Chapter Four: Home, Sweet Loan

The history of increasing government intervention in the housing industry; the stifling of free-market forces in residential real estate; the resulting crisis in the S&L industry; the bailout of that industry with money taken from the taxpayer.

As we have seen in previous chapters, the damage done by the banking cartel is made possible by the fact that money can be created out of nothing. It also destroys our purchasing power through the hidden tax called inflation. The mechanism by which it works is hidden and subtle.

Let us turn, now, from the arcane world of central banking to the giddy world of savings-and-loan institutions. By comparison, the problem in the savings-and-loan industry is easy to comprehend. It is simply that vast amounts of money are disappearing into the black hole of government mismanagement, and the losses must eventually be paid by us. The end result is the same in both cases.

Socialism Takes Root in America

It all began with a concept. The concept took root in America largely as a result of the Great Depression of the 1930s. American politicians were impressed at how radical Marxists were able to attract popular support by blaming the capitalist system for the country’s woes and by promising a socialist Utopia. They admired and feared these radicals; admired them for their skill at mass psychology; feared them lest they become so popular as to win a plurality at the ballot box. It was not long before many political hgures began to mimic the soap-box orators, and the voters enthusiastically put them into office.

While the extreme and violent aspects of Communism generally were rejected, the more genteel theories of socialism became Popular among the educated elite. It was they who would naturally become the leaders in an American socialist system. Someone had to look after the masses and tell them what to do for their own good, and many with college degrees and those with great wealth became enamored by the thought of playing that role. And so, the concept became widely accepted at all levels of American life — the downtrodden masses as well as the educated elite — that it was desirable for the government to take care of its citizens and to protect them in their economic affairs.

And so, when more than 1900 S&Ls went belly-up in the Great Depression, Herbert Hoover — and a most willing Congress — created the Federal Home Loan Bank Board to protect depositors in the future. It began to issue charters to institutions that would submit to its regulations, and the public was led to believe that government regulators would be more wise, prudent, and honest than private managers. A federal charter became a kind of government seal of approval. The public, at last, was being protected.

Hoover was succeeded by FDR in the White House who became the epitome of the new breed. Earlier in his political career, he had been the paragon of free enterprise and individualism. He spoke out against big government and for the free market, but in mid life he reset his sail to catch the shifting political wind. He went down in history as a pioneer of socialism in America.

It was FDR who took the next step toward government paternalism in the S&L industry — as well as the banking industry — by establishing the Federal Deposit Insurance Corporation (FDIC) and the Federal Saving and Loan Insurance Corporation (FSLIC). From that point forward, neither the public nor the managers of the thrifts needed to worry about losses. Everything would be reimbursed by the government.

A House on Every Lot

At about the same time, loans on private homes became subsidized through the Federal Housing Authority (FHA) which allowed S&Ls to make loans at rates lower than would have been possible without the subsidy. This was to make it easier for everyone to realize the dream of having their own home. While the Marxists were promising a chicken in every pot, the New Dealers were winning elections by pushing for a house on every lot.

In the beginning, many people were able to purchase a home who, otherwise, might not have been able to do so or who would have had to wait longer to accumulate a higher down payment. On

the other hand, the FHA-induced easy credit began to push up the price of houses for the middle class, and that quickly offset any real advantage of the subsidy. The voters, however, were not perceptive enough to understand this canceling effect and continued to vote for politicians who promised to expand the system.

The next step was for the Federal Reserve Board to require banks to offer interest rates lower than those offered by S&Ls. The result was that funds moved from the banks into the S&Ls and became abundantly available for home loans. This was a deliberate national policy to favor the home industry at the expense of other industries that were competing for the same investment dollars. It may not have been good for the economy as a whole but it was good politics.

Abandonment of the Free Market

These measures effectively removed real estate loans from the free market and placed them into the political arena, where they have remained ever since. The damage to the public as a result of this intervention would be delayed a long time in coming, but when it came, it would be cataclysmic.

The reality of government disruption of the free market cannot be overemphasized, for it is at the heart of our present and future crisis. We have savings institutions that are controlled by government at every step of the way. Federal agencies provide protection against losses and lay down rigid guidelines for capitalization levels, number of branches, territories covered, management policies, services rendered, and interest rates charged. The additional cost to S&Ls of compliance with this regulation has been estimated by the American Bankers Association at about $11 billion per year, which represents a whopping 60% of all their profits.

On top of that, the healthy component of the industry must spend over a billion dollars each year for extra premiums into the so-called insurance fund to make up for the failures of the unhealthy component, a form of penalty for success. When some of the healthy institutions attempted to convert to banks to escape this Penalty, the regulators said no. Their cash flow was needed to support the bailout fund.

Insurance for the Common Man?

