CHAPTER 8   NEXT CHAPTER

A CASE STUDY IN BAD GOVERNMENT:
THE SAVINGS AND LOAN DISASTER

 

The Savings-and-Loan Fiasco Cost Taxpayers About One-Half Trillion.  It combined Flawed Monetary Policy Favoring the Few with Bad Legislation, Worse Execution.  

            From the time Jefferson lost the battle to the financial aristocracy, the country has suffered cycles of speculation, followed by impoverishment of the farmer and job-loss by workers.  The pattern never changed.  A few gained riches in both directions, while the worker and farmer were hurt in the up and devastated in the down,  the monetary system was so flawed that occasionally it couldn’t even fund the seasonal demand to get crops to market.  Democratic Capitalism, however, proved to be powerful enough to overcome the impediments and the country went on flourishing.

             During the twentieth century, the flaws in the monetary system were combined with the accelerating growth of big government to produce mistakes of gargantuan proportions.  The Savings and Loan disaster in a case-study for new leaders, to help them understand root causes and the disaster in the century, the earlier two being the ’29 Crash and subsequent Depression, and the misdirection of $2.6 trillion in workers’ pension money to speculative capitalism.  In each case, mistakes were made in a flawed structure producing a flawed process.  After each speculative craze reached its inevitable damaging conclusion, the process continued with a new generation of politicians producing a new generation of mistakes.  The people sensed failure of leadership but didn’t know how bad it was.  

            On October 15, 1982 , President Reagan signed the Garn-St. Germain Act.  Two hundred people were invited to the Rose Garden for this “Most important legislation for financial institutions in 50 years.”  Two years into his first term, the President apparently felt that he was honoring his campaign pledge to get the government off peoples’ backs in order to allow the private sector to grow and create jobs.  He was, in fact, sustaining a disaster and giving deregulation a bad name.

             Back in 1932, President Franklin Roosevelt had threatened to veto a bill that would provide government insurance for bank deposits of $2,500, later $5,000.  He felt then that it was a dangerous abrogation of market place disciplines and would inevitably encourage risky business decisions with the financial damage paid for by prudently managed banks.  He was later convinced by his advisors that the panicky banks runs could only be stemmed with such extreme damage-control legislation.  

            The new law didn’t have a “sunset provision phasing out such protection after the crisis and there was no effort to insure on a risk-oriented basis.  (At the time the Garn-St. Germain bill was being designed in the early 1980s, such insurance deposit had increased to $40,000.  As the bill was being expedited to conclusion, the persistence of an industry lobbyist was rewarded with having the insured level increased to $100,000 without limitation on the number of locations.

             A modest protection for the small depositor, controversial as that was, was now converted to an insured financing vehicle for “prodigals and projectors”,  as Adam Smith called them.  Deposits were not only insured, there was no relation between risk and reserve.  A trillion-dollar obligation had been added to the U.S. economy.  This mistake cost about half that, all dumped onto the taxpayer.

            Thrifts were started in the mid-nineteenth century as a way for people to pool assets to help expedite home-buying.  The banks were too engrossed in commercial lending to service the home mortgage market thoroughly.  Government incentives could have helped add this to the existing infrastructure, but they were lacking.  This simple thrift idea, modeled after similar institutions in England , worked well.  Supported by a steady economic growth, home ownership in the U.S. reached record levels, with 2/3 of families owning their own homes during the twentieth century.

             In due time government regulation crept in.  Regulation Q had mandated a maximum 5.25% interest payment on bank savings.  Paul Volker’s term as Chairman of the Federal Reserve in the late 1970s saw his uncoordinated attack on inflation driving interest rates up to as high as 20%.  This quickly exposed the fundamental flaw in the now-regulated S&L, an inversion of the normal banking principle.  The were borrowing high-cost monthly short, to invest in low-return long.  Putting the industry in a destructive economic vise.  It might be educationally beneficial to analyze what would have happened if there had been no regulation, or what other alternatives could have been explored.  The original mission was low-cost, available home mortgages.  Because of uncoordinated government intervention the mission now became, save the S&Ls.  

