How Did It Happen? -Steve Waldman and Rich Thomas

How could the savings and loan crisis possibly have happened? How could the government inadvertently lose $250 billion-an amount approaching the cost of the Vietnam War? "This is the single most grievous legislative error of judgment this century," says Republican Rep. Jim Leach of Iowa, a House Banking Committee member who warned in vain about the problem for years. "It's the single greatest accounting misjudgment this century. It's the largest lapse on the part of the press. It's the single greatest regulatory lapse of this century. It's the single greatest indicator of the defer-at-all-costs approach to government in this century."
 It would be comforting to think the scandal occurred because of a conspiracy of unusual forces, the political equivalent of a rare planetary alignment. But actually the forces that caused the S&L problems to fester for so long are familiar parts of American political culture. The warped campaign-finance system, failures to police white-collar crime, ethical permissiveness-all contributed to the S&L crisis and all could, without dramatic reform, cause the next scandal.

 A Failure of (De)Regulation
Before the 1980s, S&Ls were the most boring businesses in America. They loaned money to individuals to buy houses. Period. No loans for office buildings, none for breathtaking shopping malls or brash oil ventures. The motto was 3-6-3: offer 3 percent on savings, lend at 6 percent, and hit the golf course by 3 o'clock. The staid life changed with the high inflation of the late '70s as depositors pulled funds out of S&Ls to take advantage of higher-yield possibilities like money-market funds. The S&Ls were left holding long-term mortgages that paid them little. That left Congress with a choice: shrink the industry or let it fly free in the winds of deregulation. They chose the latter course-and the industry quickly became a lot more aggressive.
 Congress took three key steps to revitalize the industry, all of which contributed to the fiasco. In 1980 it allowed S&Ls to pay much higher interest rates. The effect: S&Ls competed by offering savings-account rates as high as 13 percent. But to make up for the money they lost by paying more interest, they needed to generate extra income from investments. So in the early 1930s, Congress and many states allowed thrifts to invest in anything they wished. Effect: the thrifts bought everything from palatial estates for their owners to an Iowa plant that converted manure to methane. The government also permitted investors to open an unlimited number of accounts, each insured up to $100,000. That brought in more deposits-and gave irresponsible S&L managers more Monopoly money to spend. Together, these steps gave the industry the money and the freedom to fly high. "All in all," said Ronald Reagan when signing the 1982 deregulation act, "I think we've hit the jackpot."
Unfortunately, that "we" included a lot of high rollers with vivid imaginations. Don Dixon, head of Vernon Savings and Loan in Vernon, Texas, took his wife on a "gastronomique fantastique" tour of fancy European restaurants. But he defended the junket as a scouting trip for investments. "You think it's easy eating in three-star restaurants twice a day six days a week?" he protested.
Such behavior was allowed to persist because of a profound flaw in the Reagan administration's thinking about deregulation: that markets should be liberated not only by writing new laws but by weakly enforcing existing ones. Officials did this at other agencies, like the Occupational Safety and Health Administration, but the financial cost was greatest at the Federal Home Loan Bank Board, which regulated S&Ls. The three other regulatory bodies that oversee banks hired more examiners to monitor commercial banks, which had been partially deregulated in the early 1980s to compete with other financial markets. But while those agencies could pay for new cops by increasing fees on banks, S&L regulators had to go cup in hand to ask the White House budget office. The White House turned them down flat.
Adding insult to bureaucratic injury, the other financial agencies then picked off some of the Bank Board's most talented examiners. That wasn't hard: in 1983 the starting salary for an accountant at the Comptroller of the Currency, which regulates federally chartered banks, was $26,000-, at the Bank Board it was $14,000. In the early '80s, the S&L overseer lost about half of its veteran examiner staff. Those who remained were told by Reagan's first S&L regulator, Richard Pratt, to adopt new accounting procedures that let thrifts pretend to be solvent until they worked their way back-or so they hoped-to real health. These gimmicks made things seem better, but in the same way a doctor can make a patient appear better by whiting out a tumor on an X-ray.