The average private savings deposit is about $6,000. Yet, under the Carter administration, the level of FDIC insurance was raised from $40,000 to $100,000 for each account. Those with more than that merely had to open several accounts, so, in reality, the sky was the limit. Clearly this had nothing to do with protecting the common man. The purpose was to prepare the way for brokerage houses to reinvest huge blocks of capital at high rates of interest virtually without risk. It was, after all, insured by the federal government.

In 1979, Federal Reserve policy had pushed up interest rates, and the S&Ls had to keep pace to attract deposits. By December of 1980, they were paying 15.8% interest on their money-market certificates. Yet, the average rate they were charging for new mortgages was only 12.9%. Many of their older loans were still crunching away at 7 or 8% and, to compound the problem, some of those were in default, which means they were really paying 0%. The thrifts were operating deep in the red and had to make up the difference somewhere.

The weakest S&Ls paid the highest interest rates to attract depositors and they are the ones which obtained the large blocks of brokered funds. Brokers no longer cared how weak the operation was, because the funds were fully insured. They just cared about the interest rate.

On the other hand, the S&L managers reasoned that they had to make those funds work miracles for the short period they had them. It was their only chance to dig out, and they were willing to take big risks. For them also, the government’s insurance program had removed any chance of loss to their depositors, so many of them plunged into high-profit, high-risk real-estate developments.

Deals began to go sour, and 1979 was the first year since the Great Depression of the 1930s that the total net worth of federally insured S&Ls became negative. And that was despite expansion almost everywhere else in the economy. The public began to worry.

Full Faith and Credit

The protectors in Washington responded in 1982 with a joint resolution of Congress declaring that the full faith & credit of the United States government stood behind the FSLIC. That was a reassuring phrase, but many people had the gnawing feeling that somehow, we were going to pay for it ourselves. And they were right. Consumer Reports explained:

Behind the troubled banks and the increasingly troubled insurance agencies stands the full faith and credit of the Government — in effect, a promise, sure to be honored by Congress, that all citizens will chip in through taxes or through inflation to make all depositors whole.

The plight of the S&Ls was dramatically brought to light in Ohio in 1985 when the Home State Savings Bank of Cincinnati collapsed as a result of a potential $150 million loss in a Florida securities firm. This triggered a run, not only on the thirty-three branches of Home State, but on many of the other S&Ls as well. The news impacted international markets where overseas speculators dumped paper dollars for other currencies, and some rushed to buy gold.

Within a few days, depositors demanding their money caused $60 million to flow out of the state’s $130 million insurance fund which, true to form for all government protection schemes, was terribly inadequate. If the run had been allowed to continue, the fund likely would have been obliterated the next day. It was time for a political fix.

Chi 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.

This was not the first time there had been a failure of state-sponsored insurance funds. The one in Nebraska was pulled down in 1983 when the Commonwealth Savings Company of Lincoln failed. It had over $60 million in deposits, but the insurance fund 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.

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.

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. Keeping the S&Ls in business was costing the FSLIC $6 million per day. By 1988, two years later, the thrift industry as a whole was losing $9.8 million per day, and the unprofitable ones — the corpses which were propped up by the FSLIC — were losing $35.6 million per day. And, still, the game continued.

By 1989, the FSLIC no longer had even two-tenths of a penny for each dollar insured. Its reserves had vanished altogether. Like the thrifts it supposedly protected, it was, itself, insolvent and looking for loans. It had tried offering bond issues, but these fell far short of its needs. Congress had discussed the problem but had tailed to provide new funding. The collapse of Lincoln Savings brought the crisis to a head. There was no money, period.

The Fed Usurps the Role of Congress

In February, an agreement was reached between Alan Greenspan, Chairman of the Federal Reserve Board, and M. Danny Wall, Chairman of the Federal Home Loan Bank Board, to have $70 million of bailout funding for Lincoln Savings come directly from the Federal Reserve.

This was a major break in precedent. Historically, the Fed has served to create money only for the government or for banks. If it were the will of the people to bail out a savings institution, then it is up to Congress to approve the funding. If Congress does not have the money or cannot borrow it from the public, then the Fed can create it (out of nothing, of course) and give it to the government. But, in this instance, the Fed was usurping the role of Congress and making political decisions entirely on its own. There is no basis in the Federal Reserve Act for this action. Yet, Congress remained silent, apparently out of collective guilt for its own paralysis.

Finally, in August of that year, Congress was visited by the ghost of FDR and sprang into action. It passed the Financial Institutions Reform and Recovery Act (FIRREA) and allocated a minimum of $66 billion for the following ten years, $300 billion over thirty years. Of this amount, $225 billion was to come from taxes or inflation, and $75 billion was to come from the healthy S&Ls. It was the biggest bailout ever, bigger than the combined cost for Lockheed, Chrysler, Penn Central, and New York City.

