For many Americans, obtaining a home mortgage has frequently meant a trip to their local savings and loan company. The small financial institutions, similar to trust companies and credit unions in Canada, offered personalized service in towns and medium-sized cities across the United States and were considered by many Americans to be as reliable as a bank. Indeed, until the early 1980s, after the Reagan administration took office and a reform-minded Congress began to deregulate the industry, the S&Ls had been carefully restricted to granting mortgages to home buyers and paying out low interest rates to depositors. But after they were deregulated, hundreds of S&Ls quickly became involved in large speculative financial operations that later collapsed. Since then, the debacle has severely shaken confidence in the entire American banking system—and brought chaos to one of the country’s economic pillars.

Already, losses have skyrocketed to at least

$211 billion from an estimated $17.4 billion in 1985. Now, Washington is struggling to find the billions to pay the cost of the collapse. Last month, Treasury Secretary Nicholas Brady told the Senate banking committee that the $84.7 billion that Congress appropriated for the bailout last year would have to be raised to

at least $103 billion, and perhaps to as high as $151 billion. The administration’s General Accounting Office (GAO) says that the total cost of the disaster could easily reach $580 billion over the next 30 years, the equivalent of about $2,300 for every man, woman and child in the United States.

As well, rescue costs will likely push the current $ 176-billion federal budget deficit still higher, because the government will inevitably have to pay most of the costs of the largest public bailout in history. It may even force President George Bush to break his longstanding “No more taxes” vow.

Aside from deregulation, other causes contributed to the astonishing S&L meltdown. In Texas and other southwestern states, where the crisis is most acute, a sharp decline in oil prices in 1986 led to a collapse in the real estate market. As a result, the S&Ls’ mortgage portfolios plummeted in value after they had committed themselves to paying high interest rates to depositors. As well, dozens of S&L

executives are under investigation for alleged fraud, using financial contributions to influence politicians and diverting depositors’ money for their own uses.

Still, industry analysts say that Washington could easily have prevented most of the huge losses by dealing with the problem at the very beginning. Said Paul Craig Roberts, a former assistant secretary of the Treasury and now an economist with the Center for Strategic and International Studies in Washington: “The S&L mess is entirely a creation of the government.’’

Reagan’s objective with deregulation was to rejuvenate the sluggish S&Ls by permitting the near-banks to invest in much wider—and riskier—portfolios. But many S&Ls used their funds on deposit to buy overpriced real estate and back ill-advised development projects, such as shopping malls in poor commercial locations. Others invested heavily in high-yield, high-risk junk bonds. One of the most notorious cases involved Irvine, Calif.-based Lincoln Savings and Loan, which sold billions of dollars of bonds on behalf of now-disgraced financier Michael Milken, a close business associate of Lincoln’s then-chairman, Charles Keating. As a result,


Pretax earnings of U.S. savings and loan institutions ($ billions)

the government’s Resolution Trust Corp. (RTC), which was set up last August to take over the insolvent S&Ls, has launched a $ 1.3billion fraud suit—the largest in U.S. history— against Lincoln’s parent company, American Continental Corp., of which Keating is still chairman.

Keating, now bankrupt, is also a central figure in a Washington political scandal over millions of dollars in contributions from S&L executives to several U.S. senators. The Senate ethics committee is currently investi-

gating the so-called Keating Five—Alan Cranston of California, John Glenn of Ohio, Donald Riegle of Michigan and Dennis DeConcini of Arizona, all Democrats, and Arizona Republican John McCain—who received a total of $1.6 million in campaign contributions from Keating.

As well, James Wright resigned as Speaker of the House of Representatives and gave up his seat last year in the midst of a House ethics committee investigation of his lobbying on behalf of beleaguered S&L operators. Democratic whip Tony Coehlo also resigned last year after The Washington Post revealed that Beverly Hills, Calif.-based Columbia Savings and Loan provided him with millions of dollars to buy junk bonds from Milken.

The Federal Bureau of Investigation is currently pursuing allegations of criminal fraud at 234 faded S&Ls. It is also examining the tax and other records of S&L executives who have allegedly improperly purchased art, houses and private planes with depositors’ money.

As the scandal deepens inexorably, many of the nation’s more than 1,900 still-solvent S&Ls are now struggling to avoid bankruptcy. In total, by mid-May the RTC had foreclosed on 423 institutions with assets totalling more than $255 billion, and had disposed of only 93 of them. Two-thirds of the country’s 2,898 S&Ls are profitable, but there are about 570 S&Ls still in private hands, and most of them are expected to be1 come financially insolvent, adding to the chaos.

In order to finance a bailout, the RTC is selling off houses, office buildings and other assets held by bankrupt S&Ls. It is also selling some $52 billion in governmentbacked bonds this year alone. Still, Treasury Secretary Brady says that, despite those efforts and $58 billion allocated by Congress last year, money-raising efforts will fall short. He estimates that the RTC may have to issue $151 billion in bonds to cover debts left by insolvent S&Ls.

