Move over, Charles Keating.
To most Americans, Charlie is a crook. Keating's abuse of his Lincoln Savings and Loan--and the favors he purchased from DeConcini and four other senators--provoked a $2.5 billion taxpayer-financed bailout: 10 dollars from every man, woman, and child in America. Keating personifies the rank thievery that characterized the savings and loan crisis, the largest financial disaster since the Depression. It has already cost at least $110 billion--a figure that could more than triple by the time we finish paying. This debacle made it more difficult for Americans to buy homes. And it left the country deeply cynical about the failure of its political system. Much of this you can blame on greedy rogues like Charles Keating.
But not all.
In the seventies and early eighties, a host of special interests, including some you might not suspect, laid the groundwork for the crisis. Consumer and senior citizen groups--groups often assumed to speak for the public interest--put thrifts in a desperate bind by lobbying to keep loan interest rates low and deposit interest rates high. In other words, S&Ls had to pay out a lot more than they could take in. In return, another set of lobbyists, speaking for a small but powerful group of S&Ls, pushed Congress to jack up their insurance coverage to $100,000 per depositor, exposing their insurers--the taxpayers--to more risk. In 1982, those same thrifts won permission for S&Ls to move beyond low-risk housing loans. This encouraged renegade thrifts to take risky gambles with federally insured money. Charles Keating was just around the bend.
As lobbies press the 104th Congress to give banks greater risk-taking powers, while leaving their deposit insurance safety net intact, it's worth remembering what the S&Ls taught us: When special interests, competitive or cozy, come together to make policy, the outcome rarely reflects the common good. As the S&Ls brazenly remade themselves in the early eighties, special interests got a lot. All we got was screwed.
The Old, the Bold, the Angry
The S&L tradition that lobbyists took two years to unravel dates back to the Great Depression. After thousands upon thousands of home foreclosures, the government stepped in, establishing a contract of sorts. Savings and loans, or "thrifts," would be allowed only to make home mortgage loans; in return, their deposits would be insured. Deposits at full-service banks were given the same insurance, but thrifts were allowed to pay slightly more interest on savings accounts to give them an edge in attracting money. Thrifts would also receive tax breaks. As much public utility as private enterprise, savings and loans--and the millions of homes they financed--testified to the success of New Deal liberalism.
For more than three decades, running a thrift was, for most, a blissfully simple business: Take in deposits from the community, give out loans for housing. Americans bought homes in large numbers, so there was no lack of business. Congress controlled competition among S&Ls by capping the amount of deposit interest they could pay and kept banks, thrifts' main competitors, at bay.
Traditional banks weren't happy, but there was little they could do. America's political culture and power centers were changing: The Eastern establishment was increasingly irrelevant politically, and banks embodied that establishment. Banks mocked the S&Ls as the "polyester lobby," but a Democratic Congress thought of S&Ls as the "salt of the earth," and bankers as snobs. "The banking business was hard to get into if you were in the wrong religious or ethnic group," concedes Denis O'Toole, a former lobbyist for the American Bankers Association. "The industry was dominated by Ivy League types, the Brahmins of the community." Savings and loan executives, understanding that their survival depended on political favor, became powerful political animals. They made friends with legislators, and helped run and bankroll campaigns.
Thrifts also had, as their bodyguard on the Hill, the U.S. League of Savings Institutions, one of the country's most powerful lobbies. The League milked the industry's social function, populist image, and its 4,000 members' presence in every congressional district. Long before fax trees or phone banks, the League had mastered grassroots lobbying. At crucial moments, it would blanket the Hill with S&L executives and flood Congress with mail.
But in the seventies, clouds began to mass over this pastoral scene. The thrifts' income came from portfolios of low, fixed-rate 30-year loans--loans to which they were bound. And when inflation began to push up interest rates, S&Ls were hamstrung. They began losing deposits to money market accounts and mutual funds, which, unlike S&Ls, could pay as much interest as they wanted.
In 1979, the storm broke. Paul Volcker, the chairman of the Federal Reserve, "spiked" interest rates--sending them over 20 percent at one point--to control escalating inflation. That year, only seven percent of S&Ls were losing money; only one year later, 85 percent were in the red.
Throughout the seventies, as deposit interest rates rose, the thrifts had been pushing for adjustable rate mortgages, which would allow them to tie home loans to market interest rates. In other words, if a thrift's deposit payments went up, so would its charges on loans.
