Portrait of An Industry In Crisis

JIMMY STEWART EXPLAINED IT BEST IN IT’S A Wonderful Life, this business of savings and loans. The movie was set in the Thirties-more than forty years before deregulation. You remember the scene. There’s a run on the S&L in the sleepy town of Bedford Falls; people want their money, and Stewart as banker George Bailey delivers a soliloquy fit for economics 101: “You’re thinking of this place all wrong. . .as if I had the money back in a safe. The money’s not here. Why, your money’s in Joe’s house, that’s right next to yours, and in the Kennedy house, and Mrs. Maiden’s house, and a hundred others. You’re lending them the money to build and then they’re gonna pay it back to you as best they can.”

And so it was in most of the towns across this country-towns that were virtually built by the simple save-and-loan formula of the thrift. From the time that Congress set up the system of government-guaranteed deposits in 1933 until deregulation in the Seventies, S&Ls were heavily regulated agencies that primarily took in consumer deposits (insured by the federal government) at low interest rates (set by the government) and invested those funds in home mortgages (also insured by the government). If the S&Ls followed the government regulations, they virtually couldn’t fail. All the S&L examiner (the guy with the green visor who comes in to look at the books) had to do was to make sure that both sides of the equation balanced.

George Bailey wouldn’t recognize today’s S&Ls. Nor would he recognize his counterparts who run them. And if he looked at the books, Mary would probably have to make him some warm milk and put him to bed. Thrifts no longer stick to their historical business of making low-risk single-family home loans. And thrifts don’t get their money from passbook savings accounts any more.

It’s a Wonderful Life circa 1987 would include a cast of characters very familiar in Dallas. Shrewd, young, bright-these leading men knew an opportunity to make a profit when they saw it. And for hundreds of them, and their counterparts across the country, that opportunity came in the form of the new savings and loan system created by Congress in the late Seventies and early Eighties through deregulation, Ironically, the new brass ring had a tarnished underside. The vastly altered system of S&Ls is now being blamed for the current overbuilding problems in Dallas and for the turmoil the thrift industry and the Federal Savings and Loan Insurance Corporation now face. The Federal Home Loan Bank Board estimates that 216 thrifts with assets of about $80 billion will require federal assistance in some form during the next few years. And the dollars for that monumental bailout will come from the pockets of the U.S. taxpayer.

Deregulation of the thrift industry began in the Seventies. At that time, the majority of S&L assets were long-term mortgages fixed at the lower interest rates of the early part of the decade. Most of the liabilities were short-term passbook deposits. With the increased competition that came with deregulation and the advent of high interest rates, alternatives like money markets were offering depositors more return for their money. S&Ls were forced to pay higher interest or lose deposits.

That put the thrifts in a catastrophic cash crunch. They had loans locked in for twenty or thirty years at 5, 6, and 7 percent while they had to pay 15 and 16 percent for deposits. So Congress, in its wisdom, devised the solution: it would allow S&Ls to sell off their mortgages to raise the cash to pay the higher interest rates or to pay depositors who were taking their money elsewhere. (Remember George Bailey’s lesson. The S&Ls couldn’t take the money out of “’every Joe’s” house. They had to get it somewhere.) But when the S&Ls sold their mortgage portfolios, the book value of the mortgages was higher than the market value, so they suffered enormous losses. To solve that problem, Congress, in 1981, created a new accounting system for S&Ls that permitted them to amortize those losses over the twenty- and thirty-year lives of the mortgages. The regulators were betting that by allowing S&Ls to convert their mortgages to cash and freeing their investment powers, the thrift industry could earn enough profit to eventually cover its losses.

Thus Congress allowed S&Ls to take leave of their traditional investment vehicles-home mortgages-and enter the world of high finance. S&Ls became players in the more speculative markets. And in Texas, that meant the apartment, land, and office building games.

In the safe, insured, government-controlled system, S&Ls were only required to have 3 percent capitalization versus banks’ 10 percent (for every dollar loaned, the owners of the S&L put up three cents; the government insured the other ninety-seven cents of deposits). But in a deregulatory environment, those low capital requirements took on a new meaning.

