COLUMN ONE : Lincoln’s Risky Road to Disaster : How an Irvine savings and loan fueled a real estate empire--and became one of history’s biggest financial fiascoes.

In late 1985, Shirley Lampel was a woman in anguish. Her husband had just died, and years of suffering from diabetes had left her without sight in one eye and only limited vision in the other.

The one ray of hope was financial. Her doting husband, Sy, an auto mechanic, had left a $30,000 life insurance policy. Prudently invested, it would help support her modest but comfortable life in Santa Maria, Calif.

But Lampel reckoned without Irvine-based Lincoln Savings & Loan and Arizona home builder Charles H. Keating Jr., who had acquired the thrift the year before. As a result of what she thought was a rock-solid investment with Lincoln, her savings were devoured in what was to become one of the great financial fiascoes of American history--one that could eventually cost taxpayers about $2 billion.

“Lincoln gives a whole new definition to bank robbery,” a bitter Lampel said recently. “It used to be that a person puts on a mask and goes in with a gun and robs a bank. Now we go into the bank and we get mugged. When did the bank become the crook?”

That’s not how Keating and his subordinates see it. But what they did was use Lincoln’s millions of dollars in federally insured deposits as new money for his cash-hungry real estate and financial empire. Shunning traditional home mortgages, they channeled the S&L;’s funds into huge tracts of raw land in Arizona, luxurious hotel projects, a portfolio of junk bonds and other speculative ventures, according to federal regulators.

Now, federal and state investigators, regulators and lawmakers are poring over the details of Keating’s activities. Already, regulators have filed a civil racketeering lawsuit accusing Keating and other Lincoln executives of squandering $1.1 billion in federally insured deposits through a series of “illegal, fraudulent and imprudent acts.” The suit and other documents allege that Keating and his associates sought to evade regulatory restrictions on such investments by making bogus loans to “straw” property buyers.

They also devised a tax plan that let them divert $95 million to Lincoln’s parent company by creating “phantom” profits through sham land swaps and loans, the regulators allege, and used accounting gimmicks, legal maneuvering and political string-pulling to further their operations and slow down investigators.

The Senate Ethics Committee decided last week to appoint an outside counsel to investigate Sen. Alan Cranston (D-Calif.) and four other senators who accepted large campaign contributions from Keating and then intervened with regulators on his behalf.

Compounding the ultimate cost to others, Keating and his associates sold about $200 million in now-worthless debt securities to unwary customers such as Mrs. Lampel at Lincoln’s branch offices. Many of the purchasers were elderly Southern Californians who thought the securities--issued by Lincoln’s parent company--were federally insured.

Keating has repeatedly denied the government’s charges. He has accused regulators of seeking revenge against him, harassing his employees and failing to understand real estate development. That, not his own actions, drove Lincoln to ruin, he says.

As a longtime home builder and mortgage lender, he said, his operation always has concentrated on single-family housing. He simply turned Lincoln, an institution whose financial health was questionable when he bought it, from a mortgage lender into a company that prepared raw land for residential construction, and he had a number of projects successfully built, he maintained.

Whatever the various government investigations ultimately disclose, it is already clear that Lincoln is one of the worst disasters in the nationwide savings and loan debacle.

Began as Lawyer

Keating, a collegiate gold medal swimmer in the Pan American Games and a Navy fighter pilot in World War II, began his business career as a lawyer in Cincinnati. In a conservative business community that traced its antecedents to the days when the Ohio River was the key to settling the American heartland, Keating stood out as an aggressive risk-taker and a stubborn competitor.

He was once described by his brother, William, as an “impatient” person who never worried about the popularity of his positions.

Also, he showed an early taste for combining business with politics. In the political arena, he became a vociferous opponent of pornography, aiding prosecutions, lobbying elected officials. He was even appointed to a federal commission that studied pornography.

And he managed his brother’s successful congressional campaigns in 1970 and 1972.

At the same time, Keating pursued a career in real estate development that eventually made him a top executive in a firm owned by wealthy Cincinnati financier Carl H. Lindner, who specialized in making aggressive takeover bids for other companies. The close association they developed continued long after Keating left Cincinnati in 1976 to take over a foundering Lindner real estate development firm in Phoenix.

A few years after moving West, Keating had his first serious brush with federal regulators. In 1979, Lindner and Keating consented to a Securities and Exchange Commission order prohibiting them from fraudulently diverting corporate assets to their personal use.

By the early 1980s, Keating--riding the tide of explosive growth in the Sun Belt--had built the former Lindner construction firm, renamed American Continental Corp., into one of the nation’s 10 biggest home builders.