This was crucial. Thrifts' primary income was the interest they collected on loans. And their primary expense was the interest they paid on deposits. Take yourself as an example. If your housing costs and grocery bills doubled, say, and your income stayed fixed, you would be in trouble.
As interest rates rose, S&Ls saw this situation coming and were in effect begging Congress for a simple and effective way to up their income. Jerry Levy, a politically active Wisconsin thrift executive, repeatedly visited his senator, William Proxmire, to push for adjustable rate mortgages. Proxmire, like most of his colleagues, said no. His reason? "Consumer sentiment was opposed."
So who were these consumers? In the seventies, consumer lobbying had come of age, producing landmark legislation to protect safety and the environment. Besides Ralph Nader, these activists included the Consumers Union, minority groups, and the Gray Panthers, the network of firebrand elderly activists--"Old, Bold and Angry," one headline read--who pressed for fair treatment on issues from hearing aids to housing. Consumer groups had built-in credibility with the press and politicians: They were presumed to speak for the American people. Often, they did.
But not always. These groups believed that if someone were going to pay more to absorb rising interest rates, it should be business, and not consumers--even if it drove businesses into the ground. And so throughout the seventies, consumer groups beat back the industry's effort to charge market interest on loans, objecting to adjustable rate mortages as too confusing and too costly.
Then, in 1980, the same groups launched a campaign to lift the limit on the amount of interest that banks and S&Ls could pay on their federally insured deposits. Small savers--many of them senior citizens--could not meet the minimum investments required for high interest money market accounts, and even many seniors who did have enough money for money market accounts mistrusted them because of their lack of federal insurance. And so the Gray Panthers led the fight to lift the cap, spreading buttons with their slogan--"Savings can be hazardous to your wealth"--far and wide. The Panthers worked the press. They went to Capitol Hill.
They also found unexpected allies in historical opponents: the banks. Banks had long chafed under the deposit interest rate cap because it forced them to pay less deposit interest than thrifts and prevented them from competing with money market accounts. Now they saw a way to capitalize on Congress's soft spot for consumers. Citicorp ran a full-page advertisement in The Washington Post aimed squarely at Congress, with the words, "Give us $100, and we'll give you $75 back," in reference to small savers' inability to keep up with inflation at banks and thrifts.
Could congressmen say no to feisty grandmothers? Just before one Senate hearing, a four-foot-ten, gray-haired Panther sashayed up to California Senator Alan Cranston, handed him a "hazardous to your wealth" button, and said sweetly, "For me, won't you wear this?" TV cameras caught him and other members wearing the buttons. Public pressure was too strong: Cranston supported lifting the deposit interest cap.
Fearful of direct competition with banks, the U.S. League lobbied fiercely against lifting the cap. It lost. "It was inevitable we would win," says a still-giddy Bob Gnaizda, a public interest lawyer who helped coordinate the Panther campaign.
That's right: The same consumers who refused to pay market interest on their loans demanded market interest, with federal insurance, on their deposits. Lifting the cap may have been inevitable, but denying S&Ls any means to handle the change had not been. Harry Snyder of the Consumers Union today concedes the unfairness of his group's combined demands. "We should have thought that through," he says. "But it's hard at the time to see all the wrongs that need to be righted."
Having satisfied consumers and the banks, Congress needed to placate the thrifts. Threatened with paying market interest on deposits, and mired in a sea of low, fixed-rate loans, thrifts were in a precarious position. And so, as part of the 1980 legislation, their lobbies pressed for an exorbitant increase in the level of insurance coverage, from $40,000 to $100,000, claiming it would help lure depositors.
Now, if your life was insured for $40,000, and you wanted to more than double that amount, any private insurance company would raise your premiums. The S&Ls asked for a better deal: They wanted their coverage raised for free. If something went wrong, the U.S. Treasury--and, by extension, taxpayers--would be left holding the bag.
Many congressmen felt guilty about lifting the interest cap, and wanted to help the small-town thrifts they thought it might hurt. The irony, though, was that small thrifts still dealt mostly with small savers, and the increase to $100,000 in insurance meant little to them at the time. It meant a lot, however, to large thrifts, mostly in California, that wanted to compete with banks, and which could use higher deposit insurance to lure big savers from Wall Street and Latin America.
From the fifties, California's thrifts had been hungry. The state's building boom had provoked a desperate rush for mortgage capital. By the seventies, the state had accumulated more than one-fifth of the country's S&L assets. Many California S&Ls became multi-billion dollar institutions, signing Bob Hope, John Wayne, and George Burns as spokesmen. Their top officers became major political players. "He's a son of a bitch," John Kennedy supposedly once said of Bart Lytton, Beverly Hills S&L magnate and Kennedy supporter, "but never forget he's our son of a bitch."
