No End To S&L Pay-Offs — YET
It used to be that the biggest source of mortgage money was as close as your local savings and loan association. S&Ls were nearby companies that collected deposits, never issued checks, and paid a somewhat higher interest rate on savings than local banks. If you needed a mortgage, S&Ls were the first place to look.
The S&L system worked great for decades until greed and government got in the way. The result has been $165 billion in tax dollars paid out to date, with at least another $30 billion likely to be lost.
Why are taxpayers now likely to owe another $30 billion? Hold on to your wallet and I’ll explain.
To see what happened imagine the financial world that existed until the early 1980s, a world divided into four major realms.
- Commercial banks offered checking accounts and made commercial loans.
- Savings and loan associations made mortgage and auto loans. They offered savings accounts with interest that was, by law, .25 percent higher than commercial banks — but S&Ls could not create checking accounts. S&Ls qualified for special tax breaks unavailable to banks if at least 82 percent of their assets were invested in mortgages. (“Mutual savings banks,” hybrid institutions found largely in New England that melded bank and S&L functions, had to invest 72 percent of their assets in mortgage loans.)
- Stockbrokers handled the underwriting, sale and purchase of stock. They offered no checks, made no loans, and did not sell insurance.
- Insurance companies sold insurance and invested in large commercial projects such as office buildings and shopping centers.
The system worked extremely well until the 1980s when traditional territories began to erode.
S&Ls were allowed to offer “negotiable orders of withdrawal.” So-called “NOW” accounts meant, in effect, that you could do your checking account with an S&L.
In 1982 the interest-rate differential between banks and S&Ls was ended under the Garn-St. Germain Depository Institutions Act — a law which also allowed S&Ls to make more commercial loans.
Meanwhile, investors became increasingly interested in mutual funds offered through stockbrokers. Money that once would have gone into S&L savings accounts instead flowed into mutual funds through IRAs and Keoghs.
Not wanting to be left behind, banks reasoned that if stockbrokers could compete for deposits, bankers should compete for investors. The result is that today many banks sell shares through brokerage subsidiaries.
Buried in the changes above were a few twists that now haunt us all.
Remember that S&Ls used to make lots of home mortgages? Under the 1982 rules, many S&Ls began to make big commercial loans. Alas, the economics and risks of commercial loans are vastly different than home mortgages for nearby neighborhoods. Historically-conservative S&Ls began making more and more commercial loans to maximize shareholder benefits, one reason many office markets were over-built.
Soon the S&L industry was a mess and federal promises to protect insured borrower deposits would have to be honored — unless a way could be found to unload troubled S&Ls.
The solution was to re-define financial solvency. Under government rules, something called “supervisory goodwill” was seen an asset, meaning that S&Ls could make loans with less cash on hand than might otherwise be necessary.
In 1989, however, the “Financial Institutions Reform, Recovery and Enforcement Act changed the rules. “Supervisory goodwill” was no longer an asset. With “fewer” assets, many S&Ls were instantly and unfairly defined into bankruptcy, taken over by government regulators because they did not meet capital standards, and then sold at fire-sale prices. The cost to taxpayers: $165 billion.
But not so fast. The government had allowed the use of “supervisory goodwill” in the first place. By changing the rules the government took solvent S&Ls and made them appear bankrupt — thus robbing shareholders of the value they had created. In 1996, in the Winstar case, the Supreme Court ruled that shareholders had been wronged and the feds were now obligated to pay up.
“The Government,” said the Supreme Court, “had express contractual obligations to permit respondents to use goodwill and capital credits in computing their regulatory capital reserves. When the law as to capital requirements changed, the Government was unable to perform its promises and became liable for breach under ordinary contract principles.”
Now we have the Golden State ruling, the first settlement to emerge since the Winstar case. The feds, a court has said, must pay Golden State investors $909 million.
There’s another $30 – $35 billion in S&L claims to be settled and undoubtedly you will now hear how such settlements are “unfair.” They aren’t. The money involved was taken from investors through regulatory chicanery of the worst sort. Given the size and scope of the damages, we’re lucky that the tab isn’t higher.
With all the changes, greed, and turmoil described here, it’s worth noting that many local S&Ls stuck with their traditional roles. You can find such institutions today in virtually every community — healthy, profitable, and ever-friendly. Many with roots as S&Ls have now become “banks” to qualify for less restrictive regulation, but — at heart — they’re really community lenders from the S&L mold.
Indeed, if you want an interesting financial experience, check out the small banks and S&Ls in your area. They may not be useful if you need a quick $850 million to erect a steel mill, but for most consumers they work very well.
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Published originally by Realty Times on April 20, 1999 and posted with permission.
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