Moreover, he--like others--had noticed a new opportunity: Congress, trying to rescue a savings and loan industry saddled with traditional low-rate, long-term home mortgage loans in an era of soaring interest rates, was dismantling the web of federal regulations that had always circumscribed the industry.

Under deregulation, banks and S&Ls; were allowed to place a part of their assets in direct investments such as ownership interests in real estate projects and other ventures, instead of just making loans on which they would collect interest. They were also allowed to place customer funds in high-yield, high-risk “junk” bonds and other non-traditional investments.

Real estate developers saw the thrifts as ideal sources of cash for their own ventures. They liked savings and loans better than banks because they had broader investment powers and were cheaper to acquire. In addition, the rules required thrift owners to put up only $3 of their own cash for every $100 in S&L; investments. The capital requirement for banks was twice as high: $6 for every $100 in assets.

California was an especially tempting target for such takeovers. In an effort to prevent state-chartered savings and loans from converting to federal institutions, California had enacted an even more liberal deregulation law than the federal government. In 1983, the state allowed thrifts to put 100% of their money into direct investments.

From his headquarters in Phoenix, Keating spotted a California thrift that seemed ideal for his expanding purposes.

Lincoln Savings & Loan was an Orange County thrift that had experienced losses in the early 1980s, but it had returned to profitability by the end of 1983. Keating bought it in February, 1984, for $51 million. At the time, regulators say, they were assured that Lincoln’s previous management and lending policies would be retained.

Instead, Keating transformed the traditional mortgage lender into a post-deregulation dynamo. Indeed, he said he bought Lincoln to take full advantage of California’s deregulation law.

Keating ousted the old executives, turned away from the S&L;’s traditional areas of business and began seeking bigger profits from riskier strategies:

--He used Lincoln’s deposits to buy huge tracts of undeveloped Arizona desert in an effort to create shining new communities from dust. The most ambitious of those projects was Estrella, a 20,000-acre planned community 20 miles southwest of Phoenix that was to include 50,000 homes for 200,000 residents as well as retail, industrial and office space.

--He assembled parcels of land in the affluent Phoenix suburb of Scottsdale to build a $296-million luxury resort hotel called the Phoenician Resort. He also bought the Hotel Pontchartrain, a troubled hotel in downtown Detroit, and initiated elaborate renovations.

--He used Lincoln funds to buy junk bonds and dabble in foreign currency trading. He bought big blocks of stock in other companies, prompting speculation that he might be a budding corporate raider.

He even sold the home-building unit of American Continental as he created a complex organization with 55 subsidiaries primarily devoted to real estate investment and development.

Efficacy in Doubt

In Washington, meanwhile, some were beginning to question the efficacy of the government’s prescription for the ailing thrift industry. Edwin J. Gray, whose position as chairman of the Federal Home Loan Bank Board made him the nation’s top savings and loan regulator, was one of them.

Across the country, S&Ls; were using their customers’ money to acquire stakes in windmill farms, restaurants and a host of other businesses they knew little about. Such investments, far from returning the industry to health, were bringing new losses so huge they threatened the solvency of the federal deposit insurance fund.

Gray began speaking out. What’s more, he proposed a rule to require all federally insured thrifts, including state-chartered S&Ls; such as Lincoln, to limit direct investments to 10% of their assets.

Keating for one was furious. As he describes it, he had barely gotten into the S&L; game and already the rules were changing. Arguing that Gray’s proposed restriction would destroy the industry, Keating began lobbying hard against it.

He hired Alan Greenspan, a respected economist who had served as a senior official in the Richard M. Nixon and Gerald R. Ford administrations and now heads the Federal Reserve Board, to analyze the proposed rule. Greenspan produced a report opposing it.

Although executives at other savings and loans also lobbied against the direct investment rule, Keating was perhaps the most prominent and persistent opponent.

Keating arranged for a congressional resolution that called on Gray to delay implementing the investment restriction for six months. Although 225 House members signed the resolution, it failed to sway the regulators.

Unable to stop the restriction, Keating found a way to blunt its impact on Lincoln.

The Gray rule would be adopted in early 1985, Keating learned, but would be applied retroactively to Dec. 10, 1984; any direct investments made before that date would be permitted to stand, even if they exceeded the 10% limit.

Three days before the expected deadline, Lincoln won approval from the California Department of Savings and Loan to move an additional $800 million into direct investments. That increased Lincoln’s direct investments to about 40% of its $2.2 billion in assets.