While most thrifts were still mom-and-pop operations, thrifts in California--and some in Florida and Texas--were aggressive in their drive to move into commercial and consumer lending. They even had their own lobby: the National Savings and Loan League. Its 250 to 300 members-- well under 10 percent of S&Ls country-wide-- held more than 20 percent of the industry's assets.
The entrepreneurial thrifts used their muscle to shape industry policy. Most of the National League's members were also members of the U.S. League, the industry's "big tent," which was struggling to balance the interests of the small and large, the conservative and aggressive thrifts. "Our role was to put pressure on the U.S. League and the industry," says Jonathan Lindley, who ran the National League from 1978 to 1983.
Unlike their smaller, sleepier brethren, the aggressive National League thrifts couldn't have cared less about the loss of the interest rate cap; in fact, some argued for lifting it. They saw the lifting of the cap--the thrifts' historic advantage--as the perfect opportunity to secure the $100,000 concession for the industry from an eager-to-please Congress. They lobbied for it, and pushed the U.S. League to do the same. It didn't hurt that both associations had several key friends on the Hill.
One was Fernand St Germain of Rhode Island, the wily, soon-to-be-chair of the House Banking Committee, and a consummate politician with a real talent for rounding up campaign contributions and sweetheart investment deals. St Germain eventually lost his seat after it was revealed, among other offenses, that he had accepted free flights and favorable property deals in 1979 and 1980 from a Florida S&L executive who happened to be a former president of the National League.
St Germain's partner-in-crime was Alan Cranston, then the Senate majority whip. Nineteen eighty was not just any year for Cranston--it was an election year. Since his previous race six years earlier, the cost of campaigning had hyperinflated. He spent more than $2.8 million in 1980, more than any other congressional candidate that year, and he needed California's thrifts to help offset the cost. They did. The California League of Savings Institutions gave him $7,000--a hefty contribution at the time--and the other large thrifts and their employees provided similarly generous gifts.
Cranston needed to offer something to his home state S&Ls, and he was in a position to do it. The allure of increasing deposit insurance was that it would appease one lobby without alienating any other. Hundred-thousand-dollar deposit insurance cost nothing up front. Even the banks liked it. Best of all, there were no well-heeled representatives of future taxpayers to contend with.
The new insurance level debuted during what they call on the Hill a "loose" conference, when items not in the House or Senate versions are added to the final bill. Lobbyists do their best work at such times, which is why the National League's Jim Cousins says he was "all over" members and staff offices pushing the increase during the heated conference. The bill that came to conference raised the insurance level to $50,000. No one is certain who initiated the amendment for more, but Richard Still, then a House Banking staffer, claims Cranston scrawled out "$100,000" on a note and passed it to St Germain. In any case, St Germain sponsored the amendment, and the bill passed.
Cranston won reelection that November. James Grogan, a lobbyist for Charles Keating, later testified about meeting Cranston at the 1984 Democratic Convention. "I've worked hard for California savings and loans," Cranston said, whipping out a three-by-five card to write down Grogan's name. Within days, Grogan received a phone call from Cranston's fundraiser.
Cranston and St Germain deserve blame, but it takes more than two congressmen to get a bill through Congress. There was no discussion of the amendment, let alone opposition. The consumer lobby was conspicuously silent.
The success that both the consumer and thrift lobbies had in bamboozling Congress is best evidenced by William Proxmire, the chairman of the Senate Banking Committee, who oversaw the $100,000 sellout. On behalf of the consumer lobby, Proxmire resisted adjustable rate mortgages--he now admits he was wrong--and insisted that the deposit interest rate cap be lifted. And then, although no big thrift bought him--he shunned contributions for his last two campaigns--Proxmire pushed the insurance increase, too.
Proxmire's example also helps explain why the increase went unchallenged when the average saver, whom deposit insurance had been designed to protect, had $6,000 in the bank in 1980. How did insurance, an instrument designed to correct the market, instead become its tool? Because congressmen are light years away from the Main Street they sentimentalize. "Members of Congress get good salaries," says Proxmire. "We didn't feel $100,000 was as exotic as it really was."
On March 31, 1980, President Carter signed the Depository Institutions Deregulation and Monetary Control Act into law. The next day in California, newspaper ads featured a grinning Bob Hope. "$100,000," the ads screamed. "Now California Federal gives you two-and-a-half times more insurance on your savings." Some estimate that the deposit insurance increase trumpeted by Hope boosted the cost of the bailout by a third.
