Wall Street Crime And Punishment: The Savings And Loan Crisis, An Imperfect Storm That Rained Chaos

Does crime pay?

Wall Street Crime and Punishment is a weekly series by Benzinga's Phil Hall chronicling the bankers, brokers and financial ne’er-do-wells whose ambition and greed take them in the wrong direction.

For many years, the savings and loan industry saw itself through the spectrum of the classic film “It’s a Wonderful Life,” with Jimmy Stewart running the world’s most holistic financial institution while earning eternal love from his community of customers.

But reel life is not the same as real life, and good ol’ Jimmy Stewart-types were never in surplus supply in the financial services world.

By the 1980s, the savings and loan institution (S&L) world looked less like “It’s a Wonderful Life” and more like an unholy mash-up of “Wall Street” and “Titanic” — and the wreckage residue from the industry’s crash can still be found if one looks closely.

When Good Times Go Bad: S&Ls, also known as thrifts, can be traced back to Pennsylvania in 1831. These institutions primarily focused on serving consumers through savings accounts and personal use lending, particularly mortgages.

S&Ls took on new prominence with the passage of the Federal Home Loan Bank Act of 1932, which established the Federal Home Loan Bank System as a liquidity source for S&Ls. This was during the midst of the Great Depression and President Herbert Hoover was eager to reanimate the housing market by making low-cost mortgages available to would-be homebuyers.

S&Ls thrived in the post-World War II years when returning servicemembers were eager to buy new homes. By 1980, there were approximately 4,000 S&Ls with $600 billion in total assets, of which approximately $480 billion were in mortgages — half of the entire home mortgage market.

S&Ls were mostly smaller than commercial banks and had more restrictions on the types of activities they could pursue. Unlike banks, S&Ls could only rely on short-term passbook savings to fund their long-term, fixed-rate home mortgages.

This was not a problem for these institutions during years of prosperity and economic serenity — indeed, S&L failures were relatively rare before things began to go awry into the 1970s when inflation and interest rates were on the rise, along with unemployment levels. This situation created a maturity mismatch with the S&Ls stuck in lower interest rate long-term mortgages while paying higher interest rates to their depository customers — and the decline in homebuying during this period made a bad situation worse.

And then, it got even worse when the Federal Reserve under the leadership of Paul Volcker raised short-term interest rates from 9.06% in June 1979 to 15.2% in March 1980.

By mid-1982, the entire S&L industry staggered through collective losses of nearly $9 billion and every institution within this sector had a negative net worth.

A Solution Is Offered: The U.S. Congress looked upon the problems being faced by the S&Ls and decided that these institutions could quickly bounce back to strong health if there was less regulation placed on them.

The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St. Germain Depository Institutions Act of 1982 enabled S&Ls to expand their product offerings, including transaction accounts instead of merely savings accounts, and adjustable-rate mortgages instead of the fixed-rate products, which created financial straight jackets during the maturity mismatch period.

S&Ls also began to enjoy operational liberties that they never had before, including the elimination of loan-to-value ratios and interest rate caps, the ability to make commercial loans, and the chance to pay higher rates than previous regulations allowed.

S&Ls were also given the green light to invest in real estate and junk bonds, which offered greater risks but also had the promise of greater rewards.

Initially, it seemed as if the S&Ls’ problems were solved — by 1985, S&Ls assets were up by nearly 56% to $1 billion, nearly twice the growth rate of banks. And even though roughly one in five S&Ls were still not profitable, the industry seemed to be on the road to recovery — except that it wasn’t.

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The Growing Miasma: As regulatory controls were lifted on S&Ls, many institutions jettisoned responsible leadership in pursuit of a fast buck.

The industry’s regulator, the Federal Home Loan Bank Board (FHLBB), did a spectacularly bad job in maintaining oversight during this abrupt change in operational procedures.

Among the regulator’s many mistakes was raising the lending limit from no more than 75% of the appraised value of a home to as much as 100% and allowing real estate developers to buy S&Ls and use them to finance their projects.

The FHLBB was also hobbled by a small workforce of examiners who lacked the training to handle the new environment thrust upon the S&Ls and many examiners found themselves recruited by the S&Ls, thus creating a constant shortage of qualified FHLBB workers.

Also complicating matters was the Federal Savings and Loan Insurance Corporation (FSLIC), the institution that administered the industry’s deposit insurance. By 1983, the FSLIC found itself faced with a slowly rising number of S&Ls facing insolvency. Shuttering these institutions would require the FSLIC — and, by extension, the American taxpayers — to pay for their losses, which were later estimated at a collective sum of $25 billion and the FSLIC only had $6.3 billion in its reserves.

Percolating Wreckage: By 1984, the S&L industry began to engage in a slow-motion collapse as institutions around the country began to fail as the result of reckless or dishonest executive decisions.

Empire Savings & Loan Association of Mesquite, Texas, expanded from $13 million in assets in 1981 to more than $300 million in 1983 thanks to deregulation. When it failed in March 1984, more than 90% of its liabilities were in large certificates of deposit — Empire paid about 100 basis points more than commercial banks for its certificates of deposit.