Some observers, like Paul Zane Pilzer, a managing partner in the Dallas-based real estate investment firm Zane May Interests, think Congress made a fatal error and that deregulation of the S&L industry will go down as a tragic mistake of the deregulatory era. Pilzer is a Wharton MBA. a former banker, and an adjunct professor of finance at New York University. He was a lobbyist for Citibank during the late Seventies and testified last summer before Congress on the S&L crisis.

“It didn’t take long for the nation’s most savvy investors to realize that by investing through an S&L, one could reap 100 percent of the profits and only risk 3 percent [thrift capital requirements] of the losses. But in the zero-sum-game world of financial investments where one investor’s gain is another investor’s loss, the ultimate, sure-fire, 100 percent loser is the deposit insurance system, which insures 100 percent of both the winners’ and losers’ deposits,” Pilzer says.

Texas is a perfect-and extreme-case study for what went wrong in the S&L industry. After 1981, S&Ls in Texas began to change hands fester than dice in a craps game. This is how Pilzer says those new S&L owners made money: a typical S&L’s speculative investment might be a high-interest (2 percent over prime) $100 million loan to a land speculator. The institution would usually demand three or four points, $3 to $4 million, paid up front, plus a 25 percent to 50 percent profit participation.

Why would someone take such a high-cost loan? “Probably because the loan was too speculative for a bank to touch it,” Paul Pilzer says.

So, if the land speculation is successful and makes $60 million for the S&L, the owners are allowed to dividend out the profit to themselves. If the speculation fails and the value of the property falls to. say. $40 million, the S&L owners would only lose the $3 million (3 percent) in capital that they had to put up to make a $100 million loan. The other $57 million loss would be picked up by the federal government, which has promised to pay off the insured depositors 100 percent. But here’s the catch: while those losses on highly speculative deals don’t have to be recognized immediately, the profit can be taken by the investors. Even if the land falls in value and the S&L will eventually lose, the $3 to S4 million up front and the money earned by the premium interest rate can be paid to investors as “profit.” Meanwhile, the S&L is still playing the game and making more and bigger investments. Who wouldn’t like to play this hand of blackjack? You risk three cents of your own on each dollar but keep 100 percent of the winnings.

THIS POPULAR GAME IS COMING TO AN agonizing end as we watch many S&Ls change hands again, this time being dumped : on Uncle Sam. Many savings and loans that aren’t federally operated are either being guided or at least watched very carefully by the Federal Home Loan Bank. The new savings and loan system-a speculator’s dream-coupled with the devastating blows dealt the Texas economy during the last two years have not made for a healthy combination. Following is a look inside Federal Home Loan Bank records on four local S&Ls that epitomize the problem.

●In 1980, John W. Harrell was president of Big Country Savings Association of Stam-ford, about forty miles due north of Abilene. The community S&L had three branches ’ and total assets of $87.2 million. By 1982, Robert H. Hopkins had taken over as chairman of the S&L. now called Commodore Savings Association. In 1982, the majority of Commodore’s convenlional loans were for single family homes. But between 1982 and the third quarter of 1986 the S&L’s loans on apartment complexes rose from $1.2 million to $104.9 million. In that same period Commodore’s loans on other commercial real estate rose from $5 million to $160.6 million. Land loans rose from $273,000 to $192.2 million. Other secured and unsecured commercial loans, not including mortgages, grew from zero in 1982 to $86.1 million in the third quarter of 1986. At that time, these more speculative loans outnumbered traditional home loans by nearly $4 to $1. The cracks started to show in 1985. Commodore’s repossessed real estate rose from $4.7 million in 1985 to $23.7 million by the third quarter of 1986. And along with that repossessed real estate grew Commodore’s loss-es-from $874,000 in 1985 to $29.9 million by the end of the third quarter last year. Commodore had a negative net worth of $7.4 million on total assets of S1.05 billion. Hopkins is no longer with Commodore Savings Association. Its new chairman is John W. Harrell.