The Impact of Political Money
Debates about the role of money in politics often make the need for reform seem either abstractly moralistic ("an affront to democratic values") or oddly trivial ("we're trying to eliminate not wrongdoing but the appearance of impropriety"). The S&L scandal shows clearly the dangers of having legislators depend so heavily on campaign funds from interest groups and businessmen with dealings before the federal government. Quid pro quo can rarely be proven but we do know this: never has so much money gone to such key legislators who worked so hard for measures that cost taxpayers so dearly.
The biggest politician to fall was Jim Wright, who resigned as speaker of the House in 1989 as the House Ethics Committee zeroed in on his attempts to bully regulators on behalf of thrift operators. Tony Coelho, the House majority whip who raised hundreds of thousands of dollars from thrift owners for the Democratic Congressional Campaign Committee, also retired that year under fire for a deal with Columbia S&L. Fernand St. Germain, former chairman of the House Banking Committee, lost his bid for re-election after disclosures he was using the credit card of the U.S. League of Savings Institutions for his personal entertainment. Now the Senate Ethics Committee is investigating the Keating Five, a group of powerful senators (Alan Cranston, John Glenn, Donald Riegle, John McCain and Dennis DeConcini) who received a total of $1.4 million in contributions from Charles Keating, head of the Lincoln S&L. That's not to mention the $131,000 Keating gave to Arizona state politicians and the $255,000 he gave to politicians in the Phoenix area, according to a PBS "Frontline" documentary. Near Phoenix, Keating built the Phoenician, a lavish hotel with gold-leaf ceilings and $12 million in Italian marble.
Mostly what the S&Ls got from these politicians was delay. In 1986 Wright sat on a key piece of reform legislation that would have raised $15 billion in desperately needed bailout funds. During the ensuing delay, the bailout's price tag rose several billion dollars. The Keating Five helped push regulators into putting off action against the Lincoln S&L. The senators deny wrongdoing, but after their intervention the Bank Board waited another two years before shutting down Lincoln-a postponement that may have cost taxpayers millions more.
Responding to questions about whether his money had influenced the senators, Keating said, "I want to say in the most forceful way that I can, I certainly hope so." All five senators denied the money swayed them and Cranston said, "I never did anything to derail any investigation of anybody." Glenn argues that there's a difference between pressure and questioning: "I learned very quickly that as a senator I can ask any question that I want. How [the regulators] answer is their decision." The senators also say part of their job is to help constituents-whether it's Aunt Sally with her social-security check or Keating with his S&L. Yet as William Black, a top Bank Board enforcer, puts it, "there were lots of constituents that needed protecting.     But the one constituent who put up more than a million bucks in contributions to the five senators is the only one that got the protection." The pressures of the campaign-finance system tempt legislators to define the "public interest" as the sum of narrow special interests-too often the special interests with the most money

The Hired Gun Syndrome
Follow the bouncing buck. Regulators eased off Charles Keating after intervention from the senators. The senators say that they interceded on behalf of Keating because they were persuaded by a letter written by Alan Greenspan, now chairman of the Federal Reserve and then a private consultant, vouching for Lincoln's health. And Greenspan was paid to write the letter by a law firm that was representing Charles Keating.
Greenspan claims he genuinely thought, as he wrote, that Lincoln's management was seasoned and expert" and that the S&L itself was a financially strong institution that presents no foreseeable risk. He says Lincoln was regarded as a sound thrift when he wrote his endorsement and he is now "surprised and distressed" by the S&L's demise. Financial consultant Bert Ely, who has studied the case, says that if Greenspan had objectively studied the existing data "there's no way he could have reached those conclusions. It was clearly an inappropriate letter. "
Keating was also helped because Arthur Young, a big-eight accounting firm, diagnosed his S&L as sound and accused the government of harassment. DeConcini cited the Arthur Young study in his meeting with regulators, asking, "You believe they'd prostitute themselves for a client?" Michael Patriarca, chief thrift regulator in San Francisco, answered: "Absolutely; it happens all the time." Jack Atchison, the accountant who gave Lincoln a glowing report, soon afterward joined Keating's firm at a salary of more than $900,000.
Atchison declined to comment. Arthur Young officials say the firm carefully considered regulators' arguments at the time but concluded they were wrong.
Other hired guns contributed to the mess. "Professional" real-estate appraisers valued a parcel of California land at $30 million even though most of it was on a sloped, completely undevelopable piece of Mountainside. Margery Waxman, a lawyer in the Washington law offices of Sidley & Austin, helped get the Bank Board to take the Keating investigation out of the hands of the San Francisco office, which was leading the charge. "As you know," she wrote Keating, "I have put pressure on [then Bank Board Chairman M. Danny] Wall to work toward meeting your demands and he has so instructed his staff." Waxman declined to comment last week, but a Sidley & Austin spokesman told Legal Times that the firm holds her "in high regard."
Lobbyists, corporate lawyers and consultants often compare their work to that of the noble public defender tolling in a grimy municipal court. Their point: society doesn't chastise a criminal-defense lawyer for representing a murderer-it's part of our adversary system, after all-so it shouldn't blame an advocate for representing an unpopular business client. But campaigning for government benefits should not enjoy the same moral standing as protecting constitutional rights. When professionals become, in effect, political lobbyists, they should be held accountable if their efforts succeed. That would force them to make some independent judgments about what they're advocating and provide an important check on irresponsible behavior.

