Banking Law

A reader sent a link to this blog post and said "what do you think?" The answer is, "Not much, and yet, quite a bit."

Here's a mortgage expert's (at least, that's how he's billed) take on the 1980s S&L crisis, and how we haven't learned from it, or, maybe how banks have learned from it, but the lesson they learned is how to be bad guys and get away with it.

A grossly abbreviated summary:  thrifts and S&L?s made spectacularly bad loans, betting big on one asset class.  When the asset class (largely land and partly junk bonds) didn?t pan out, S&L?s started to die.  They were hyperleveraged, which should be legal.  What is incorrect is the explicit and implicit guarantees that the federal government makes to the millionaires that make big and unsustainable bets.

Without batting an eye, the government stood up to cover the bets that they made.  What?s more, without batting an eye, we subsidized incompetence, fraud, malfeasance, corruption, stupidity, greed, and idiotic regulation.  Regulation caused the S+L crisis: remember, the depression?s bank failures caused the government to severely limit the menu of products that Thrifts/S+Ls could invest in.  When the menu was expanded, it was still relatively limited.  The thrift managers didn?t have access to the entire market, just a basket of products and programs, suggested by lobbyists, and acceptable to the Carter administration.  FDIC insurance gives the government the right to be part of the conversation, as they become stakeholders.

Betting big that land would continue to appreciate 20% and more, S&L?s allowed all sorts of land speculation in exchange for high interest rates.  Underwriting guidelines went from prudent to, "aww,hell, he says he?s good for it?what?s the harm?"  Somehow, nobody is willing to believe any market cycle can possibly come to an end. Ever.  So when the land?s price and it?s utility got far enough apart, the market lost its appetite, and the S&L?s lost their capital.

Not wanting to let these thrifts implode, the government decided to give the millionaires money.  Lots of money. Because, hey, we can?t let the banks collapse, now, can we?  They need the money, or else the capital markets will totally seize up! Community banks were what we were saving in the 1980?s.

Today, it?s Joe Homeowner.  He?s the hostage?or front man?we must protect.  Because when we bail him out, we?re also going to see a bunch of bankers that made these investments breathe a sigh of relief.

And the beat goes on.

The author of the post states that the account is "grossly summarized." I'd assert that it was "grossly inaccurate" and even, in some important details, "dead wrong."

A commenter to that post, who claims to have worked for the RTC, sets the blogger straight about the fact that the only people "bailed out" by the government in the S&L crisis were the insured depositors, who the government was obligated to bail out in any event. What the commenter doesn't state is that the owners of the thrifts and banks that failed were wiped out. Their investment was gone, their ownership interests were terminated. That's what happens when banks are put into receivership. The "millionaires" who owned the failed thrifts didn't get a dime, which is reasonable, given the fact that their institutions were grossly insolvent.

In addition, in most cases, the RTC and FDIC aggressively pursued former owners, directors, officers, and employees of failed banks and thrifts where malfeasance or gross negligence was involved, and in many cases, where ordinary negligence occurred. Many hearts were broken, many wallets were thinned. The really bad guys were pursued by the US Justice Department, went to jail, and forfeited huge amounts in fines. Appraisers, accountants, attorneys and other professionals who represented or advised failed institutions also suffered. If there was a professional liability insurance policy in place or other assets to pursue, and the RTC or FDIC could make a good faith claim against a professional firm (enough to survive a Rule 11 sanction, at any rate), they generally went after the firm. The theory was that the public purse needed to be reimbursed, and those who had played poorly had to pay up. Many firms simply negotiated a financial settlement to put it all behind them.

Not everyone who deserved it received his or her just deserts, but enough innocent people were battered that rough justice was done, at least from a bureaucratic perspective, where you're inflicting pain and not receiving it. Human beings on the other end of the firing line believed that the government went overboard on many occasions. From my personal experience, I can vouch that a number of decent human beings who were in the wrong place at the wrong time were steamrolled, right along side the nefarious types who deserved their beating. None of these folks felt they were "bailed out."

The government still took a huge net loss (and  we'll set aside for now a discussion of the losses that ensued because the government broke its promises to institutions and investors who came to the rescue of failed thrifts prior to the enactment of FIRREA in 1989). Nevertheless, I'd like to know who were the "millionaires" to whom the government gave "lots of money" in connection with the S&L bailout.

As for "saving the community banks," small community banks weren't the main source of the problem, and community banks are doing fine, no thanks to the bailout. The Southwest Plan used by the FSLIC and the FHLBB consolidated huge numbers of thrifts into a relatively few number of much larger thrifts, which, one-by-one, sold out to much larger thrifts or commercial banks over the ensuing decade. (Guaranty Bank is still around and was recently spun off by Temple-Inland, but it's one of the few institutions whose owners didn't "cash out.") When that plan was abandoned, and the FDIC began to simply liquidate the thrifts that failed, the result was a further reduction in the number of thrifts. As to larger regional commercial banks, Texas lost almost all of its largest "home grown" commercial banks, the retail deposits of which (and some assets of which) were sold to larger out-of-state banks, some of whom were themselves later gobbled up by even larger institutions. When the "bailout" was completed, the thrift industry was drastically smaller (if that's what the blog's author is referring to as "community banks"), and the regional banks in the Southwest were, for the most part, gone (Cullen Frost being an exception in Texas).

Usually, we live by the motto "twice the attitude and only half the knowledge," so throwing stones when you live in a glass house is probably problematic. Nevertheless, having lived through, and participated in, the pain of the S&L crisis, I just couldn't let that one pass, especially when the allegation is made that the government stepped in and bailed a lot of fat cats out of hot water. That's simply not what happened, and comparing the S&L bailout to a potential bailout of subprime mortgage borrowers is not appropriate.