The High Life
For the National Savings and Loan League, the early eighties were a heady time: Ronald Reagan was in the White House, and deregulation was in vogue. The industry regulator, the Federal Home Loan Bank Board (FHLBB), had a new chair named Richard Pratt, a charismatic academic who, like the aggressive S&Ls, fervently believed thrifts ought to be more like banks. So did Jake Garn, the new Republican chair of the Senate Banking Committee. Entrepreneurial S&Ls, which had been lusting after bank-like powers since the early seventies, saw their moment.
The industry as a whole had one lobbying success after another. Accounting standards were relaxed. The amount of capital reserves a thrift had to keep on hand in case of crisis was lowered, then lowered again. Most damaging of all, the U.S. League continuously pushed pliable regulators and congressmen for government forbearance on insolvent institutions. In other words, the government let bankrupt thrifts stay in business. Thanks to higher deposit insurance and the ability to pay higher interest rates, failing thrifts could now lure in "brokered deposits," $100,000 chunks of "hot" money from Wall Street and wealthy investors who perpetually sought out the highest interest rates around the country. The thrifts were desperate for cash, and $100,000 deposit insurance gave them powerful incentive to gamble to get it.
The hemorrhaging that had begun in 1979 continued, as thrifts still saddled with their low-rate loan portfolios paid increasingly high interest. The industry's net worth plummeted from $32.2 billion in 1980 to $3.7 billion in 1982. The thrifts could have waited for interest rates to drop to sustainable levels and the government should have stopped subsidizing the most insolvent institutions. Instead, the U.S. League pushed for continued forbearance. And the large thrifts and the National League used the crisis to demand that Congress let them move into the potentially more profitable, but far riskier, commercial and consumer lending they had been eyeing for more than a decade.
"Of course we listened more to the California institutions," recalls M. Danny Wall, then the Senate Banking Committee's chief of staff. "California was where ideas and trends came from, and you tend to look at someone who's big and say they must be doing something right."
Wall and Garn called those reluctant to take on new powers "The Flat Earth Society." Meanwhile, Garn took Texas, where thrifts had had some expanded powers since the seventies, as a model for the deregulation bill he was sponsoring.
Some model. Those powers, and lax regulation, encouraged so much overlending, overbuilding, and fraud that Texas eventually accounted for 40 percent of all U.S. taxpayer losses. And the "Flat Earthers" that stuck with home loans survived the crisis and prospered. They include three of the four largest thrifts in the country today.
In 1982, the "big tent" U.S. League was dubious about expanded powers, and rightfully so. Dennis Jacobe, a League economist at the time, says the industry had been doing studies of the potential for success in just about every field (even travel agencies) beyond home loans. The results were, by and large, negative: The risks far outweighted the potential benefits, and the League knew it. But Pratt--the chief S&L regulator and deregulation devotee--and the big, aggressive thrifts put the hard sell on the U.S. League. "You can grow out of your problems," Pratt insisted.
He was a convincing salesman. The U.S. League ignored its better instincts and agreed to support the bill that Pratt, Garn, the White House, and the National League were drafting. "Dick [Pratt] led, and the U.S. League followed," says Jacobe.
The bill that emerged--the Garn-St Germain Act of 1982--was like giving a killer a knife for one last spree before prison: It kept insolvent thrifts open longer while encouraging them to take bad risks. S&Ls were now permitted to invest 90 percent of their assets outside home loans.
Congress passed Garn-St Germain on a voice vote, with little debate. Rep. Henry Gonzalez spoke up against the bill, but was ignored. In granting expanded powers, as in raising deposit insurance, the risk for Congress was an abstract one: no money down. In both cases, Congress had served larger, wealthier thrifts--a special interest within a special interest.
The banks, who were opposed to expanding thrifts' powers, could have been the brakes in the system. For a time, they were. "A sweetheart deal" for the thrifts, the banks' lobbyists growled about the plan. But then the bill went to another "loose" conference, and out came money market accounts with unlimited interest, a power that banks had craved desperately. Suddenly they too were praising the bill. It's like four gas stations at an intersection. They might compete and keep prices down. But then again, they might get together and jack prices up even higher, and if you're looking for cheap gas, you're out of luck.
