Special Report: The Savings And Loan Crisis

"You know, George, I feel that in a small way we're doing something important, satisfying a fundamental urge. It's deep in the race for a man to want his own roof and walls and fireplace. And we're helping him get these things . . ."

-- Peter Bailey to his son George in It's a Wonderful Life

In the 1946 film, George Bailey took that advice to heart and, despite the requisite dramatic difficulties, made his family's building and loan association a pillar of the community. But in real life, the outcome has been much different. America's failed savings and loans have become the country's biggest, most scandalous financial mess. Devastated by a legacy of bad management, rampant fraud and inept Government supervision, more than 500 of the 3,150 federally insured thrifts had fallen into insolvency as of the beginning of last year. Because the U.S. failed to own up to the problem and launch a major rescue soon enough, the cost has now grown higher than almost anyone had imagined. Says Michigan Democrat Donald Riegle, chairman of the Senate Banking Committee: "We've never faced a problem of this scale. The answers aren't going to be happy ones."

Last week President Bush came forward with a long-awaited bailout plan in which he sought to spread around the unhappiness in an evenhanded way. Said Bush: "Nothing is without pain when you come to solve a problem of this magnitude." His program will require taxpayers and S & Ls to share the burden of a rescue that will cost an estimated $126 billion during the next decade. The taxpayer portion would amount to about $60 billion, which would be contained in the federal budget over the next ten years. The Government would borrow $50 billion by issuing 30-year bonds to be repaid through revenues collected from S & Ls. Including the interest expense, half of which will be borne by taxpayers, the total package could cost $200 billion or more over the course of three decades.

The Government is obliged to spend $40 billion to cover bailout cases to which federal regulators are already committed, including 205 savings and loans that the Government closed or sold last year. The $50 billion bond issue would be spent to liquidate or auction off the remaining 300 or more insolvent savings and loans. Those failing thrifts will be isolated from the rest of the industry by bringing them under a new agency called the Resolution Trust Corp., which will oversee their cleanup.

Besides rounding up all that cash, Bush proposes to reform the system that supervises the thrift industry and insures its deposits. The main regulatory agency, the Federal Home Loan Bank Board, which has been accused of being too chummy with thrift-industry leaders, will be replaced by one chairman who will answer to the Treasury Secretary. The exhausted Federal Savings and Loan Insurance Corp., which guarantees deposits, will be overseen by its healthier and better-staffed counterpart for the banking industry, the Federal Deposit Insurance Corp. Banks and thrifts have traditionally had separate regulators and roles: S & Ls specialized in taking long-term savings deposits and issuing residential mortgages, while banks typically held shorter-term accounts and concentrated on making commercial loans.

In his budget speech on Thursday night, Bush called on Congress to approve his proposal within 45 days. "We must not let this situation fester," he said. "Any plan to refinance the system must be accompanied by major reform." For the most part, his proposal found bipartisan support. Said Iowa Republican Jim Leach, a member of the House Banking Committee: "In his first inning, Bush has stepped up and hit a home run." Another member of the committee, New York Democrat Charles Schumer, said that Bush deserves "a heck of a lot of credit for bellying up to the bar and putting a real plan on the table." Most Washington insiders think the bill will move quickly. "This package is a speeding bullet. The lobbyists will try to put a few of their own nicks in it, but really it is just a blur," said Kenneth Guenther, executive vice president of the Independent Bankers Association of America.

One widespread early complaint was that Administration officials, notably Budget Director Richard Darman, were using sleight of hand to downplay the bailout's true cost. Darman originally seemed to say that the cost to taxpayers would total about $40 billion in the first decade, but that number in fact described only how much the plan would aggravate budget deficits. The actual spending from general revenues would be closer to $60 billion. But purely from an accounting standpoint, its impact will be offset by $20 billion in increased insurance-premium fees to be collected from the banking industry -- even though the funds will be earmarked for future banking bailouts rather than for cleaning up the thrifts.

Moreover, financial consultants pointed out that the Administration was projecting the cost of the rescue based on the rosy scenario of a robust economy, declining interest rates and fast-growing thrift deposits. Over the next decade, taxpayers may have to shoulder rescue costs that are tens of billions more dollars than now expected. Yet even those who recognized the Bush plan's shortcomings praised it as the best and boldest solution so far.

A primary objective of such a sweeping rescue was to restore the confidence of thrift depositors, some of whom have withdrawn their savings in fear of the system's insolvency. In fact, the Administration secretly feared a long-shot possibility that the drama of its bailout might spark a run on S & L deposits. To prepare for that dire prospect, senior White House officials and Federal Reserve Board Chairman Alan Greenspan met in the Roosevelt Room of the White House the night before Bush's plan was made public. Greenspan agreed that the Fed would stand ready to pump billions of dollars in emergency loans into threatened thrifts.

