World of Shareware - Software Farm 2/wosw_2.zip/wosw_2/FINANCE/SLCRISIS.ZIP/S&L_CRIS.DOC

Text File | 1992-07-13 | 12KB | 296 lines

                                                   May 11, 1990

MEMO:  Origins of the S&L Crisis

     Much like Earth Day, the danger exist in the S&L crisis that the
lawmakers may act more on the cries of the media and pro-big government
liberals, than on the rational evidence available.

     On the policy side, many in government and the media are blaming
the S&L industry's current troubles on Reagan's deregulation in 1982,
the Garn-St Germain Act.  But in fact, S&Ls were having major problems
before Reagan came into office.

      An article in Newsweek in 1981 (Dec. 29) ran the headline: "THE
S&Ls IN DEEP TROUBLE."  The article said that a memo circulated among
Reagan transition-staff members stated, "When it assumes control of the
government on Jan. 20, the new Administration may well face a financial
crisis not of its own making."




     In 1980, Congress passed the Depository Institutions Decontrol Act
that permitted S&L's to pay whatever interest they needed to compete for
deposits.

Before the DID Act, whenever market interest rates rose above the
legal limit on thrift savings accounts, money would flow out of the
institutions, squeezing mortgage-lending and housing and hastening a
recession that would eventually help reduce interest rates.

But after the DID Act, thrifts were allowed to pay market rates for
large six month deposits.  The problem created was the widening gap
between the rates paid for deposits and the income generated by mortgage
portfolios.

An S&L in 1980, for instance, may have paid 15 percent on six month
certificates but earned only 8 percent on mortgages.  Thrift
institutions found their cost rising rapidly while their income remained
stagnant.





In addition, the DID Act raised FSLIC insurance coverage from $40,000 to
$100,000, increasing in one stroke the government's exposure to risk in
the S&L business two and a half times.

Warren Brookes says that "many think the entire S&L crisis can be traced
to the 1980 decision [DID Act] by Congress in the dying days of the
Carter disaster."   During the first half of 1980, says Jonathan Gray of
Sanford Bernstein & Co, at least 40 or 50 percent of all S&Ls ran
losses- -meaning roughly 2,000 institutions had $250 billion in money-
losing assets.

     By 1981, some 85 percent of the industry reported operating losses,
and the aggregate net worth of the Savings & Loan industry was minus
$110 billion.

Continued interest-rate controls would have precipitated a crisis
earlier, because both solvent and insolvent banks would have lost
deposits to the money-market funds and other unregulated financial
instruments, which would have been able to offer investors a better
return on their savings.



The problem with Reagan's 1982 deregulation (Garn-St Germain Act) is
that reform of the industry did not go far enough.

From the 1930s through the 1970s, the savings and loan industry was
bound tightly in a regulatory cocoon, insulating it from competition and
strictly limiting its business activities.

The government required S&Ls to provide long-term, fixed-rate mortgages
funded with short-term deposits. By the 1970s, it had become apparent
that U.S. banking rules were limiting U.S. financial institutions
severely in an increasingly competitive international business world;
new financial instruments, such as money-market accounts, began to
challenge the protected position of the thrifts.

     The long term survival of the solvent thrifts is made difficult
when bailout and merger deals give troubled depositories a cost
advantage over their healthier counterparts.






To minimize short-term cash outlays and avoid politically undesirable
failures, the federal authorities often agree to strip problem
institutions of their bad loans, guarantee the income from the remainder
of their portfolio, and throw in tax concessions for good measure.

Thus, a depository that should have been closed is rebuilt with federal
assistance into an institution that has advantages over competitors that
have not required assistance.

One example of this is Section 244 of the Tax Act which allows owners of
money losing S&Ls receiving FSLIC subsidy payments to deduct the S&Ls'
operating losses for tax purposes, but does not require them to count
FSLIC payments as income.

If you can buy an S&L losing $100 million a year with a guarantee the
FSLIC will cover the $100 million, you can't lose.   You shell out the
$100 million loss, get a $46 million refund from the IRS, and then get
$100 million from the FSLIC.  Net cash flow: $46 million.





Weaker firms should be leaving the industry, and the survivors should be
consolidating and reorganizing their operations to reduce costs and more
effectively serve customers.

Unfortunately, regulatory practices are slowing this process by keeping
insolvent depositories in operation and imposing legal barriers on
institutions attempting to restructure their operations.

One example of regulatory restrictions introducing risk is the
long-standing prohibition against nationwide branching.

U.S. banking law has made it difficult for banks to diversify either the
sources of their deposits or their loan portfolios, and consequently,
these constraints have created a history of recurring local and regional
banking crises.









     By failing to deal promptly with insolvent depositories or by
providing financial assistance to failing institutions, regulators
reinforce depositors' lack of concern about the financial health of
their banks and S&Ls, and federal authorities send depository managers a
message that undermines the impact of threats of regulatory action
directed at inappropriate behavior.