            During the S&L decade of the 80;’s, Danny Wall was the central figure. He had worked for a Savings and Loan in Salt Lake City and came to Washington as chief administrative aide to Senator Jake Garn (R-Utah).  In 1989, the Wall Street Journal described him as “The S and L Looter’s Waterboy.”  If Wall was the “waterboy,” then the S&L lobbying group, the U.S. League of Savings Institutions, was the coach.  In 1985, Senate records show the waterboy’s taking 30 trips paid for by the coach.  The same article described this former assistant city administrator in Salt Lake City becoming chairman of the Federal home Loan Bank Board, a clear case of Peter Principle.

             In 1980, the Senate Banking Committee addressed the predicament that the S&L industry was in due to uncoordinated government intrusion earlier.  There was a low level of interest on deposits, based on Regulation Q, combined with a high cost of new monbey due to the Volker Federal Reserves scorched-earth policy to lick inflation.  The S&Ls were borrowing high cost money short and investing low cost money long in fixed rate mortgages: banker’s nightmare.   

            When the Senate undertook damage control, Danny Wall was involved in drafting the new legislation as his boss, Jake Garn, was Chairman of the Committee.  One common denominator, of all of these key players was a lack of knowledge or experience in the complex financial engineering in which they were engaged.  The mixed government structure was adversarial, superficial, and on a political schedule allowing untalented people to write laws by depending on the self-serving expertise of the lobbyists. Unfortunately there was no lobbying force for Democratic Capitalism anticipating the damage and providing useful counter-proposals.

             The product of Wall’s drafting, coached by the U.S. League, was the Depository Institutions Deregulation and Monetary Control Act of 1980.  This act phased out interest-rate controls and at the same time raised the FLSIC insurance coverage from $40,000 to $100,000.  The coverage had been raised by Congress from $20,000 in 1974.  The 5.5% interest cap had been extended by Congress to the thrifts in the 60s, on the interesting theory that capping deposit interest would help keep down mortgage costs.  

            It was a popular law, in favor of low-cost housing, probably used by every politician within reach during campaigns such as an example of his productivity and vision.  It was a good concept if applied in a vacuum.  The new law quietly removed the limitation on brokered deposits to 5% of total deposits.  Brokered deposits were the device that investment bankers like Merrill Lynch later used to suck out all these low-return, but no-risk, savings accounts to move the money to the newly high risk S&L’s.  Why not?  It was insured.

             The leap to $100,000 worth of deposit insurance was integrated at a late-night session on Capitol Hill, pushed by the chief Washington lobbyist of the U.S. League.  It had no opposition and was later described as an afterthought.  But it was typical of the sporadic, uncoordinated laws affecting the Savings and Loan industry.  Until 1932, thrifts were regulated only at the state level.  When the Federal Reserve was centralized in 1932, thrifts were given the option of being federally- chartered.  In 1934, the first deposit insurance of $5,000 was passed for both banks and thrifts, with the reserve funded by assessments of members.  

            Not surprisingly, the 1980 legislation did not resolve the S&L dilemma, as a law to help attract funds could not work if the return on funds was not improved.  In the first half of 19823, thrifts lost $3.3 billion, and cried for more government relief.  This was the intention of the 1982 Garn-St.  Germain Bill that President Reagan proudly announced.  This bill attempted to deregulate the industry so it could now earn higher returns on the higher-cost deposits stimulated by the 1980 bill.  It was an impressive laundry list:  

             As a source of funds for state regulation, this last item sparked a liberalization competition where states such as California outdid the Federal with no limits on non-residential loans,  The only state that outdid California was Texas .  The already liberal rules in the booming oil economy got a shot of adrenaline with the $100,000 deposit insurance.  Texas bid the highest rates for brokered deposits and grew at three times the national average…”By 1987, 50% were run by managers who had entered the business after 1979 (over 80% were former real estate developers).”  Danny Wall reappears later, fighting reform efforts as the crisis developed.  In 1987, as a reward for loyalty and services rendered, he became Chairman of the FHLBB.  

            1983 was the beginning of Edwin Grey’s agony.  He was well known and popular at the U.S. League of Savings Institutions, representing Great American First Savings Bank of San Diego as their P.R. man.  His background was solid Ronald Reagan loyalist, as Grey had been his press secretary during his years as Governor, and he had worked a short time as Assistant to the President and Director of the White House Office of Policy and Development.  