Customers Targeted

In 1986, Keating and his executives came up with an innovative way to raise unrestricted funds for American Continental: They would sell debt securities similar to the bonds issued by most of America’s major corporations. But, instead of selling them through Wall Street brokerages and other investment firms, they would peddle the securities to Lincoln customers.

The California Department of Corporations routinely approved American Continental’s first request to sell the debt securities, called subordinated debentures. About the same time, the state Department of Savings and Loan allowed American Continental to set up desks in the lobbies of Lincoln’s 29 branches to sell the securities.

Although the securities were, in effect, junk bonds, Keating said he would have recommended them to anyone, even to the Roman Catholic charities he supported heavily with donations. In fact, the Sisters of Charity in Cincinnati bought $444,000 of the securities.

In early 1988, American Continental sought approval for a second debenture offering. The California Department of Corporations approved the sales, even though the agency’s own staff and the state’s top savings and loan regulators expressed concern about the company’s financial condition and ability to repay the debt.

In little more than two years, American Continental sold about $200 million worth of debt securities to nearly 22,000 investors. About two-thirds of them were elderly Southern Californians who bought them at Lincoln branch offices.

Some of them have said in lawsuits and congressional testimony that they were persuaded to buy the securities instead of certificates of deposit by American Continental sales representatives, who assured them that the securities were safe.

Some have said they thought that the debentures were backed by federal deposit insurance--a costly mistake, as things turned out.

Regulators Cool

By 1986, federal regulators in the regional office in San Francisco were becoming distinctly unsympathetic to Keating’s operations. They began a detailed audit of Lincoln’s books that stretched over a full year--far longer than such examinations normally take. They concluded that Keating was handling Lincoln in an unsafe and unsound manner.

In particular, examiners reported that Lincoln had made a substantial number of loans without proper appraisals, without verification of borrowers’ credit and even, in some cases, without a loan application.

To a large extent, the examiners said in their reports, it appeared that Lincoln was making bogus loans in an effort to get around the new restrictions on direct investments in real estate and to record profits that it had not really earned.

Many major loans were made to “straw” buyers: people who bought properties with Lincoln funds on favorable terms and who never intended to repay the loans, thus leaving the savings and loan in control of the properties, the regulatory reports allege.

The examiners said that, after making the loans, Lincoln claimed as profits the up-front fees and interest such loans normally generate. However, in many cases Lincoln had also provided the money for the fees and interest in addition to financing the entire purchase price.

In May, 1987, the examiners recommended to their superiors in Washington that the government seize the institution or at least impose a restrictive order to curtail its high-flying operations.

Lincoln executives defended their practices, saying government regulators did not understand the S&L;’s development-oriented business. Regulators insisted, for instance, on using standards that applied to single-family loans to evaluate Lincoln’s commercial loans. The thrift had obtained audited financial statements from the borrowers, and those documents provided a better picture of possible risks than a consumer credit report, they said.

They contended also that regulators made simple mathematical errors in computing such items as how much Lincoln should set aside in reserves to protect against possible losses.

The big loans were made to borrowers who came up with 25% down payments, company executives said. Lincoln did not finance 100% of the purchase price, they said, and any other loans that the buyers obtained were not for the purpose of providing the down payments. Lincoln, they said, was entitled to record the profits on the loans.

The recommendations of the regional regulators were not adopted by Gray or M. Danny Wall, who replaced Gray as head of the Federal Home Loan Bank Board in July, 1987. Wall, a former staff aide to the Senate Banking Committee, said that there was insufficient evidence to justify the extreme action proposed by the San Francisco overseers.

If the rebuff angered the regional examiners, what came next stunned them. A year later, Wall stripped them of their supervisory responsibility for Lincoln and transferred jurisdiction to Washington.

Wall said an internal investigation had determined that substantial animosity had developed between Lincoln and the San Francisco regulators and that leaks of confidential financial information had damaged the savings and loan. Wall ordered a new examination directed by Washington-based regulators.

Instead of absolving Lincoln, however, the new audit reached even more damaging conclusions. Among other things, it called into question the tax-sharing plan Lincoln and its accountants had devised in 1986.

As a subsidiary of American Continental, Lincoln did not deal directly with the Internal Revenue Service on taxes. Instead, American Continental collected money from all its subsidiaries, then filed a consolidated tax return and made tax payments to the IRS on their behalf.

Over a period of a little more than two years, Lincoln made $95 million in tax-sharing payments to its parent company, ostensibly to cover taxes on profits it had earned.

But the government alleges in its racketeering lawsuit and other documents that Lincoln did not owe $95 million in taxes at the time and that American Continental never paid any of that money to the IRS.