In the process, the FSLIC was eliminated because it was hopelessly insolvent and replaced by the Savings Association Insurance Fund. Also created was the Banking Insurance Fund for the protection of commercial banks, and both are now administered by the FDIC.

As is often the case when previous government control fails to produce the desired result, the response of Congress is to increase the controls. Four entirely new layers of bureaucracy were added to the existing tangled mess: the Resolution Trust Oversight Board, to establish strategies for the RTC; the Resolution Funding Corporation, to raise money to operate the RTC; The Office of Thrift Supervision, to supervise thrift institutions even more than they had been; and the Oversight Board for the Home Loan Banks, the purpose of which remains vague but probably is to make sure that the S&Ls continue to serve the political directive of subsidizing the home industry. When President Bush signed the bill, he said:

This legislation will safeguard and stabilize America’s financial system and put in place permanent reforms so these problems wiU never happen again. Moreover, it says to tens of millions of savings-and-loan depositors, You will not be the victim of others mistakes. We will see — guarantee — that your insured deposits are secure.

The Estimates Are Slightly Wrong

By the middle of the following year, it was clear that the $66 billion funding would be greatly inadequate. Treasury spokesmen were now quoting $130 billion, about twice the original estimate. How much is $130 billion? In 1990, it was 30% more than the salaries of all the schoolteachers in America. It was more than the combined profits of all the Fortune-500 industrial companies. It would send 1.6 million students through the best four-year colleges, including room and board. And the figure did not even include the cost of liquidating the huge backlog of thrifts already seized nor the interest that had to be paid on borrowed funds. Within only a few days of the announced increase, the Treasury again revised the figure upward from $130 billion to $150 billion. As Treasury Secretary Nicholas Brady told the press, No one should assume that the estimates won’t change. They will.

Indeed, the estimates continued to change with each passing week. The government had sold or merged 223 insolvent thrifts during 1988 and had given grossly inadequate estimates of the cost. Financiers such as Ronald Perelman and the Texas investment partnership called Temple-Inland, Inc., picked up many of these at fantastic bargains, especially considering that they were given cash subsidies and tax advantages to sweeten the deal. At the time, Danny Wall, who was then Chairman of the Federal Home Loan Bank Board, announced that these deals took care of the worst thrift problems. He said the cost of the bailout was $39 billion. The Wall Street Journal replied:

Wrong again. The new study, a compilation of audits prepared by the Federal Deposit Insurance Corporation, indicates that the total cost of the so-called Class of ‘88 will be $90 billion to $95 billion, including tax benefits granted the buyers and a huge amount of interest on government debt to help finance this assistance …

But the 1988 thrift rescues’ most expensive flaw doesn’t appear to be the enrichment of tycoons. Rather it’s that none of the deals ended or even limited the government’s exposure to mismanagement by the new owners, hidden losses on real estate in the past, or the vicissitudes of the real-estate markets in the future … And some of the deals appear to be sham transactions, in which failing thrifts were sold to failing thrifts, which are failing all over again …

Although the thrifts proved to be in far worse shape than the Bank Board estimated, Mr. Wall defends his strategy for rescuing them with open-ended assistance. We didn’t have the money to liquidate, he says.

When Congress passed FIRREA the previous year to safeguard and stabilize America’s financial system, the staggering sum of $300 billion dollars was authorized to be taken from taxes and inflation over the following thirty years to do the job. Now, Federal Reserve Chairman Alan Greenspan was saying that the true long-term cost would stand at $500 billion, an amount even greater than the default of loans to all the Third-World countries combined. The figure was still too low. A non-biased private study released by Veribank, Inc. showed that, when all the hidden costs are included, the bill presented to the American people will be about $532 billion. The problems that President Bush promised would never happen again were happening again.

Bookkeeping Sleight of Hand

Long before this point, the real estate market had begun to contract, and many mortgages exceeded the actual price for which the property could be sold. Furthermore, market interest rates had risen far above the rates that were locked into most of the S&L loans, and that decreased the value of those mortgages. The true value of a $50,000 mortgage that is paying 7% interest is only half of a $50,000 mortgage that is earning 14%. So the protectors of the public devised a scheme whereby the S&Ls were allowed to value their assets according to the original loan value rather than their true market value. That helped, but much more was still needed.

The next step was to create bookkeeping assets out of thin air. This was accomplished by authorizing the S&Ls to place a monetary value on community good will! With the mere stroke of a pen, the referees created $2.5 billion in such assets, and the players continued the game.