            The November, 1982, League convention in New Orleans featured Ronald Reagan as keynote speaker,  During that convention, Grey was asked to become Chairman of the Federal Home Loan Bank Board.  He was sworn in on May 1, 1983 by his friend, Ed Meese, Attorney General.  As described in “Inside Job,” this man, soon to become a pariah in an epic drama, expected the be a cheerleader for the industry for a couple of years and then go back to San Diego.  His function was driven home his first day on the job when he received a phone call from Treasury Secretary Don Regan.  “You’re going to be a team player, I take it,” Regan asked him.  “Sure,” Grey answered.  End of conversation.  

            Financial capitalism, soon to become speculative capitalism, was well represented. Don Regan was former Chairman of Merrill Lynch; retiring League Chairman Richard Pratt, a former Utah University professor, was headed to Merrill Lynch to be Chairman of their Capital Markets Group;  John Heimann, Controller of Currency, was later Vice Chairman of Merrill’s Capital Markets Group.  When the rush of money sucked out of low-paying savings accounts passed through deposit brokers like Merrill Lynch on their way to the highest bidding thrift, they left as much as $150 million a year in Merrill fees.  

            When Grey became chief cheerleader, he had limited qualifications and was paid commensurately.  If he had known what he was getting into, he probably wouldn’t have taken the job, or would have insisted on hazards duty pay.  The 1980 legislation gave the thrifts an opportunity to pay better than competitive rates for deposits; the 1982 law gave the opportunity to invest this high-cost money seeking high-profit return.  

            Most importantly, with deposit insurance now backed by taxpayers if the FLSIC went broke, no one cared what the risk was.  While going broke, troubled thrifts bid higher for deposits and kept effectively doubling the bet.  Why not?  The money was available.  The deposit brokers, like Merrill Lynch, had advanced technology with national communication networks on line to computers to give daily information on where to place more bets.  Package it at $99,999, the investors like the rate, the thrifts like the money, Merrill likes the fees, the politicians like “saving the S&Ls,” and everyone is a winner. Wrong!  

            Before Grey went into office, the missile was fired up and the countdown had begun, but the government was still busy with its uncoordinated design for disaster.  Congress passed the Economic Recovery Act of 1981, making commercial real estate attractive by liberalizing taxation.  This initiative from the Treasury Department of Don Regan would encourage new projects, many funded by thrifts.  This misadventure helped the speculative craze in the “up” direction, but with the usual erratic government action, when the overbuilding problem gained visibility, a new law was passed.   

            The Tax Reform Act of 1986 pulled the plug on tax benefits and now produced a downward effect after the earlier upward one.  This law lengthened the depreciation period from 19 to 31 years, “thus collapsing the present values of real-estate prices.”  Not content with this blow, the reformers deprived present values of real-estate prices.”  Not content with this blow, the reformers deprived passive investors of certain tax deductions on interest and depreciation, thus hiking the costs of investments.  In case any profit were left, the reform raised the capital-gains tax rate 20% to 28%.  

            While the missile was ready to fire, there were numerous warning signals.  Study of the Penn Central Bank failure in 1981 provides lessons on high-risk, insured real-estate ventures.  Government-insured deposits had recently broken the half-trillion level, up from $2.1 billion in 1940, $11.2 billion 1950, $55.8 billion in 1960, and $137.2 billion in 1970.   

            CATO, a Washington organization, wrote about thrifts in 1982, that “The ailing giant was on the brink with a total net worth of negative $70 billion,” pointing out the continuing abnormally of borrowing short to invest long.  It predicted that the government could not substitute for market oversight in controlling the risk inherent in insuring deposits   ten years later, after the predicted debacle, the government has yet to  fully address the insuring of deposits without regard to risk.  Worse than that, extrapolating the theory of insured deposits, it has created the “too big to fail” theory by rescuing the worst managed banks, such as Continental Illinois.

             In Grey’s first year in office, he had to grapple with the failure of Manning Savings and Loan in Chicago .  “The $117 million thrift had failed after growing rapidly, not by attracting local deposits but by using deposits from deposit brokers to invest in questionable real estate ventures.  They had overdosed on brokered deposits.”  This 1982 failure was the first warning of the damage done to the industry and ultimately to the taxpayer by eliminating the limit of 5% brokered deposits to total deposits.  The limit had been established by the FHLBB in 1963, to shut the door on the thrifts’ bidding up the cost of this source of money, in turn stimulating risky investments trying to pay for this high-cost money and make a profit.

