands and agreed to a financing plan that will place the cost of the bailout on the federal budget. The Senate had wanted an off-budget financing plan.

Both Senate and House must vote on the package approved by the conferees, and Senate opponents of on-budget financing claim to have the votes to defeat the bill. Also, the possibility of a presidential veto looms over the controversy. Bush has strongly supported the off-budget approach.

But, if the bill finally is approved, it will create a new federal agency known as the Resolution Trust Corporation whose job it will be to close or merge 600 to 700 of the nation’s sickest S&Ls; as quickly as possible. The corporation already is controversial--and it has not even been formed yet.

Tough new capital standards, aimed at curbing high-risk lending, are expected to lead to waves of mergers and acquisitions as strong thrifts gobble up weak ones. And, for the first time, the bill allows bank holding companies to buy healthy thrifts and convert them into commercial banks.

“There is going to be a massive consolidation of the industry,” said James B. Bemowski, partner in the Los Angeles office of McKinsey & Co., a consulting firm.

The consolidations do not bode well for consumer pocketbooks. The added competition provided by hundreds of failing thrifts--the ones now targeted for liquidation--meant higher interest rates for deposits and lower rates on home loans.

Once those thrifts are closed, rates on deposts will fall and mortgage rates will increase, some experts believe. “For the consumer, (the bill) is not beneficial for mortgages or deposits,” said Robert Adelizzi, president of Home Federal Savings & Loan in San Diego.

Retreat From Deregulation

The bill marks a major step back from the deregulation legislation of the early 1980s that allowed thrifts to make major investments in areas beyond their traditional expertise in home mortgage lending.

Those laws, both state and federal, ultimately led to huge losses and the need for today’s taxpayer-assisted industry bailout, estimated to cost about $166 billion during the next 10 years. The U.S. taxpayer will foot about three-quarters of the cost, and the industry will pay for the rest.

The problems have caused a huge crack in the traditionally cozy relationship between Congress and the savings and loan industry. Thrift executives found lawmakers’ doors slammed in their faces after years of access.

“We’re being treated like a bunch of scoundrels,” complained Patrick H. Price, chief executive at San Francisco Federal Savings & Loan and a leading industry spokesman in California. “I can’t get a congressman to call me back . . . . I guess I resent that more than anything else.”

Hike in Tangible Capital

The bill has developed a new safety standard that will require thrifts to keep cash capital, also known as tangible capital, at 3% of assets. Tangible capital is the equivalent of shareholders’ equity minus intangible assets known as good will.

The bill will require a 1.5% capital standard at first, but regulators will not be required to limit the growth of institutions violating the rule until June, 1991. The 3% rule will take full effect in 1995.

And that will cause real problems for institutions with capital consisting largely of good will, the intangible value beyond an S&L;’s cash and physical assets. Currently, the capital requirement is 3% of assets, including good will.

In addition, the bill creates a separate safety standard that varies the level of capital according to the risk of the loan. As a result, investments in mortgage-backed securities and single-family homes, viewed as safe investments, will require less capital than money lent in riskier projects like apartment buildings and commercial office buildings.

Critics argue that the cleanup operation will need an additional $20 billion to $50 billion to do the job right and say that banking regulators will have to return to Congress in two to four years for more money.

“The day the ink is dry on this bill, they’re going to have to start working on a new one,” one former top federal thrift regulator, who asked not to be identified, warned.

Will Increase Costs

Executives at healthy thrifts complain that the bill will both increase their costs of deposit insurance to help fund the bailout and require them to raise more capital. The twin goals are not compatible, they argue, and may even push some now-solvent thrifts into insolvency.

At the same time, many experts are forecasting major problems for the Resolution Trust Corporation. According to Daniel C. Vladeck, a public interest lawyer in Washington, the agency is another scandal waiting to happen.

The trust corporation--to come under the general control of the Federal Deposit Insurance Corporation, the insurance system for commercial banks--must undertake an unprecedented effort to manage and sell assets worth $400 billion to $500 billion that will be taken over from failed thrifts.