In the end, depositors stayed calm, even though some chafed at the idea of the cost of the bailout. "Honestly, it's the stupidest thing I've heard," said Leroy Scrues, a Detroit retiree. "Why should the public be paying for these rich peoples' mistakes?" Yet legislators and savers were relieved that Bush repudiated a proposal that his Administration had floated two weeks earlier: to levy a fee -- 25 cents for each $100 of deposits -- on all insured accounts. That ploy was widely seen as a tax in everything but name. The short-lived proposal was so distasteful that it made Bush's new plan seem all the more palatable. Said Fred Dorey, a Los Angeles medical statistician: "We were going to pay for it one way or another. At least the banks have to pay some too. It's a fair deal."

The healthy portion of the thrift industry will pay its share through an increase in its insurance premiums. The rate would rise from the current $2.08 per $1,000 of deposits to $2.30 from 1991 until 1994, after which it would decline to $1.80. The rate for banks would increase too, from 83 cents per $1,000 to $1.20 in 1990 and $1.50 thereafter. Even though both industries' insurance funds would be administered by the FDIC, their proceeds will be kept separate.

One reason for raising the banking industry's fees as part of the rescue package is to ensure that they do not obtain too much of a competitive advantage over thrifts in terms of their costs of doing business. Another reason is simply to bolster the banking industry's reserve fund so that it does not run into the same problems encountered by the FSLIC. In the end, at least some of the increased costs will probably be passed along to consumers, since thrift profits are already squeezed. Said Texas Democrat Henry Gonzalez, chairman of the House Banking Committee: "The little consumer will pay in the form of higher fees on checking accounts, new fees for automatic tellers and a myriad of other charges."

* The thrift industry seemed to meet the proposal with grudging acceptance but a fair amount of grumbling. Healthy S & Ls object philosophically to paying excessive cleanup costs for their fraudulent and incompetent brethren. Says Adam Jahns, chairman of Chicago's Craigin Federal Savings & Loan: "I don't think we should have to pay for serious crimes committed by others." Another complaint by S & Ls is that by combining thrift and banking supervision, the Bush plan may blur the distinction between the two and eventually remove any competitive advantage the thrifts still have, principally the ability to borrow long-term funds from federal Home Loan banks. Commercial banks are restricted to taking shorter-term loans from Federal Reserve banks. Besides paying higher premiums under the Bush plan, S & L owners would be required to follow stricter accounting rules and to boost their reserve capital from 3% of assets to 6%.

Bankers were miffed too about being tied up with the S & Ls. The symbolic point of contention was the trusted FDIC decal that banks display prominently on their premises and in their advertising. The Administration at first told thrift owners that they would be able to display the symbol under the new plan. To many depositors, the seal represents greater safety and security than the thrift industry's own logo. Bankers therefore vociferously oppose sharing the FDIC seal, maintaining that it would be effectively tarnished if given to the thrifts and would lead to the complete merging of the two insurance funds. By week's end, the Administration had backed away from its promise of the seal to the S & L industry.

The FDIC wasted no time in wielding its new authority over the thrifts. Within a day after the Bush announcement, the Government agency took charge of four insolvent S & Ls and three days later assumed control of six more. The agency intends to take over the 224 most hopelessly insolvent S & Ls within the next month. The FDIC also decided to freeze temporarily all negotiations for the sale of ailing thrifts. Last year the FSLIC completed a flurry of deals -- 34 in December alone -- in an effort to offer investors tax breaks that expired on Dec. 31. Because of the rich payoffs guaranteed to investors in those deals, they were highly controversial. Said L. William Seidman, chairman of the FDIC: "Before we go forward, we are going to evaluate, along with the FSLIC, where we stand."

Seidman said talks with investors will resume after the FDIC takes control of the remaining insolvent S & Ls. But since the FDIC said it would then allow only deals that were supported by the cash of the FSLIC -- a fund that is currently bankrupt -- more Government-assisted sales would seem unlikely. The FDIC might also try to renegotiate some of last year's sweet deals.

When the huge cost of the cleanup hit home last week, so did a strong sentiment in favor of pursuing the fraudulent thrift owners who made off with the loot. Regulators have estimated that at least one in every four S & L failures has been the result of fraud. In fact, the Bush rescue plan proposes to give the Justice Department an additional $50 million a year for probing S & L fraud, a sum that would pay for 200 new investigators and 100 more prosecutors.

Even so, in testimony before the Senate Banking Committee last week, Attorney General Richard Thornburgh said most of the lost money is long gone. "In many cases, the assets have been dissipated through laundering schemes or taken out of the country, and are beyond the reach of federal authorities," he said. "We'd be fooling ourselves to think that any substantial portion of these assets is going to be recovered." Besides the money that was simply stolen, billions of dollars were lost on high-risk investments and frittered away by paying excessively high interest rates to attract depositors.

How did the S & Ls arrive at such a sorry state? Traditionally, running a thrift was a relatively tranquil business. S & L managers used to follow what was known as the 3-6-3 rule: pay depositors 3%, lend money at 6% and tee up at the golf course by 3 p.m. When interest rates remained stable, the strategy worked well. But by the late 1970s, thrifts began steadily losing depositors to the new money-market funds, which were not covered by deposit insurance and paid higher interest rates.

