Creature From Jekyll Island by G. Edward

On March 15, Ohio Governor Richard Celeste declared one of the few "bank holidays" since the Great Depression and closed all seventy-one of the state-insured thrifts. He assured the public there was nothing to worry about. He said this was merely a "cooling-off period ... until we can convincingly demonstrate the soundness of our system." Then he flew to Washington and met with Paul Volcker, chairman of the Federal Reserve Board, and with Edwin Gray, chairman of the Federal Home Loan Bank Board, to request federal assistance. They assured him it was available.

A few days later, depositors were authorized to withdraw up to $750 from their accounts. On March 21, President Reagan calmed the world money markets with assurances that the crisis was over.

Furthermore, he said, the problem was "limited to Ohio."2

This was not the first time there had been a failure of state-sponsored insurance funds. The one in Nebraska was pulled down ln when the Commonwealth Savings Company of Lincoln

failed. It had over $60 million in deposits, but the insurance fund 1- "How Safe Are Your Deposits?", Consumer Reports, August, 1988, p. 503.

Ohio Bank Crisis That Ruffled World," U.S. News & World Report, April 1, 1985, 72 THE CREATURE FROM JEKYLL ISLAND

had less than $2 million to cover, not just Commonwealth, but the whole system. Depositors were lucky to get 65 cents on the dollar, and even that was expected to take up to 10 years.1

AN INVITATION TO FRAUD

In the early days of the Reagan administration, government regulations were changed so that the S&Ls were no longer restricted to the issuance of home mortgages, the sole reason for their creation in the first place. In fact, they no longer even were required to obtain a down payment on their loans. They could now finance 100% of a deal—or even more. Office buildings and shopping centers sprang up everywhere regardless of the need.

Developers, builders, managers, and appraisers made millions. The field soon became overbuilt and riddled with fraud. Billions of dollars disappeared into defunct projects. In at least twenty-two of the failed S&Ls, there is evidence that the Mafia and CIA were involved.

Fraud is not necessarily against the law. In fact, most of the fraud in the S&L saga was, not only legal, it was encouraged by the government. The Garn-St. Germain Act allowed the thrifts to lend an amount of money equal to the appraised value of real estate rather than the market value. It wasn't long before appraisers were receiving handsome fees for appraisals that were, to say the least, unrealistic. But that was not fraud, it was the intent of the regulators. The amount by which the appraisal exceeded the market value was defined as "appraised equity" and was counted the same as capital. Since the S&Ls were required to have $1 in capital for every $33 held in deposits, an appraisal that exceeded market value by $1 million could be used to pyramid $33 million in deposits from Wall Street brokerage houses. And the anticipated profits from those funds was one of the ways in which the S&Ls were supposed to recoup their losses without the government having to cough up the money—which it didn't have. In effect the government was saying: "We can't make good on our protection scheme, so go get the money yourself by putting the investors at risk. Not only will we back you up if you fail, we'll show you exactly how to do it."

1. "How Safe Are Deposits in Ailing Banks, S&Ls?," U.S. News & World Report, March 25,1985, p. 74.

HOME, SWEET LOAN

73

THE FALLOUT BEGINS

In spite of the accounting gimmicks which were created to make the walking-dead S&Ls look healthy, by 1984 the fallout began- The FSLIC closed one institution that year and arranged for the merger of twenty-six others which were insolvent. In order to persuade healthy firms to absorb insolvent ones, the government provides cash settlements to compensate for the liabilities. By 1984, these subsidized mergers were costing the FDIC over $1 billion per year. Yet, that was just the small beginning.

Between 1980 and 1986, a total of 664 insured S&Ls failed.

Government regulators had promised to protect the public in the event of losses, but the losses were already far beyond what they could handle. They could not afford to close down all the insolvent thrifts because they simply didn't have enough money to cover the pay out. In March of 1986, the FSLIC had only 3 cents for every dollar of deposits. By the end of that year, the figure had dropped to two-tenths of a penny for each dollar "insured." Obviously, they had to keep those thrifts in business, which meant they had to invent even more accounting gimmicks to conceal the reality.

Postponement of the inevitable made matters even worse.