Suicide by Fountain Pen
Co-signing someone else's loan is known in private business as "suicide by fountain pen." It is a simple problem of human nature: people are less careful if they know someone else will pick up the pieces after the crash. If Uncle Sam pays off any deposits if an S&L goes under, the depositors may be less careful about where they put their money.  That is why the government's decision to allow large investors to open unlimited numbers of guaranteed $100,000 accounts is considered one cause of the catastrophe. Savvy investors started putting money in the S&Ls with the highest interest rates, which gave men like Charles Keating the money with which to build their dreams. Meanwhile, "the gamblers at least could reassure themselves that depositors wouldn't suffer," says Northwestern University economist Haskel Benishay. And the deeper in trouble the owners became, the less they had to lose by gambling some more.
This "moral hazard," as economists call the effect of government guarantees, has plagued other programs as well. Congress will soon have to spend $1 00 billion to $150 billion on top of the S&L bailout to cover losses from programs ranging from student loans to flood insurance to commercial banking. Ironically, Congress loves these programs because they seem so cheap. The cost becomes clear only years later, when the loan goes bad or the disaster happens.
Even though these programs often cover bad risks, they get lax scrutiny because they are off-budget.  "Nobody dreamed we'd have to raise $120 billion to bail out savings and loan depositors," says Rep. J. J. Pickle. "Nobody dreamed we'd have to put up $4 billion for the Farm Credit System. Nobody dreamed. Why, all of a sudden we realize that there's a tremendous risk.    We've handed credit cards to these folks without ever watching what happened."

The Culture of Financial Crime
Picture the following scene- five senators sit in a room with a local district attorney who is prosecuting an accused bank robber, The senators charge the D.A. with harassing the bank robber and a few help a Senate employee, friendly with the accused, to be appointed the new D.A. Even the most cynical observer cannot fathom this happening. Yet five senators didn't view inquiries on behalf of Keating to be improper-even though the Bank Board's investigation was attempting to protect taxpayers from huge losses and, as it turns out, alleged fraud.
In the private sector, people who would be outraged to see a thief snatch an old woman's purse become numb to the implications of a senior being ripped off through fraud. Such a double standard is reinforced by the cdminal-justice system: an unarmed bank robber who steals $1 00,000 will get a sentence between 51 and 63 months. Someone who commits a $100,000 fraud gets between 15 and 21 months.
Political and corporate culture can include pockets of permissiveness about crime just as ghetto subcultures can incubate violent crime. Until the insider-trading crackdown, Wall Street financial crime often went unpunished because it was so complicated-and in some cases so routine. The same sort of lapse in ethical standards lay at the heart of the HUD scandal, as Housing and Urban Development officials gave out grants on the basis of political ties instead of merit. People seem to forget that their gain comes at someone else's expense.
As part of his reform efforts, Rep. Henry Gonzalez, chairman of the House Banking Committee, required that regulators log contacts from congressmen. The S&L meddling suggests a further step, a ban on lawmakers privately lobbying regulators about the solvency problems of an individual bank or company.

The Big Denial
Adolf Hitler theorized that "the big lie" would work because human beings have a limited capacity to fathom deception on a grand scale. The S&L scandal provides a corollary that might be called "the big denial." When the facts present a situation so extraordinarily bad, human beings will devise brilliant ways to avoid reality. Congress and the regulators didn't face the S&L crisis early in part because they just couldn't believe it was as bad as people thought. The same has been true with problems like nuclear-waste disposal at the Department of Energy facilities, which will require an additional $150 billion in taxpayer funds to correct.
Facts weren't faced for more mundane reasons as well. To do so would have meant paying for a bailout earlier, which might have required an unpopular tax increase. Thrift watchers charge that Wall continually downplayed the size of the thrift problem to keep it from becoming an issue in the 1988 presidential election campaign, a claim Wall denies. Examiners within the Home Loan Bank Board feared that if they pushed too hard they would incur the wrath of their bosses who, in turn, were being browbeaten by the politicians.
The failure to confront the S&L crisis made a bad problem into the worst financial scandal in American history. The sicker S&Ls became, the more their managers threw good money at bad. If Congress had confronted the problem in 1984 it would have cost $40 billion, estimates consultant Bert Ely-a lot of money but a small fraction of what we'll end up paying. "It's like the government has been borrowing from a loan shark," Ely says. So if it depresses you to think of how much we'll be paying now that we're confronting the problem, think of how much we're saving by dealing with it now instead of in 1995.