The Garn-St Germain Act showed the true meaning of an omnibus bill: Everyone gets on the bus. Realtors got exempted from the Truth in Lending Act, insurance companies got an amendment keeping banks off their turf, the securities lobby got a lower minimum investment for their money market accounts than banks, and so on. In 1982, all the financial industries, from realtors to securities to banks, had given Congress a total of nearly $12 million--a substantial increase over 1980, reflecting both the rising cost of campaigning and the high-stakes frenzy provoked by financial legislation. Nobody walked away unhappy.
Except for the taxpayers. Regulators, the Office of Management and Budget, and Congress combined to reduce sharply the supervision of thrifts, which could now take greater risks. State legislatures worried that they would lose money if state-chartered S&Ls switched to federal charters for Garn-St Germain's freedoms, so the states passed laws allowing even crazier risks. California, for example, decided that thrifts could invest 100 percent of their money--federally insured money, don't forget--however they wanted. And so they did.
The Low Lifes
The thrifts' new powers and diminished supervision enticed a whole new breed of developer, speculator, and crook into the industry. Charles Keating was only one of many. The business grew rich with characters like Don Dixon of Dallas's Vernon Savings and Loan, a builder who used federally insured deposits to buy six Lear jets, a yacht, a mansion, $5 million in art, and prostitutes to "entertain" customers. And Ranbir Sahni, a former airline pilot whose American Diversified Savings Bank funded windmill farms, chicken farms, and junk bonds, but never a single home loan.
Home ownership was dropping during this period for the first time since the Depression, as even thrift executives who had spent their whole lives making simple home loans ventured, usually unsuccessfully, into the wilds of shopping centers and ski resorts. Thrifts with nothing to lose "gambled for resurrection." They lost. If plain, humble S&L buildings and suburban homes embodied the success of the New Deal, the architectural symbols of its undoing were the see-through office buildings lining I-30 in Dallas, the windmill farms alongside California highways, and the giant resorts now overcome by cacti in the Arizona desert.
The money lost by loose-cannon S&Ls didn't just disappear. It went into cars and condos and concrete. It also went into the pockets of politicians, as the thrifts spent vast amounts (of our money, it turns out) to keep government's hands off the industry. S&L interests invested more than $11 million in Congressional candidates and party committees during the eighties. It was public campaign financing--in the service of a private interest.
If insolvent thrifts had been closed in 1983, the cost would have been $25 billion. Instead, with industry encouragement, politicians afraid of having a bailout on their watch successfully postponed action until after the 1988 election. Finally, in 1989, Congress stopped letting the industry try to solve its own problems and started doing its job. It passed the Financial Institutions Reform, Recovery and Enforcement Act, which closed insolvent institutions and repaid depositors, radically reordered the industry's regulatory structure, and officially confirmed that taxpayers would foot the bill.
The lobbies--"consumer interest" and greedy thrift executives alike--had done their work. When the bailout finally began, President Bush and the 101st Congress borrowed money to keep the massive cost "off-budget." We'll be paying interest on the bonds they issued until 2029.
Now, a Congress infected with a missionary zeal for deregulation is preparing to repeal the Depression-era Glass-Steagall law, which erected walls beween commercial and investment banks to contain the risks that federally insured institutions could take. At minimum, the legislation before Congress will allow any bank to underwrite securities; at most, it will allow any commercial institution to own a bank.
We all ought to be a little nervous. The government still guarantees $100,000 in federal deposit insurance per person, per institution. If a bank should play the market, and the market crash, as it did in 1987, you could be left holding the bag. "As long as any institution can offer insured accounts and pursue risky activities," the National Commission on Financial Reform, Recovery, and Enforcement warned in 1993, "taxpayers could be vulnerable to some future set of 'unique' circumstances and events that could grow into another debacle."
Tell that to the banks. "We think we ought to be able to offer all financial services ... and to do so in a manner that isn't loaded up with a bunch of regulatory restrictions," says Edward Yingling of the American Bankers Association. Flushed with record profits, banks are pushing for "regulatory relief" and expanded powers. They have more than 100 lobbyists helping them do it. They've given nearly two million dollars to members of the House Banking Committee since 1991. And every other financial industry is gearing up to get on the bus.
"We're here to educate them," says Ron Ence of the Independent Bankers Association of America about the Banking Committee and its 15 freshmen. In fact, some of the lobbyists who are now busy "educating" Congress are the same ones who lobbied so effectively, and so destructively, in the early eighties.
Maybe the taxpayers ought to hire lobbyists, too. At least then we would stand a chance.
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|Title Annotation:||causes of the savings and loan scandal|
|Date:||May 1, 1995|
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