             Grey knew the background of brokered deposits.  He could see what had happened at Penn Central and Manning Savings, and he initiated action to eliminate FSLIC insurance protection for brokered deposits.  This P.R. man from San Diego , this regular guy, this cheerleader, understood the impending disaster and took and took courageous action.  Courageous in that he would end up opposing the industry as well as Don Regan, the father of brokered deposits.  But Grey made progress when Bill Isaac, Chairman of the FDIC, gave his support and the FHLBB approved the brokered-deposit limitation, to go into effect October 1, 1984 .  Grey’s arguments were supported by brokered deposits increasing form $3 billion at the end of 1981 to $29 billion at the end of 1983.  His recommendation resulted in several years of personal abuse and frustration.  

            The industry, with its great lobbying strength, later highlighted by the activities of the “Keating Five,” thought they had installed a cheerleader as chairman of the FHLBB, but what they got was a public servant, identifying the industry’s hurtling toward financial disaster, and with a plan Congress started hearings on the proposed regulation, but it didn’t have much of a chance.  Led by Danny Wall, Staff Director of the Senate Banking and Urban Affairs Committee, coached, funded, and entertained by the thrift lobby, “legislation was introduced that would have gutted Grey’s brokered-deposit regulation.  

            The California S&L Commissioner, Larry Taggart, warned a Washington banking law conference that cutting off the supply of 80% of the money flowing into the S&L, would do great damage as the only problem was occasional bad management.  He didn’t discuss high-yield CDs sucking up savings accounts pumping it into thrifts that could only complete the equation by chasing higher-return, higher-risk projects.  

            The body blow to Grey’s solution came from a different direction.  The First Atlantic Investment Corporation Securities Inc. (FAIL) of Miami and the Securitites Industry Association sued in federal court to have Grey’s brokered-deposit regulation overturned.  On June 20, 1984 FAIL won a victory, when Federal Judge Gerhard Gessell ruled that the brokered-deposit ban was illegal and that action for such a band had to come from Congress.

            Grey was under attack from many directions.  The Washington jungle fighters were at work and at various times it was reported that he was fired, under FBI investigation, and messing up his expense accounts.  The FBI cleared him on all charges, but he must have learned how hard it is to try to play offense and defense at the same time.  He later settled a $28,000 expense question with some embarrassment.  

            Grey was determined, despite setbacks, and used speeches during 1984 to warn of the impending disaster.  He emphasized brokered deposits, risky lending, direct investments, and inaccurate appraisals, and reintroduced risk-based insurance.  In January of 1985, he attacked the other end of the problem.  If he could not turn the valve to show the pressure of money, he would try to curb its excessive risk.  The new proposal would limit direct investments to 10% of thrifts, total assets and would limit growth to 25% a year.  Some argue that growth at this rate will produce a rate of change beyond managements’ competence to control, but some thrifts were then growing at rates of 100 to 500%!  Grey’s new regulation was scheduled to go into effect in March, 1985.  

            Congressional hearings were scheduled for late March, after 220 House members signed a resolution asking the Thrift Bank Board to delay implementation.  Eventually, despite opposition and personal attacks, Grey got this new regulation.  The league’s good thrifts became increasingly aware of what the crooks were doing to their industry.  Senator Proxmire, Chairman of the Senate Banking Committee, provided steady support and, in time, St. Germain backed the bill.  

            The new rules were useful, and apparently Grey thought that 700 additional examiners were, too.  Their inspection quickly showed a substantial number of thrifts requiring seizure, but such seizure would require funds to pay off the deposit-insurance obligation.  By 1986, the FSLIC reserve had plummeted from $6 billion in two years to $2.4 billion.

             In 1985, the Thrift Board was recommending a “recap” with as much as $25 billion in new funds to shut thrifts.  This inevitably provoked opposition from both the good thrifts and the crooks.  The good thrifts would have to fund the money, the crooks would have been put out of business, so both opposed.  After two years of opposition, in April, 1987, the bank board sued Don Dixon and Vernon Savings for $540 million.  

            Dixon had been one of the early crooks, but Congressman Jim Wright had helped his Texas constituent fight off regulation.  After the law suit, Wright, the Speaker of the house, gave his support.  By then, the reduced version of shut-down money was $15 billion.  In May, the Senate passed $7.5 billion and the House $5 billion.  With such delay, costs were running $10 million a day supporting these “brain dead” thrifts.  Congress finally passed a $10.8 billion recap bill in August of 1987.