Home Savings Bank in Cincinnati, with $1.2 billion in assets, failed in March 1985 after a disastrous business relationship with ESM Government Securities Inc., a brokerage firm specializing in term repurchase agreements. Gov. Dick Celeste was forced to declare a three-day banking holiday for state-insured savings institutions covered by the Ohio Deposit Guarantee Fund in order for them to receive deposit insurance protection from either FSLIC or the Federal Deposit Insurance Corporation.

Old Court Savings and Loan in Pikesville, Maryland, saw its assets swell from $140 million in 1982 to $840 million in 1984. Jeffrey Levitt, the S&L’s president, helped himself to his institution’s good fortune, embezzling $13.6 million.

In May 1985, the state of Maryland shut down Old Court Savings and its 35,000 depositors had their accounts frozen. It would take four years before they could regain their funds.

As more S&Ls failed, the FSLIC buckled under the strain of their weight and collapsed into insolvency in 1987. Two years would pass before Congress created the Financial Institutions Reform, Recovery and Enforcement Act that allocated $50 billion to close failed institutions and created the Resolution Trust Corporation to wind down failing S&Ls.

Friends In High Places: Two S&L failures stood out during this time due to political connections enjoyed by the institutions’ executives.

Colorado’s Silverado Savings and Loan failed in 1988, and one of its directors was Neil Bush, the son of then-Vice President George H. W. Bush, who was elected to the presidency later in that year.

Although the U.S. Office of Thrift Supervision would determine the younger Bush engaged in "breaches of his fiduciary duties involving multiple conflicts of interest," he was never indicted on criminal charges relating to the S&L’s failure but was fined $50,000 in an out-of-court settlement that was paid by his father’s financial backers.

Over in California, Lincoln Savings and Loan Association Chairman Charles Keating used his Capitol Hill connections to delay an FHLBB probe into his institution’s questionable business dealings. When the FHLBB seized Lincoln in April 1989 — at a cost of $3.4 billion to the federal government — Keating’s influence-peddling became public knowledge.

A quintet of U.S. senators, four Democrats — Alan Cranston of California, Dennis DeConcini of Arizona, John Glenn of Ohio and Donald W. Riegle Jr. of Michigan,  plus Arizona Republican John McCain — became known in the media as the “Keating Five” and were the subject of a Senate Ethics Committee hearing that probed the relation between Keating’s generous campaign contributions and their actions on his behalf in dealing with the FHLBB.

None of the senators faced indictment or worse: Cranston was reprimanded, DeConcini and Riegle were found to have acted improperly, and Glenn and McCain were chastised for showing poor judgment. Keating would be convicted on both state and federal charges in 1990 and 1993, respectively, but these were overturned in 1996. He accepted a plea deal ahead of a federal retrial in 1999 and was sentenced to time served.

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The Financial Graveyard: In “It’s a Wonderful Life,” Jimmy Stewart’s S&L president affirms at the film’s ending that an angel gets his wings every time a bell rings. By the end of the S&L crisis, the only ringing bells were from a funeral dirge for the victims of a collapsed industry.

By the time the Resolution Trust Corporation wound down the last failed S&L in 1995, 1,043 out of the nation’s 3,234 thrifts were shuttered. The ultimate cost to clean up this mess was $160 billion, with taxpayers footing $132.1 billion of that bill.

While the FSLIC died during this period, it was not alone in being collateral damage from the collapsing industry. More than 500 S&Ls were insured by state-run funds and their failures totaled $185 million. This spelled the end to state-run bank insurance funds.

The FHLBB was abolished in 1989 and supervision of S&Ls became the responsibility of the Office of Thrift Supervision.

More than 1,000 S&L executives were convicted and jailed for their actions in driving the sector off the rails. The aforementioned embezzling Jeffrey Levitt of Old Court Savings and Loan in Maryland received a 30-year prison sentence and served 7½ years; he relocated to Florida and became the proprietor of a cigar store.

But not everyone connected with the catastrophe faced life from a prison cell. Rep. Jim Wright (D-Texas), the Speaker of the U.S. House of Representatives, resigned from Congress in May 1989 while facing a wealth of ethics charges, including influence-peddling on behalf of S&L executives trying to halt regulatory investigations. He retired to Texas to become a university professor and historian and would later lament his resignation was a "gross misjudgment."

In comparison, none of the Keating Five resigned. Cranston, DeConcini and Riegle served out their terms while Glenn ran for re-election in 1992 and left Congress in early 1999.

McCain remained in the Senate until his death in 2018 while making two failed attempts to win the presidency. Although he pocketed $112,000 in political contributions from Keating and was a frequent unpaying guest at Keating’s Bahamas resort, McCain declared the Senate Ethics Committee’s findings a “full exoneration” of his actions in connection with Keating and he never offered a public apology for his role in the scandal.

Photo: John McCain, photo courtesy of Pimkie / Flickr Creative Commons.