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The Sordid History of the S&L Crisis BY CURTIS J. LANG ONLY HOURS AFTER the GarnSt. Germain Deregulation Act became law in 1982 a small group of Texas businessmen moved to take advantage of what the new legislation allowed them. According to the London Economist, “On the day President Reagan signed the deregulation bill, a group of speculators associated with the Bell Savings and Loan Association in Belton, Texas, sat around the table and bought and sold three parcels of land over and over again; they changed hands five times, netted the developers paper profits of $12m and left the S&L with $14.4m in bad loans. Such loan auctions became standard.” What happened in Belton was repeated again and again across the country as speculators took advantage of what was then the most recent of the thrift industry deregulation measures that started in the Carter Administration and continued during the Reagan Presidency. S&L owners and eager builders and developers devised new industry standards during deregulation and insider abuse became common business practice. M. Danny. Wall, Chairman of the Federal Home Bank, now estimates that the Federal Savings and Loan Insurance Corporation in Texas. The figure, released in July, is 100 percent higher than Wall’s earlier projections and private analysts claim that FSLIC losses in the state could run as high as $23 billion. The FSLIC insurance fund, which guarantees S&L deposits under $100,000, was $13.7 billion in the red at the end of March, according to the General Accounting Office. Wall’s latest loss projections followed a June report in which Federal investigators announced they had uncovered $11 billion in possible fraud at a dozen or so failed or ailing Texas thrifts. And FHLB regulators plan to eventually close or merge more than 130 “zombie” thrifts in the state. Ten prosecutors, 25 FBI agents, and five IRS officers continue to investigate Texas S&Ls while losses mount at an estimated rate of Curtis J. Lang is a freelance writer living in Houston. Funding for this story was provided by the Fund for Investigative Journalism of Washington, D.C. $10-15 million per day. What has happened here is not the result of a downward trend in the business cycle. That’s only part of the story. How is it that the once-staid S&L industry, the mortgage lender for workingand middle-class Americans, was turned into a land-flip casino where speculators made huge profits inflating the value of properties that secured loans? The answer will be found in a story of incremental deregulation that should serve as a caution The industry’s problems began in the 1970s; deregulation made it worse. ary tale to those who advocate deregulating the nation’s banks. Any informed diagnosis of the thrift industry’s illness usually notes that the industry’s problems began with the fastrising inflation of the late 1970s. “This present period reflects a lengthy deregulation period that began in the 1970s and has gathered momentum since,” said Henry Schechter, the Deputy Director of Economic Research at the AFL-CIO in Washington, D.C. Schechter served on the Federal Savings and Loan Advisory Council from 1976 to 1981, during Jimmy Carter’s Presidency and discussed the industry’s history in a telephone interview earlier this year. According to Schechter, as inflationary fears grew in the ’70s, members of the progrowth wing of the S&L industry advocated a lessening of government’s role in the industry’s affairs. The S&L lobby persuaded the federal government to reduce the number of home loans they were required to make, then got permission to go into other types of financing. “The S&Ls wanted to create subsidiaries which could carry on business activities totally unrelated to financial services. They even wanted to be able to invest the S&Ls outside the country,” Schechter said. High interest rates prompted clever individuals to invent the money-market fund. Shares in loans to large banks or S&Ls were sold to small investors. These small investors could then take their money out of their lower-paying bank or S&L accounts and reinvest at higher rates of interest in the New York money market. S&L insiders used fear of money-market funds and inflation to persuade Washingtonians that only by allowing S&Ls to compete for money, to diversify their business activities, and to operate without much government interference, could Washington save the industry from obsolescence. While Paul Volcker was quietly implementing his plan to control the nation’s money supply, drive up the price of money, and plunge the nation into the worst recession since the Great Depression to “break the back” of the mythical Inflation Monster, the nation’s S&L industry geared up to embark on a course of unbridled growth and unlimited competition. This was bad timing. “NOT MONEY” JUNKIES The year 1980 was a year of wild economic gyrations. High interest rates contributed to a recession in the first quarter, but by midsummer the recession had ended. The prime interest rate, charged by commercial banks, climbed to 20 percent in July, and by December the Federal Reserve Board had let it creep even higher, to 21.5 percent. Since S&Ls borrow short term to lend long term, many S&Ls found themselves caught between the high interest rates of the day and the low interest rate mortgages they carried on their books as assets. In response to this disparity, and because of fear of inflation and money market funds, Congress passed the Depository Institutions Deregulation and Monetary Controls Act of 1980, allowing the S&Ls to grow as big as they wanted while only allowing them to invest in fixed-rate home mortgages that were bound to lose money in an inflationary environment. This legislation allowed the S&L industry to pay as much as it wanted to for deposits. Astronomical interest rates were not thought THE TEXAS OBSERVER 11