Keating and his subordinates engaged in a series of sham transactions designed to create the appearance of higher profits, and thus higher tax obligations, as a device for siphoning money out of Lincoln and moving it to American Continental, which kept the extra funds, according to federal investigators.

Higher profits also boosted American Continental’s stock price. That in turn helped Keating and his family collect $34 million over five years from salaries, gains on stock sales and other benefits, regulatory records state. The stock sales were made to American Continental’s employee stock ownership plan, which obtained loans guaranteed by Lincoln to acquire the shares.

Lincoln executives said they did not misuse the tax-sharing arrangement.

The executives contend the transactions that generated the profits were legitimate and that Lincoln owed taxes, although they acknowledged that the taxes might not have been due immediately.

And, although Lincoln owed the taxes as a separate entity, they said, American Continental could use $250 million in tax credits it had accumulated itself to offset any profits on a consolidated basis that it or its subsidiaries made. Meantime, executives argued, the parent company could invest Lincoln’s tax payments any way it chose.

The tax plan was reviewed and approved by regulators, they pointed out.

They sold stock to the employee stock ownership plan, the executives said, because the plan, by its very nature, required the purchase of American Continental stock.

Because the stock was thinly traded, the plan could not acquire the big blocks of stock it needed except through sales by insiders. They said also that the price the insiders received for their stock was slightly below prevailing market prices.

And any allegations of boosting stock prices to get money out of the employee stock ownership plan through the sales, they said, fall flat because most of such stock purchases occurred in 1985, long before the allegedly fraudulent transactions occurred.

Example Cited

One example of how Lincoln conducted its business, according to government regulators, is a loan it made to Ernest C. Garcia, a Phoenix-area developer.

Early in 1987, Garcia approached Lincoln to see if he could borrow money to buy the remaining stock in a company in which he already held a 20% interest. Lincoln executives agreed to make the loan, regulators allege, but there was a condition.

According to the government’s racketeering lawsuit, the following events occurred:

As a condition of lending him the money he wanted, Lincoln asked Garcia to buy 1,000 acres of land owned by a Lincoln subsidiary for $14 million. The 1,000 acres were part of an 8,500-acre tract called Hidden Valley Ranch.

Garcia told Lincoln that he could not make the purchase himself, so he arranged for a firm called Westcontinental Mortgage & Investment Corp. to buy the 1,000 acres instead. Lincoln agreed to the arrangement and lent Westcon $10.5 million, or 75% of the purchase price.

At the same time, Lincoln lent Garcia $20.2 million, and Garcia lent $3.5 million of that amount to Westcon. The $3.5 million was used by Westcon to make the 25% cash down payment on the land purchase.

Lincoln recorded an $11-million profit on the transaction, even though the only cash it received was $3.5 million that had come out of its own coffers, the suit contends. Westcon has never made a payment on its $10.5-million loan.

In a May, 1988, letter, Westcon acknowledged that it had acted as Garcia’s nominee and asked him to “arrange for the transfer of this property to its rightful owner as soon as possible.”

That transaction was the first of 10 involving Hidden Valley Ranch property. The government alleges that, altogether, Lincoln claimed “phantom profits” of $82 million from the 10 deals. Those profits resulted in Lincoln’s making $31 million in tax-sharing payments to its parent company.

American Continental executives rejected the government’s characterization of the Hidden Valley loans. They said that Garcia, for instance, obtained a $30-million line of credit and that the $20.2 million he borrowed on the line was wired directly to the Tucson Electric Power Co., which owned 80% of the company Garcia had founded in 1981.

The Hidden Valley deal, they said, was not a condition for obtaining the line of credit, and Garcia, a major developer, used his own funds to lend Westcon the down payment.

Senators Intervene

It was during this period that one of the most controversial episodes in the Lincoln case occurred. In his struggle against the regulators, Keating enlisted the aid of five U.S. senators, who intervened on his behalf in two now-controversial meetings with thrift regulators in April, 1987.

The five senators--Cranston, Dennis DeConcini (D-Ariz.), John McCain (R-Ariz.), John Glenn (D-Ohio) and Donald W. Riegle Jr. (D-Mich.)--had received more than $300,000 in campaign contributions from Keating, his family and his business associates.

In addition, Cranston solicited $850,000 from Keating for three voter registration groups that signed up primarily Democrats. Glenn solicited $200,000 for a political organization he controlled. And McCain’s wife and her father invested nearly $360,000 in a 1986 Keating partnership that put up a Phoenix shopping center.

The first meeting, on April 2, 1987, involved bank board Chairman Gray and Sens. DeConcini, Glenn, McCain and Cranston. Gray later stated publicly that the four senators tried to make a deal for Keating by promising to get Lincoln to make more traditional home mortgages again if Gray would rescind the 10% limit on Lincoln’s direct investments.