Much of the responsibility probably will be subcontracted outside the government, because the trust corporation will have just a comparative handful of workers for its massive management and disposal job. “With few employees to carefully monitor these transactions, this structure is an open-handed invitation to abuse,” Vladeck said recently.

Massive Amount of Assets

Just the size of those assets, the equivalent of four times the real estate value of Rhode Island, will make the trust corporation one of the nation’s most formidable banking organizations, lending and housing experts point out.

The assets include an estimated $100 billion or more in problem loans and properties that are in foreclosure, are delinquent or have inadequate collateral. They range from apartments and office buildings to industrial parks and raw land.

“It is going to be extremely difficult (to sell these properties), the equivalent of organizing and executing D-Day,” said Donald Crocker, a real estate liquidation specialist who is president of J. E. Roberts Co. in Alexandria, Va. “It is very labor-intensive and takes highly qualified people to do it right.”

Many worry that the Resolution Trust Corporation will play havoc with local real estate markets if it sells assets at fire-sale prices. That could depress already depressed markets, particularly in Texas, where about half of the problem real estate is situated.

“The whole problem is: Do you get rid of the assets quickly and depress the market, or do you hold on to them and let the losses mount?” said Robert Litan, senior fellow at the Brookings Institution in Washington.

So complex is the task that many expect the trust corporation to remain in business for 5 to 10 years and perhaps even into the next century. “I expect them to be a . . . fixture of the Washington landscape for quite a while,” Litan said.

Until the 1980s, thrifts were largely non-controversial lenders whose main job was to provide homeowners with low-cost mortgage loans and keep depositors’ money in government-insured savings accounts. It was a comfortable but important business that made home ownership an integral part of the American dream and gave thrifts enormous clout with Congress.

The relationships started to change early in this decade when soaring interest rates drove up deposit costs and drenched thrifts in red ink because most of their assets were in fixed-rate mortgage loans. The industry never did recover from that experience, which led to total losses of nearly $9 billion in 1981 and 1982 and several hundred S&L; failures.

Although its capital was badly depleted, the industry emerged from the debacle with vastly expanded investment powers that took it far afield from mortgage lending. This kind of deregulation was supposed to give thrifts other ways to make money. Instead, for many, it merely provided other ways to lose money at a time they could least afford it.

As the industry enters the 1990s, it faces the prospect of its clout’s being further eroded because its ranks will be thinned even more. S&Ls; in the worst shape will be liquidated--and the depositors paid off--or merged, with regulatory assistance, with healthy thrifts.

Healthy Firms May Merge

Hundreds of other thrifts also will be merged out of existence, including both healthy firms that represent good buys and marginally healthy ones struggling to meet the new capital requirements, lending specialists say. Many of the acquirers are expected to be commercial banks and large thrifts seeking to expand their markets.

Price, the chief executive at San Francisco Federal Savings, estimates that only 1,100 to 1,200 thrifts will be in business by the mid-1990s and admits there is a good chance that his own financial institution will be acquired by an outsider wanting to enter the Northern California banking market.

“I think there’s a 50-50 chance we won’t be around (in three to four years),” he said. “Not because we failed, but because we have been successful.”

Some say the bailout legislation is another step in the inexorable march toward elimination of the thrift industry as a separately operated and regulated industry. Traditionally, banks have stuck to business loans and thrifts to home mortgages, but that distinction has become increasingly blurred in this decade.

“I think I’ll be a bank analyst within five years,” said Peter Treadway, a savings and loan analyst at the investment firm of Smith Barney, Harris Upham & Co.

But, even if thrifts do not survive as a separate and distinct industry, there certainly will continue to be lending institutions that specialize in home-mortgage loans.

“The function will persist, even if the (savings and loan) name doesn’t,” said Jonathan Gray, analyst for the Sanford C. Bernstein & Co. financial firm in New York. “Fifteen hundred to 2,000 (thrifts) will continue to operate as they always have--making mortgage loans using customer deposits.”