            In February, 1989, the Bush Administration, recognizing hundreds of these bankrupt thrifts, proposed legislation that was eventually passed in modified form in August of 1989.  The Financial Institutions Reform Recovery and Enforcement Act of 1989 authorized an additional $50 billion of borrowing.  The taxpayer was expected to cover 75%, the prudent and healthy thrifts the rest.  “FIRREA” abolished the bank board and FSLIC.  The FDIC, under Bill Siedman, integrated FSLIC.  

            Congress was now on a legislative roll, and mandated higher-risk-based net-worth standards such Grey advocated five years earlier.  To show their constituents how serious Congress was about this problem, they put to work enough of the 19,000 staffers to produce a 393-page document detailing the new act.  Nowhere could you find the words “We’re sorry,” but it did tell exactly “how net worth should be calculated; it cut back on the range of allowable investments by even well capitalized and well run thrifts; and, it required that thrifts increase the percentage of assets devoted to housing related activities to 70% up from the 60% level mandated two years earlier.

             With this money and new people politically unencumbered by the sorry history of dissipation of taxpayer money, the government proved again that no matter how bad the problem was it could figure out how to fix it and make it worse.  The Bush administration was very expert on the financing, as the new Resolution Financing Corporation bonds were included in government revenue, but the money spent cleaning up the mess was “off budget,” so the year’s net effect was a $14 billion reduction in the apparent deficit.  

            The FDIC moved quickly to close another 200 thrifts, those insolvent ones, which were daily wasting more taxpayer money.  Bill Seidman, the head of FDOC, said, “The amount of real estate that will be up for sale is likely to exceed $100 billion, so it is a huge task, the biggest liquidation in the history of the world.”  Seidman set the tone for the indiscriminate speed intended in dumping this distressed merchandise.  “Our basic policy is that every asset is for sale at the current appraised value.  We don’t believe we are in the business of speculating on asset value.”  

            The bad thrifts had created a new art out of balance-sheet accounting.  In a growing market, there is always a tendency to overvalue, that’s why there are reserve requirements.  The crooks had many techniques, one of which was “flipping” real estate or trading it with other crooks at increasing fictional value for the cosmetic benefit of the balance sheet.  They could quadruple values in a few hours.

             The bubble broke, as the market was over-built and the empty offices could not be ignored any longer.  In Texas , the break in oil prices was a contributing factor.  With Seidman’s haste, the values plummeted as in any fire sale.  Billions could have been saved with a longer term plan.  Quickly the smart-money guys moved in, such as the Bass brothers from Texas , and the takeover artist, Ronald Perelman.  The buyers of this heavily discounted merchandise were known as private investor groups, “PIGS.”  

            The best one-liner describing the government technique was that it “privatized the profits and socialized the losses.  The new administration struggled to resolve the problem within the “no new taxes, read my lips” guidelines.  The media covered the downward spiral with more attention than most exhibited five to six years earlier when Grey was struggling to head off disaster.  That part of the media still searching for truth would do a service reviewing how well it studied Grey’s plans compared to how quickly printed attacks on him leaked by Keating’s attorneys.  

            October 31, 1988:  Business Week “The S&L Mess and How to Fix It” points out that the famous Marshall Plan after World War II, did important rebuilding work for about $50 or $60 billion in 1988 dollars.  What might $150 billion have done if invested in education and training instead of the thrift waste?

             January 16, 1989 :  Business Week, “The Great S&L Giveaway” describes the “outrageous giveaway,” “riskless deal,” as government effectively nationalizes insolvent thrifts.

             January 30, 1989 :  FORTUNE points out that profits from 2,000 healthy thrifts are barely enough to pay interest on clean up costs.

             January 31, 1989 :  Wall Street Journal : “S&L mess isn’t all bad, at least for lawyers who were regulators.”  It describes how a former Wall Street lawyer, who helped write deregulation law, was now helping a New York law firm, Freid, Frank, generate $12 million in billings.  By 1988, the FSLIC had 200 in house attorneys but also spent $110 million in outside fees.