Thrift executives pressured Congress to let them fight back. In 1980 Congress lifted restrictions on interest rates that S & Ls could pay. But regulators waited a year before freeing the other side of the balance sheet by allowing S & Ls to grant adjustable-rate mortgages. The delay left the thrifts in a bind, because interest rates had rocketed from 13% at the end of 1979 to more than 20% a year later. Thrifts were collecting interest rates of around 8% or less on their 30-year mortgages, while paying double-digit interest to new depositors. During 1981 some 85% of all S & Ls were losing money.

) Interest rates eventually eased, but other problems arose. Congress passed a sweeping deregulatory law in 1982 that permitted S & Ls to make loans for a raft of new businesses. At the same time, some states allowed their locally chartered thrifts to run wild. Suddenly no venture was too farfetched: ethanol plants, wind farms, Las Vegas casinos and commuter airlines. S & L managers who were accustomed to making simple residential mortgages were ill prepared to evaluate the new kinds of credit risks. The great mistake in deregulation was not so much the easing of rules but the failure of the federal and state governments to boost supervision at the same time.

A perverse trait among shaky S & Ls has been their tendency to get further and further into what one bank regulator euphemistically calls "deep yogurt," in part because they must offer higher interest rates than their competitors to keep attracting savings. Big-time depositors flock to these S & Ls, knowing that they cannot lose because the Government will guarantee deposits up to $100,000. In that sense, Congress contributed to the FSLIC's liability in 1980, when it raised the coverage limit from $40,000.

Troubled S & Ls are heavily concentrated in Texas and California, where state thrift regulations were loose and local economies had booms and busts. Many Texas thrift owners who pumped money into energy ventures when oil sold for $29 per bbl. in 1983 saw their collateral collapse in value when prices plummeted below $10 in 1986. In California some thrifts invested in real estate markets that became glutted, including Los Angeles office towers and Beverly Hills condominiums.

The overall losses would have been vastly smaller if Government regulators had seized control of insolvent S & Ls years ago. In 1983 the cost of the bailouts was estimated at only $10 billion. But the FSLIC never had enough cash simply to close down the thrifts and pay off the depositors. The Bank Board lobbied Congress for more money, but the politically powerful thrift industry consistently opposed such requests, along with almost any proposal to rein in the S & Ls.

Edwin Gray, chairman of the Bank Board from 1983 to 1987, bitterly accuses congressional leaders of bowing to industry pressure. He claims that S & L lobbyists tried to coerce him by warning that his future career in the business would be ruined if he opposed them. One of the biggest defenders of S & L liberties was Texan Jim Wright, now Speaker of the House. Wright has been under investigation by the House Ethics Committee, which has been trying to determine whether he used "undue influence" in dealing with officials of the Bank Board.

Instead of liquidating insolvent S & Ls, regulators decided it would be cheaper and more expedient to sell them to private investors or merge them with healthy thrifts. Bank Board Chairman M. Danny Wall sharply stepped up the tempo of such sales last year, selling or liquidating more than 200 thrifts at an estimated cost to the Government of $39 billion in tax breaks and other incentives extended to the buyers. Critics contend that the regulators were taken for a ride. Fumed Iowa's Leach: "The dealmakers are laughing all the way to the piggy bank." But Wall staunchly defends his deals as the lesser of evils. "I much prefer to be damned for having done something than to be damned for doing nothing," he says. In fact, the cleanup is showing some results. The thrift industry's 1988 third-quarter loss of $1.6 billion was down from $3.9 billion in each of the previous two quarters.

Will thrifts ever thrive again? By blurring the distinction between banks and thrifts, the President's rescue plan prompts many banking experts to wonder whether the U.S. needs a separate S & L industry anymore. Thrifts hold about one-third of all U.S. mortgages, down from nearly 60% some 20 years ago. Says Laurence Fink, a partner in the Blackstone Group, an investment firm that is acquiring several S & Ls: "The average homeowner can get a mortgage without stepping inside an S & L. Maybe the thrifts have outlived their usefulness."

The thrift industry that survives the coming decade will probably look very different from what it is today. Says Jonathan Gray, who follows the industry for the Sanford C. Bernstein investment firm: "If there's one word to describe the industry's future, it's turmoil." Gray envisions a severe industry shake-out. In just a decade, he points out, the number of U.S. thrifts has already fallen from 4,200 to less than 3,000. By the late 1990s, he predicts, there will be just 1,000 left.

The S & L business will never be as peaceful as it once was. Surviving thrifts will have to compete with powerful rivals and satisfy a far more sophisticated customer than they did in the past. But if the industry shakes off its con artists and recaptures its basic prudence, those thrifts that remain might still do George Bailey proud.

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CREDIT: TIME Chart by Joe Lertola

CAPTION: THE PRESIDENT'S RX