Their effort, Gray declared, was an “abuse of senatorial authority” and “tantamount to an attempt to subvert” the regulatory process.

The senators heatedly deny proposing any such deal. They say they met with Gray to discuss the unusually lengthy audit of Lincoln by the San Francisco regional office; their only message, the four senators say, was that the regulators should charge Keating with something or get off his back.

The second meeting occurred a week later. Riegle joined the other four in a session with regional regulators who were conducting the protracted examination of Lincoln. Minutes of the meeting show that DeConcini mentioned the direct investment rule, but there was no subsequent discussion of the issue. The minutes indicate also that the session ended abruptly when the regulators said they intended to refer the Lincoln case to the Justice Department for criminal prosecution. That investigation is now under way.

Regardless of whether a deal over the 10% rule was ever discussed, critics of the senators’ actions suggest that their involvement may have delayed the ultimate seizure of Lincoln by two years, adding at least $1 billion to the taxpayers’ bill for bailing out the thrift.

Last Thursday, the Senate Ethics Committee decided to appoint an outside counsel to investigate whether the five senators violated ethics rules by going to bat for Keating.

Cranston, meanwhile, filed a formal response to the committee contending that he had done nothing illegal or improper in connection with Keating. He said his efforts on Lincoln’s behalf never went beyond what a member of Congress can legally do for a constituent who is experiencing problems with the government.

Cranston denied that his actions were in any way responsible for the losses facing the government or the people who bought the American Continental debt securities.

Bright Projections

And what of Keating’s enormous bets on the future of Arizona real estate?

In brochures for Estrella, his big planned community southwest of Phoenix, Keating boasted that Phoenix would soon become the 12th-largest metropolitan area in the country. Employment was rising at an annual rate of nearly 4% as new residents flocked to the Grand Canyon state, and the future seemed as bright as the desert sun.

A Lincoln subsidiary put in miles of sidewalks, created two lakes and made other improvements at Estrella. Some businesses began to move in.

Meanwhile, Keating poured a total of $296 million into the Phoenician Resort in Scottsdale, which was designed to attract the affluent tourists who had been streaming into the state in increasing numbers every winter.

Then things went bad. The influx of new residents and businesses to Arizona began to slow, but developers kept right on developing. Before long, the state was vastly overbuilt. The residential real estate market went flat. The commercial market fell through the floor. Even the tourist trade dropped off.

Today, Estrella bears little resemblance to Keating’s predictions; much of the land is still largely undeveloped. The Phoenician opened in late 1988, and, although it is generating tremendous income--$4.3 million last month alone--it is not generating enough to pay off its construction debt, regulators claim.

“Lincoln never was a viable institution under Keating,” said Bert Ely, an Alexandria, Va.-based consultant to the savings and loan industry.

Last week, government regulators seized control of the Phoenician and another Lincoln property, the Crescent Hotel in Phoenix, ousting Keating and as many as 30 of his associates from management of the lodges.

Seizure Occurs

The government finally seized Lincoln on April 14, 1989, declaring that it was being operated in an unsafe and unsound manner and that Keating and his executives were dissipating its assets.

The day before Lincoln was seized, American Continental filed for protection from creditors in U.S. Bankruptcy Court in Phoenix. The bankruptcy case prevented regulators from assuming full control of some of Lincoln’s assets.

Also, it created an unusual group of victims. Lincoln’s regular depositors would be made whole by taxpayers through the federal deposit insurance program, but the 22,000 investors who had bought the American Continental debt securities were left holding worthless paper. There was no federal insurance for them.

One of those investors was Shirley Lampel.

In 1985, Lampel’s husband had died of a heart attack at the age of 58. Despite her inability to work because of the diabetes that had left her all but blind, Lampel sought no pity. With Social Security payments and the monthly income from her husband’s $30,000 life insurance proceeds, she would make it.

One day, after moving from Santa Maria to Tustin, she had noticed a large newspaper advertisement about an investment opportunity being offered at a Lincoln office near her condominium. She took her life insurance proceeds and “practically beat down the door” at the Lincoln branch to buy American Continental debt securities.

After being assured that Lincoln was safe and sound, she had signed two pieces of paper and handed over a $30,000 cashier’s check. She could not read the fine print, and she said no one ever read the documents to her.

“I thought I was buying something similar to a certificate of deposit,” she said. “I didn’t know what debentures were. You have home insurance and car insurance, but do most of us really understand all that stuff? No. We trust.”