             Wall Street Journal also featured “Wall Street firms battle for profitable role in thrift rescue.  Shearson offering a no strings financial deal shocking Drexel, Bear Stearns, and Merrill.”  Fees were as high as $20 million on a $200-million deal with five times the average underwriting commission on investment-grade corporate bonds.  No wonder speculative capitalism has such priority.  Why should one waste time trying to build and sell something when enormous fees can be made on the downside of the speculative curve as well as on the upside?  The fees were part of the greatest pricing scam in the history of capitalism, a percentage of the deal with little reference to value added, services rendered, creativity or risk.  The labor-value theory of both Smith and Marx was lost in the mists of time.  

            Business Week set the tone on January, 1989, “The smart money in S&L bailouts offer fat tax breaks for fat-cat investors.”  It describes how the tax benefits will shelter other company profits.

             February 20, 1989 :  Business Week, “Bush S&L plan full of good intentions and holes.”  Locking-the-barn-door-after-the-horse-is-stolen mood imposed new rues such as the elimination of goodwill as capital; 1,300 out of 3,000 can’t meet the 6% tougher capital requirement.  In a poor economy, with the rush of punitive legislation, well run thrifts were being pushed over the brink into insolvency.  

            February 27, 1989 :  Robert Kuttner in Business Week observes that either market discipline or good regulation was needed but the situation was the worst of both worlds.  

            May 7, 1989 :  New York Times, “How many more big bailout bills will the taxpayer have to face before Congress finally understands that uncle Sam is a lousy banker?”  

            May 22, 1989 :  FORTUNE “This is a dirty business.”  The Resolution Trust Corp. is the final resting place of $300-500 billion of assets, including $100 billion in disposable real estate.

             October 27, 1989 :  Wall Street Journal, “The reality of life in modern America is that if you want to wreck something that works, let it fall into the hands of Congress.”

             November 6, 1989 :  Business Week, “The El Dorado of Impaired Assets; Everything Must Go.”  “The RTC’s risky sell off of $300 billion worth of assets from failed S&Ls has workout pros salivating.”  It describes Wall Street’s  plan to turn thrifts’ “trash into cash.”

             January, 1990:  Wall Street Journal, “Junk Holdings Swell Cost of S&L Bailout.”

             February 5, 1990 :  Business Week, “The Thrift Mop-Up is Already a Mess.”

             September 10, 1990 :  FORTUNE “S&Ls: Where did all those billions go?”  This colorful article shows a Sherlock Holmes type tracking footprints.  In the center, a chart shows the damage in 1990, as $147 billion, growing by 2030, with interest, to an astronomical $647 billion.

            Later, accounting firms and prestigious law firms, like Kaye Scholer, were indicted.  Considering the percentage of the total disaster, crooks like Charles Keating and politicians inevitability as the brokered deposits with insured risk guaranteed the entry of all types of high risk entrepreneurs and outright crooks.  Why not?  It was easier to buy a thrift than a casino in Atlantic City , and the skim opportunities were better.        

          March 14, 1994 :  Forbes’ Ellie Winninghoff writes about “Smart Buyers, Dumb Buyers.”  

            By forcing busted S&L’s to dump junk bonds in a panicked market, Congress cost the taxpayers billions of dollars and more or less guaranteed huge profits for well-heeled bargain hunters.  Wall Street loved it.  The investment houses were like pigs rolling in manure.  They bought and put into inventory billions of dollars of face value in junk bonds paying 20, 30 on the dollar.  When the market turned, in 1991, the big Wall Street houses made billions off their junk-bond holdings.

             The moral s of this messy situation are quite clear: a) when politicians try to fix things, they more often that not make them worse, and b) their bumbling actions often create financial opportunities that are hidden from most people but are there for people who know the ropes.

             There is very little positive about this history.  About 150 years of mistakes caused by politics’ overwhelming common sense, buy short-term ad hoc law not properly integrated with other actions of government, and by the presumption that complex, fast changing matters can be legislated and centrally administered by government.  Politics prevailed from 1984, when Grey first initiated corrective action, until 1987 when incomplete action was taken.  From a process point of view, it doesn’t matter whether the responsible politicians were effectively bought by the thrift lobby or uncomprehending of the loose monster.  Integration is also critical.  When Volker, at the Federal Reserve, undertook his campaign against inflation with a “the sky is the limit” attitude on interest rates, someone should have recognized the need to unshackle the thrift industry, allowing market-directed variable rates on both deposits and mortgages.  The earlier resistance to variable-rate mortgages was political, not reasonable.

