High Court Says U.S. Reneged on S & Ls, Must Pay

In a legal defeat that will add billions of dollars to the cost of the savings and loan fiasco of the 1980s, the Supreme Court ruled Monday that Congress reneged on a deal when it changed the rules for healthy thrifts such as Glendale Federal.

Now, the court said in a 7-2 decision, the government must pay damages for breaking its contracts after the healthy S&Ls; agreed to take over failing thrifts.

Glendale Federal alone has said it is owed $1.5 billion in damages, and analysts said the total cost to the government may run $10 billion to $15 billion. That amount would be added to the estimated $130 billion that the government already has spent cleaning up the S&L; mess.

The S&L; rulings grew from one attempt by regulators to stave off staggering losses in the thrift industry in the 1980s. But like so many moves in that era, the effort to solve the problem of mismanaged thrifts only made it more costly later on.

During the early 1980s, scores of thrifts were failing. The high inflation rates of that time caused them to lose money on their old, low-interest mortgage loans.

In response, the government gave thrifts permission to speculate in other ventures in search of higher returns. Many, however, poured money into losing projects, and their debts grew, greatly outweighing their assets.

The federal insurance fund was nearly broke, too, so regulators turned to strong S&Ls;, such as Glendale Federal, and urged them to merge with failing institutions.

In return, regulators agreed to loosen the accounting rules to allow the new, merged thrifts to lend more money.

But after these deals were worked out, Congress stepped in, passing a law in 1989 that ordered a crackdown on “accounting gimmicks.” That law effectively revoked the earlier agreements made by regulators.

The sudden changes in accounting rules nearly drove Glendale Federal out of business. Scores of other once-solid thrifts were forced into insolvency. With the court’s ruling, however, all of them are cleared to seek damages from the government to cover their losses.

A federal claims court here now will hear the pleas for damages and decide how much will be paid.

“Today’s decision by the Supreme Court reaffirms the American principle that the government, like any private citizen, cannot walk away from its contracts with impunity,” said Stephen J. Trafton, chairman and chief executive officer of Glendale Federal.

“We have endured six years of government stonewalling and delay. We now want to move rapidly with the damages trial.”

In 1981, Glendale Federal agreed to take over First Federal Savings and Loan Assn. of Broward County, a Florida thrift whose liabilities exceeded its assets by $734 million.

“It would, indeed, have been madness” for officials at Glendale and other solid thrifts to take over such losers, except for the agreement to loosen the accounting rules, said Justice David H. Souter, writing for the court.

At issue was an accounting gimmick known as “supervisory goodwill” that was used as an inducement to healthy savings and loans to acquire failing ones. The failing thrift’s negative net worth was offset by an intangible asset called goodwill, which was added to the acquiring institution’s balance sheet. It was to be written off over 40 years.

But some members of Congress who later looked into these merger agreements were disturbed. This type of accounting rests on a “shadowy concept” that is “valueless,” one representative said.

But revoking the agreements forced S&Ls; to write off hundreds of million of dollars in assets--moves that cut deeply into their net worth. Glendale Federal said that it survived only by raising millions in extra, outside capital.

Lawyers who fought the case through the courts called Monday’s ruling a victory for all government contractors.

“This means the government has to honor its obligations when it makes a contract,” said Washington attorney Jerry Stouck, who represented Glendale Federal and several other thrifts. “It can’t change the rules after it makes a deal.”

The government’s total bill for damages could run as high as $15 billion, though analysts emphasized that the estimates are fuzzy because of the volume and unpredictability of the litigation.

Before the Supreme Court, Justice Department lawyers made two main arguments. First, they said regulators cannot commit the government to follow a policy “for decades into the future.” Congress always has the right to change directions, they said.

And second, the government as a sovereign is immune from paying damages, they said.

The court majority, speaking through three opinions, rejected all of the government’s defenses.

Yes, Congress can change policy for the future but it cannot revoke earlier contracts, Souter wrote in his decision in the case (United States vs. Winstar Corp. 95-865). If regulatory policies were going to be changed later, “those agencies assumed the risk,” not the thrifts that made agreements with the agencies, he said.

Chief Justice William H. Rehnquist and Justice Ruth Bader Ginsburg dissented.

The ruling came on the final day of the court’s 1995-96 term. In a one-line order, the justices also revived a free-speech challenge to a Baltimore ordinance that prohibits billboards advertising cigarettes (Penn Advertising vs. Schmoke, 95-806). The move sends a further signal that President Clinton’s proposal to ban tobacco ads directed at minors may not stand up in court.

The decision cast doubt on city efforts to limit advertising of alcohol and tobacco. A U.S. appeals court had upheld a Baltimore law that prohibited billboards with cigarette and beer ads, but the justices vacated that ruling Monday and told the lower court to reconsider the issue.

Also Monday, the first challenge to the military’s revised ban on gays and lesbians arrived at the court.

Lt. Paul Thomasson, a former Navy officer, filed an appeal to his discharge asking the court to declare the Clinton administration’s “don’t ask, don’t tell” policy unconstitutional. Thomasson was discharged after he told his commanding officer that he is gay. His appeal will not be considered until the fall.

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Impact of the Decision

* The federal government might have to pay as much as $15 billion to settle about 100 savings and loan lawsuits over “supervisory goodwill.”

* Consumers will see little immediate change but the settlement could eventually trigger a round of mergers among cash-rich savings institutions.

What is ‘Goodwill’?

* The accounting gimmick known as “supervisory goodwill” was used to induce healthy S&Ls; to acquire failing ones. The failing thrift’s negative net worth was offset by an intangible asset called goodwill, which was added to the acquiring institution’s balance sheet. It was to be written off over 40 years.

* INDUSTRY IMPACT: The ruling’s big winners. D1

* SWEET VICTORY: GlenFed CEO vindicated. D14.