●In 1982. B.W. Baker was chairman of Citizens Savings Association of Grand Prairie, which had total assets of $40.2 million. By 1983. Thomas M. Gaubert had acquired the S&L. changed its name to Independent American Savings Association, and become its chairman. Gaubert’s stint at Independent American was short-he was gone by the end of 1985-but in the meantime Independent American’s loan portfolio changed drastically. Apartment loans grew from zero in 1982 to $76.1 million in 1985. Other commercial real estate loans grew from $4.2 million in 1982 to $221.2 million in 1985. Land loans grew from $193,000 to $188.8 million in that period. Other commercial loans grew from zero in 1982 to $26.4 million in 1985. In 1982 traditional home loans outnumbered commercial loans $7 to $1. By 1985 home loans were outnumbered S3 to $1. Independent American held $24.5 million in foreclosed real estate in 1985 and in 1986 the losses started to show-$512.8 million by the end of the third quarter. Independent American’s net worth then was negative $457.5 million on total assets of $1.12 billion. Harold Cantrell is now the chairman of Independent American.

●Edwin T. McBirney became chairman of Sunbelt Savings Association of Stephenville in December of 1981. At the end of 1982, Sunbelt had $94.4 million in total assets. Between 1982 and McBirney’s resignation in May 1986 apartment loans rose from $1.8 million to more than $800 million. Other commercial real estate loans rose from $11 million to $776 million. Land loans grew from $3.6 million to $884 million. Other nonmortgage commercial loans grew from zero in 1982 to $291 million by the end of the second quarter in 1986. In 1982, Sunbelt’s home loans outnumbered other real estate loans by more than S3 to $1. By the time McBirney left Sunbelt, home loans were outnumbered by more speculative loans $6 to $1. Sunbelt had $52.9 million in repossessed real estate on its books by the second quarter in 1986 and its losses amounted to $19.1 million by the third quarter of 1986. Sunbelt had a positive net worth of $73.2 million on total assets of $3.2 billion for September 30. 1986, but analysts say Sunbelt’s losses have only begun to show. Sunbelt’s new chairman is Thomas J. Wageman.

●Jarrett E. Woods Jr. took control of Gatesville Savings and Loan Association in late 1981, an institution with one branch and total assets of little more than $28 million. Gatesville was later known as Western Savings Association and is now known as Western Federal Savings and Loan Association. Woods left the S&L in September 1986, when Western was taken under federal control. Donald Klink is Western’s present chairman. With Woods in control in 1982, Western had $765,000 in apartment loans. By the second quarter of 1986, Western had $562.9 million in apartment loans. In that same period, Western’s other commercial real estate loans went from $2.1 million to $317.3 million. Western’s land loans grew from $43,000 to $1.4 billion. Other non-mortgage commercial loans grew in that period from zero to $118.5 million. In 1982 Western’s home loans outnumbered more speculative real estate loans $12 to $1. By the second quarter of 1986. home loans were outnumbered by more speculative loans $36 to $1. Western had more than $20 million in repossessed real estate on its books in the second quarter of 1986. By the end of the third quarter, Western had losses of $222.7 million and a negative net worth of $153 million on total assets of $1.8 billion.



THE NAMES CHANGE. BUT THE STORY stays very much the same. Congress created a system that some shrewd opportunists grabbed onto and ran with. Can you blame them? Yes. say many critics who point to the mistakes S&Ls made-the empty office buildings and vacant apartment complexes that mark this city. “They are hard to hide.” says Pilzer of the failures. “You can literally see right through them.”

And who will pay for these mistakes? Congress has again gotten in on the act with various legislation designed to bail out the ailing FSL1C and reform the S&L system. The headlines change daily: the Federal Home Loan Bank Board indicates that it will relax the capital requirements for some ail ing thrifts; Southwest thrift regulators plan to put funds from strong S&Ls into weak ones. Analysts are projecting the losses that will eventually have to be picked up by the federal government at more than $60 billion, which means ultimately we will all pay for the mistakes. Paul Pilzer says the losses from failing savings and loans will be more like $200 billion-$843 for every man. woman, and child in the United States.