             The damage from erroneous law with central administration can be put into perspective by re-studying Alexis de Tocqueville’s delineation between central government as a policy maker and central government as an administrator. The forefathers of political freedom, Jefferson and Madison, and the great prophet of economic freedom, Adam Smith, emphasized that both freedoms could with minimum government.  John Stuart Mill, in 1850, added the observation that good government can produce good ends by advice, encouragement, and guidelines to the private sector, not by legislation.

             De Tocqueville’s early warning received empirical support from the failure of central administration in Russia and Eastern Europe .  Additional proof can be found in the repeated failures in socialized South America , compared to the progress of the Asian “tiger” countries Taiwan , South Korea , Hong Kong , and Singapore .  Some have called them market-oriented and authoritarian, but the central authority works on economic policy and tax incentives, not detailed administration.

             Contemporary social philosophers, like Ludwig Von Mises, have covered the same subject in books like “Human Action” and “Bureaucracy.”  His book on twentieth century government’s handling of the thrift industry.  Hayek’s books, starting with “Road to Serfdom in 1944, emphasized the impossibility of trying to centrally administer any economy, as the variables of date, time, and attitude guarantee constant sufficiently to be within the capability of human competence.  

“We Still Don’t Get It!  Blame the Crooks, Not the Failure of Government.”

The U.S. culture is conditioned to central-government responsibility, with a decreasing ability to tell the truth about itself.  Politicians of both parties blamed the S&L disaster on deregulation and lack of regulatory supervision.  A survey in June, 1990, by the New York Times, reported that 49% of those polled blamed the S&L problem on bad management and fraud at the thrifts; 25% on lack of supervision, and 17% both.  Structural and process failure of government did not even get honorable mention, but the Times article did not say what the questions were.  The epistemological failure starts with the media.  A chronological search for root causes could include at least:  

            1800s – The states could have left the thrifts alone.  Instead they layered on popular-sounding legislation trying to eliminate all risk, all hurt, an impossible goal, producing erratic legislation.  

            1800 Early 1900s – The government did not recognize the costs and risks of a separate infrastructure.  They could have used tax laws to encourage banks to assimilate home mortgages.  Similar tax incentives could have encouraged competition from companies and credit unions.  Creative financial engineering could have given tax incentives to profit sharing/savings plans with opportunities to draw on funds for either home mortgages or major medical.  

            1932–1934 – Hoover federalized the thrifts but made it optional with state charter. When FDR reluctantly stopped bank runs with deposit insurance, a major mistake was made.  Any insurance should have been risk-oriented, or, if government mandated, it would be privately provided.  Privatization by definition would involve risk-based premiums and in the subsequent speculative craze, no insurance would be available fro very high risk.  This is the type of fail-safe system that the decentralized “market” discipline will provide, but not central government.  Even if the variables could be programmed, the decisions are adversary, political, short-term, and superficial.  For these reasons, it is not surprising that the government’s results are frequently wrong and the damage control even worse.  The latter is faulty because the visibility of the problem now involves placing responsibility, in turn making the process even more political.  

            1960s – Lyndon Johnson’s “Guns and Butter” Program resulted in printing money and inflation.  He used the usual warrior-state-leader’s technique of debasing currency to try to hide the cost of war.  His erroneous view of both the function of government and its ability to redistribute wealth put much of the money into enervating support for the disadvantaged and not into education and training.  It accelerated a pattern of government that eroded the creation of wealth and was a direct cause of inflation.  The Republicans, under Nixon, made it worse, continuing with an unfounded war, and welfare costs.  

            July, 1963 – FHLBB stops cut-throat competition for brokered deposits by imposing a limit of 5% of assets.  A limited action, but a good brake, that would have prevented the speculative craze.  Unfortunately, the inability to attract deposits resulted in eliminating the brake in 1980.  It was not changed from 5 to 20 or even 40%.  It was eliminated.  

            1966 – Congress extends the interest rates from commercial banks to thrifts (Regulation Q), presumably to try to provide low cost-mortgages.  Later higher-paying CDs and money market funds sucked out billions of depositors’ money.

             1970s – Volker, the determined inflation fighter, took action to reduce inflation but put the S&Ls into an impossible squeeze between high-cost money and government-mandated low-cost fixed-rate mortgages.