The failure on the part of federal regulators to allow the financial
market to rid itself of dead wood also penalizes healthy institutions.
Several hundred insolvent S&Ls continue to gather deposits and make
loans.

Many other uneconomic banks and thrifts have received regulators'
attention only to be supported through government-sponsored bailouts and
below-market loans.

The federal insurance creates incentives for financial institutions to
increase their risk exposure as their net worth deteriorates; for a bank
with zero or negative net worth, all of the down side risks of
questionable loans are borne by the deposit-insurance funds.



In the early 1930's, the American Bankers Association, several state
banking organizations, and even Franklin Roosevelt registered strong
opposition to the introduction of federal guarantees of deposits.

Critics argued that federal deposit insurance would lead depositors to
become indifferent about the relative stability of insured banks.

The American Bankers Association described the consequences of
introducing federal guarantees: "The deposit guaranty plan proposes to
place the reckless and speculative banks on the same level with the best
managed and the most conservative, which will lead to competition
calculated to drag all of them down to the least meritorious."

Messrs. Barth and Brumbaugh conclude in a new paper for the Stanford Law
and Policy Review: "The main culprit in the S&L debacle is federal
deposit insurance.  Without it, institutions would not have been able to
remain open while insolvent for many months and even several years."






At a House Banking hearing, Feb. 21, 1990, FDIC Chairman L. William
Seidman said, "Depositors must experience real losses in order to create
real market discipline."   He even suggested the time may have come "to
replace federal insurance with private insurance" as a means of
introducing more market discipline.

Many Americans are lead to believe that it would be too difficult for
average individuals to evaluate the stability of banks if federal
insurance was reduced or even eliminated.

But, it would not be necessary for every depositor to become expert at
evaluating bank balance sheets.   With less dependence on federal
guarantees, information about individual banks would become more widely
available.

More important, the behavior of a relatively few sophisticated
depositors placing large sums of money would affect bankers' behavior,
causing them to put increased emphasis on stability.





Evidence from before the Great Depression indicates that depositors had
access to a number of public sources of information about the relative
stability of competing depositories.

Nor were runs on healthy institutions a frequent event.

Economist George Kaufman reports that from the end of the Civil War
until 1919, failure rates among banks were below that for nondepository
firms, and the average annual losses for the nation's depositors
represented only 0.2 percent of total deposits.

While the media often throws Reagan's name around in reports on the S&L
crisis, it seems to have forgotten the name of Jim Wright.   Wright
openly went to bat for some of the Texas S&Ls.   He also got Fernand St.
Germain, head  of  the House Banking Committee,  to  cancel  hearings
rather than let FSLIC Deputy Director William Black testify on the
problems plaguing the industry.

But, Black made his point by releasing to the press the history of the
Speakers's interference in FHLBB affairs.



This account alleges that Wright persuaded FHLBB chairman Edwin Gray to
call off investigations, buyouts and lawsuits in at least three cases
involving Wright's Texas supporters.   The House Ethics Committee, whose
members are appointed by the Speaker, has cleared Representative St.
Germain on various banking-related charges.

The point man on S&L regulation once Wright stepped aside was Majority
Whip Tony Coelho.   Interestingly enough, the Democratic Congressional
Campaign Committee was recently forced to repay a Texas S&L some $48,451
for parties hosted by Wright and Coelho on the S&L's yacht.  This is one
of the S&Ls Wright had lobbied the FHLBB to ignore.

In 1985, a federal audit revealed that 434 S&Ls nationwide were insolvent.

With a problem of this magnitude, the FSLIC needed Congress to authorize
a loan backed by the future earnings of healthy S&Ls to start the clean
up.  The White House and the regulators asked for $15 billion.

Speaker Jim Wright -- not  normally  tight  with  taxpayers'  money
-- offered $5 billion.



     Without studying the underlying causes of the S&L crisis, the
government may attempt a solution with the usual regulatory policies
that are thrown at every problem.

Reporting is needed that shows a more accurate picture of the causes of
the crisis.   At stake may be the future of regular commercial banks.

Martin Mayer in the Wall Street Journal (May 7, 1990), says that with
banks buying up government-insured mortgage securities, from $37 billion
worth by 1986 to $120 billion by September of 1989, "the legislative
draftsmen had better get started writing the Commercial Bank Bailout
Bill of 1995."








                LIST  OF  PERIODICAL  REFERENCES


                LIST  OF  PERIODICAL  REFERENCES

                1 - Newsweek 12-29-80
                2 - U.S. News & World Report 1-23-89
                3 - Forbes 3-21-88
                4 - Wash. Times 5-3-90
                5 - Cato Report March/April 1989
                6 - National Review 5-19-89
                7 - Heritage Foundation, Backgrounder 1-27-89
                8 - An American Vision, Cato Institute 1989
                9 - Forbes 10-26-81
                10 - Wash. Times 5-7-90
                11 - Wash. Times 5-10-90
                12 - National Review 8-28-87
                13 - Wall Street Journal 5-7-90