Meanwhile, estimates of the final cost to Washington of the bailout continue to soar. In reaching its $580-billion estimate, the GAO included the $180 billion the federal government’s Federal Savings and Loan Insurance Corp. owes to insured depositors. It also included $121.8 billion that the RTC will have to pay out in bond interest, as well as $33 billion in short-term interest costs and $43 billion in administrative costs. And the accounting agency predicted that the total could rise by another $203 billion if there is a recession or jump in interest rates.

Indeed, the collapse of just one S&L, the Centrust Bank of Miami in February, will cost

Washington more than $2.3 billion. Said Federal Reserve Board chairman Alan Greenspan, testifying last month before the Senate banking committee: “The size of the hole is astronomical.”

Later this month, the RTC plans to begin what amounts to a fire sale of 30,000 foreclosed properties. Those massive sales have alarmed bankers and real estate investors, particularly in the southwest, who have already been squeezed by falling real estate prices. But RTC chairman William Seidman says that the agency cannot afford to pay interest and carrying costs to maintain empty houses and office buildings that are not generating rental income. Indeed, developers have already razed hundreds of unfinished or unoccupied houses and buildings that insolvent S&Ls are unable to sell.

Accounting for the S&L losses has also become a contentious political issue. Late last month, budget director Richard Darman met with congressional leaders in closed-door negotiations to find a method of accounting for the losses. Bush has kept the negotiations a closely guarded secret, hoping to avoid disclosures that could spark panic in financial markets. The budget discussions are expected to last for at least two more months. Moreover, Bush is under heavy pressure to trim the federal deficit

to meet strict limits set out in the 1985 Gramm-Rudman-Hollings deficit-reduction law. It forces the government to make dramatic budget cuts if predetermined deficit targets are not met. But by adding the S&L losses to the federal deficit, the targets could become virtually unattainable.

In order to preserve the legislated targets, some officials have recommended that the losses be put through so-called off-budget government accounts. Robert Litan, a senior fellow in economic studies at the Washington-

based Brookings Institute, recently proposed a more likely solution. Under his plan, S&L costs would be added to the deficit, but not included in the Gramm-Rudman calculations. Said Litan: “It is almost certain that government spending will be on budget, but that it won’t force the draconian budget cuts.” Government officials are also trying to soothe the growing concern in the American banking industry. Alarmed by the enormity of the S&L losses, some bankers have become more cautious about all types of lending. That trend, in turn, is threatening to create a credit squeeze in the United States. As well, because the govem| ment-backed bonds issued by § the RTC are soaking up huge ~ amounts of savings, the S&L bailout is putting upward pressure on U.S. interest rates. As a result, late last month Greenspan took the extraordinary step of meeting privately with top bankers to avoid a crackdown on credit. Financial analysts say that Greenspan is concerned that the bankers’ tight rein on lending could tip the economy into a recession. Clearly, in one way or another, the American economy will be rocked by the aftershocks from the S&L disaster for many years to come.




In an effort to guarantee that the kind of disaster currently overwhelming U.S. financial regulators does not happen in Canada, federal officials are more than just closely watching the U.S. savings and loan crisis. The S&Ls are similar to Canada’s trust companies: both are involved in real estate lending. But officials say that a financial collapse is highly unlikely in Canada, mainly because of stricter Canadian regulations. Still, speculative real estate booms supported by banks and trust companies in Vancouver, Calgary and Toronto in the past two years have put the country’s financial watchdogs on alert. Indeed, a real estate collapse in Western Canada in the mid1980s led to the spectacular failures of the Alberta-based Northland and Canadian Commercial banks, as well as Principal Group Ltd. Warns Ottawa’s chief financial regulator, superintendent of financial institutions Michael Mackenzie: “When real estate mar-

kets are hyperactive, you can get a bust.”

Mackenzie’s job is to make sure there is no repeat of the earlier failures. In the Principal collapse alone, more than 67,000 investors lost over $300 million of their savings. Governments also lost. After Ottawa closed the Commercial and Northland banks in 1985, the Federal Deposit Insurance Corp. had to pay out more than $670 million to depositors. Those Alberta institutions suffered from many of the same problems that led to the failure of hundreds of S&Ls in Texas and other southwestern states: a collapse in the oil industry quickly brought on a collapse in the real estate market. Home and

rowed heavily to finance their purchases, fell behind in their mortgage payments, while the value of the properties backing their loans plummeted.

Determined to prevent similar failures in the future, Mackenzie and his staff have increased

building owners, who bor-

their monitoring of the real estate loans of financial institutions, particularly in southern Ontario where the real estate boom has taken a sudden downturn. To ensure an early warning of potential instability, Mackenzie says that government consultants are “going through the whole range of portfolios and reviewing systems.” The news so far is good—his office has detected no instability. Says Mackenzie: ^ “Big institutions antici§ pated this downturn more I than a year ago and began z to exercise careful limits I on their lending.” Still, he adds that smaller institutions may be tempted to

result, Mackenzie says that such institutions come in for special attention to make certain that the Alberta experience is not repeated.

take higher risks. As a

P. C.