             1970s – Industry lobbied for variable-rate mortgages.  Congress was not interested.  In the ‘70s, where other government action was causing inflation and then high interest rates, sensible deregulation would have been both on deposits and mortgages.  If Congress worked on integrated plans, which it does not, tax relief could also have been provided for the first mortgage to minimize the impact of variable rate mortgages.  

            Late 1970s – FHLBB recommends risk-oriented reserve rules.  This also would have minimized the problem.  The industry successfully lobbied and prevented this proposal. Later the 5%-reserve requirement was reduced to 3% without reference to risk.  After the problem became visible and political in 1988-89, in the midst of plummeting asset values, government reacted with a 6% requirement, pushing good thrifts over the newly difined insolvency line.

             1978 – Congress passes “Right to Privacy Act.” Regulators later shutting thrifts for criminal acts could not search for information on criminal action.  

            1980 – Lobbyist and Senate aides slipped in an increase of deposit insurance from $40,000 to $100,000 at a late hour in the course of passing the bill.

             1982 – Congress passes another law allowing thrifts to invest up to 40% in non-residential, makes variable-rate mortgages phase out Regulation Q and pay interest on checking accounts.  Some states outbid federal deregulation by eliminating any limit on investment.

                       1983-86 – FHLBB, under Grey, tried to minimize the disaster by eliminating insurance on brokered deposits, adding risk-oriented insurance, limiting direct investment to 10%, limiting growth to 25% and creating a liquidation fund as high as $25 billion.  There was no action on any of these proposals until 1987, when criminal action was initiated against Vernon Savings and Don Dixon.  Another influential Congressman had earlier observed that if Vernon Savings was being closed to embarrass Speaker Wright, then Grey should be pleased that the Speaker was concerned with the homeless, because, after the end of his term in June, 1987, Grey would be “sleeping on a grate.”   

            The political delays were caused by large amounts of lobbying money being spread around Congress.  Democratic Capitalism and the average taxpayer were, as usual, silent and unrepresented.  Inside Job provides a full view of the symbiotic relationship of politicians with the free-spending thrift lobby and the extreme spending of the crooks.  The story of the politicians’ summoning the California regulators on the Lincoln Savings/Charles Keating scandal is particularly depressing.  When it was clear that they couldn’t muscle the California regulators, who were threatening criminal action, the new Chairman, Danny Wall, moved the whole investigation to Washington , an unprecedented act in the 50-year history of the FHLBB, and a devastating blow to the morale of the regulators.

             During the time that the S&L crisis was developing, the oversight was provided by the FHLBB, whose Chairman was paid $79,000 a year.  His field people made $14,000.  He certainly never had access to President Reagan, who never mentioned S&L after his 1982 deregulation party.  Grey also didn’t have access to the Secretary of the Treasury.  The examiners were detail people, with little power, and easy to deflect.

             The whole audit function could not have been weaker if it had been designed deliberately.  To get another 700 examiners, the argument was that there were so few examiners that each had to cover forty-two thrifts.  With current technology, an automated control system could be designed to work on a national network.  With the “bells and whistles” automated on the exception principle, a small number of well paid, sophisticated auditors, with decisive power, could run an effective system at a fraction of the cost.  

            1996 was the 100th anniversary of the demise of the People’s Party.  It should be resurrected to tell the people the S&L story.  The Populist failed the people and the cost of that failure continues to affect both the economy and their sense of trust.  The media fails the people by reporting on the exciting, not the profound.  The university fails by not analyzing such egregious errors and recommending monetary programs relieved of short-term political mistakes.  

            From the beginning of this republic, finance capitalism has been able to lobby undemocratic privileges for the financial benefit of a few.  From the beginning of this republic, politicians have passed poorly designed and executed laws.  Despite these impediments there was enough growing freedom for the political/economic system to steadily improve the lives of most.  Today U.S. citizens are being warned, the standard of living for most has stagnated, and millions have been effectively disenfranchised.

             What has changed?  Three things:  The financial privileges are getting bigger, the political mistakes are getting bigger and the world is becoming more competitive.  World competition now measures not only company performance, but also country performance. A country that does not follow policies supporting its job-growth economy is penalized by slower growth. The U.S. cannot afford the $1/2 trillion waste of the nation’s surplus in the S&L disaster.  While most of the intellectual community continues to debate abstractions, this country is in decline because of bad laws and worse execution.

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