Viewpoints : S&L; Fiasco Opens Way for New Banking Era

MARTIN MAYER <i> is author of "The Greatest Ever Bank Robbery: The Collapse of the Savings and Loan Industry."</i>

In the inner counsels of the White House for the last month, everybody has been worrying about a slowdown of bank lending that could exacerbate the economic slowdown.

President Bush had chief executives of several big banks in for a pep talk breakfast. Regulators were chewed out by White House Chief of Staff John H. Sununu and Commerce Secretary Robert A. Mosbacher for telling New England and Texas banks that they’d better write down the values of loans made to builders of offices and shopping centers nobody wants to rent. Treasury Secretary Nicholas F. Brady told first a bankers’ group and then a securities industry convention that the time had come for examiners to lighten up a little.

Monday, the Fed made what was blatantly described as a gift of $600 million from taxpayers to banks by cutting the non-earning reserves banks had been required to keep at the Fed overnight. But the Fed’s calculations, interestingly, implied that banks would use these new funds not to make loans but to buy Treasury bills.

In fact, none of this is likely to persuade the banks to loosen the purse strings. For the regulators and examiners no longer control the evaluation of questionable assets in banks’ portfolios.


This loss of authority stems largely from the savings and loan fiasco. If a bank has stockholders, its annual statement must be audited by certified public accountants, and given the lawsuits filed against these supposed professionals after the collapse of the S&Ls;, they want to prove out the financials for themselves, whatever examiners say.

Even more important, however, is the new demand on the banks for “capital” to back the loans they make. Before the arrival of deposit insurance in the 1930s, American banks had always run their business on a basis that about $10 of every $100 they lent was their owners’ money--their “capital ratio” was about 10%. The safety net the government put under banks allowed them to raise from the public a much higher proportion of money they lent, and by the mid-1980s the average large American bank had no more than $3 of its owners’ money in every $100 it lent.

The lesson of the S&Ls; was that when owners of such institutions don’t have enough of their own money backing up loans, they make risky or even dishonest loans. The economists’ word is “moral hazard.”

So the world’s bank regulators agreed in the late 1980s to set higher “capital standards” for their banks. The first phase of this new worldwide regulation kicks in with the dawn of the coming new year.

Now, banks that wish to grow--and even, in many instances, to stay the same size--will have to issue new shares of stock or new bonds to beef up their capital ratio. And the people who are asked to buy those stocks and bonds look at the banks a little differently from the people who are merely asked to lend banks money in the form of insured deposits or other bank borrowings protected by the government safety net.

Investors look at banks to see whether their assets really are worth what the books say they are. Any losses on the assets, after all, must be paid for by reductions in capital. If regulators have been letting banks kid themselves by overstating the value of their assets, investors will force down prices of bank stocks and force up interest rates that banks must pay for borrowings the government doesn’t protect.

And that’s what’s happened. Big banks carry on their books their Brazilian loans at 80 cents on the dollar, even though the market trades such paper at less than 30 cents--if they can find a buyer at all. Banks continue to value at 100 cents on the dollar loans they made to leveraged buyouts and mergers, even though corporations that borrowed the money are collapsing under the debt burden. Salomon Bros. reports that some banks are swapping these two kinds of loans: You take over my loan to Federated Department Stores, I’ll take your loan to Argentina.

Until recently, banks didn’t write down real estate loans even when cash flow from rentals clearly wouldn’t be enough to service the loan and the appraised value of the building had fallen below the money the bank had put out to pay for its construction. In situations where the original loan had carried an “interest reserve” the bank could use to pay itself before the structure was rented, bankers--like Sununu and Mosbacher--insisted that the loan was still “performing” and could not be downgraded by an examiner.


But the market doesn’t care what the examiner thinks or does; the market knows there are lots of losses in this stuff. And there are.

What the market is saying is that there are too many banks and too much money in the banking system. If there are too many banks, it’s folly to expect investors to put in more capital.

For the banks, the way out is to sell assets. If the rules require you to have $80 million in capital for a $1-billion bank and all you have is $72 million in capital, well, you can sell enough assets to bring you down to $900 million in assets. Because you don’t want to show a loss on these sales (which would run down your capital), you sell off the best stuff.

All the big banks sell off their credit card and automobile and home-equity loan receivables to get the assets off the balance sheet. They’re also looking at their best loans to big companies, trying to figure out who would want to buy them. They’re also shedding property. In the past couple of weeks, for example, we have seen Chase Manhattan sell its offices in Frankfurt, Germany, and Tokyo.


And while they’re selling what they’ve got, of course, there’s no way the banks will be eagerly receptive to ideas for new loans--whatever the White House says.

By no means is all this contraction in lending bad news. Unwise fiscal policies and rather loose monetary policies after 1982 had given us an asset inflation in some ways as painful as the price inflation that so troubled us at the beginning of the last decade. The deals that are not getting done on Wall Street are deals that shouldn’t be done anyway, and the shopping centers that are not being built would not be occupied if they were built.

But asset disinflation can easily bleed over into debt deflation, which is the technical name for what happened in the Great Depression. If the banks weaken further in the spring, as the Fed expects, the remedy of choice appears to be the government purchase of new issues of preferred stock to be issued by banks having trouble raising money. The intermediary might be the Fed itself, or a new institution not unlike the Reconstruction Finance Corp. of the 1930s.

No one can quarrel with the argument that at times--and 1991 may be one of those times--the government must intervene to make the banking system at least look healthy. But we must know what we’re doing. We can’t and shouldn’t go back to banking as it was in the 1980s, with its desperate struggle to grow on the back of risky loans.


Contrary to what often gets said in Washington and New York, our entrepreneurial society does not need giant banks doing all sorts of business all over the country. The giant borrowers who used to patronize and support giant banks no longer need bank loans; they borrow directly from the lenders who used to lend through the banks.

The country needs profitable, smaller banks with roots in their local and regional economies to take care of borrowers who rely on their services. The task for regulators is to help large banks shrink without draining away the credit that is heart’s blood to the economy.