Then the FSLIC began to issue certificates of net worth, which vvere basically promises to bail out the ailing S&Ls should they need it. The government had already promised to do that but, by printing it on pieces of paper and calling them certificates of net worth, the S&Ls were allowed to count them as assets on their books. Such promises are assets but, since the thrifts would be obligated to pay back any money it received in a bailout, those pay-back obligations should also have been put on the books as liabilities. The net position would not change. The only way they could count the certificates as assets without adding the offsetting liabilities would be for the bailout promises to be outright gifts with no obligation to ever repay. That may be the eventual result, but it is not the way the plan was set up. In any event, the thrifts were told they could count these pieces of paper as capital, the same as if the owners had put up their own cash. And the game continued.

The moment of truth arrives when the S&Ls have to liquidate some of their holdings, such as in the sale of their mortgages or foreclosed homes to other S&Ls, commercial banks, or private parries. That is when the inflated bookkeeping value is converted into the true market value, and the difference has to be entered into the ledger as a loss. But not in the never-never land of socialism where government is the great protector. Dennis Turner explains:

The FSUC permits the S&L which sold the mortgage to take the loss over a 40-year period. Most companies selling an asset at a loss must take the loss immediately: only S&Ls can engage in this patent fraud. Two failing S&Ls could conceivably sell their lowest-yielding mortgages to one another, and both wouJd raise their net worth! This dishonest accounting in the banking system is approved by the higfiest regulatory authorities.

U.S. News & World Report continues the commentary:

Today, scores of savings-and-loan associations, kept alive mainly by accounting gimrrucks, continue to post big losses … Only a fraction of the industry’s aggregate net worth comprises hard assets such as mortgage notes. Intangible assets, which include bookkeeping entries such as good will, make up nearly all of the industry’s estimated net Worth of 37.6 billion dollars.

Accounting Gimmicks Are Not Fraud

We must keep in mind that a well managed institution would never assume these kinds of risks or resort to fraudulent accounting if it wanted to stay in business for the long haul. But with Washington setting guidelines and standing by to make up losses, a manager would be fired if he didn’t take advantage of the opportunity. After all, Congress specifically said it was OK when it passed the laws. These were loopholes deliberately put there to be used. Dr. Edward Kane explains:

Deception itself doesn’t constitute illegal fraud when it’s authorized by an accounting system such as the Generally Accepted Accounting Principles (GAAP) system which allows institutions to forego recording assets at their true worth, maintaining them instead at their inflated value. The regulatory accounting principles system in 1982 added even new options to overstate capital … Intense speculation, such as we observed in these firms, is not necessarily bad management at all. In most of these cases, it was clever management. There were clever gambles that exploited, not depositors or savers, but taxpayers.

The press has greatly exaggerated the role of illegal fraud in these matters with much time spent excoriating the likes of Donald Dixon at Vernon S&L and Charles Keating at Lincoln Savings. True, these flops cost the taxpayer well over $3 billion dollars, but all the illegal fraud put together amounts to only about one-half of one percent of the total losses so far. Focusing on that minuscule component serves only to distract from the fact that the real problem is government regulation itself.

Junk Bonds Are Not Junk

Another part of the distraction has been to make it appear that the thrifts got into trouble because they were heavily invested in junk bonds.

Wait a minute! What are junk bonds, anyway? This may come as a surprise, but those held by the S&Ls were anything but junk. In fact, in terms of risk-return ratios, most of them were superior-grade investments to bonds from the Fortune-500 companies.

So-called junk bonds are merely those that are offered by smaller companies which are not large enough to be counted among the ation’s giants. The large reinvestors, such as managers of mutual funds and retirement funds, prefer to stay with well-known names like General Motors and IBM. They need to invest truly huge blocks of money every day, and the smaller companies just don’t have enough to offer to satisfy their needs. Consequently, many stocks and bonds from smaller companies are not traded in the New York Stock Exchange. They are traded in smaller exchanges or directly between brokers in what is called over the counter. Because they do not have the advantage of being traded in the larger markets, they have to pay a higher interest rate to attract investors, and for that reason, they are commonly called high-yield bonds.

Bonds offered by these companies are derided by some brokers as not being investment grade, yet, many of them are excellent performers. In fact, they have become an important part of the American economy because they are the backbone of new industry. The most successful companies of the future will be found among their ranks. During the last decade, while the Fortune-500 companies were shrinking and eliminating 3.6 million jobs, this segment of new industry has been growing and has created 18 million new jobs.

Not all new companies are good investments — the same is true of older companies — but the small-company sector generally provides more jobs, has greater profit margins, and pays more dividends than the so-called investment-grade companies. From 1981 to 1991, the average return on ten-year Treasury bills was 10.4 percent; the Dow Jones Industrial Average was 12.9 percent; and the average return on so-called junk bonds was 14.1 percent. Because of this higher yield, they attracted more than $180 billion from savvy investors, some of whom were S&Ls. It was basically a new market which was orchestrated by an upstart, Michael Milken, at the California-based Drexel Burnham Lambert brokerage house.

Capital Growth Without Bank Loans or Inflation

One of the major concerns at Jekyll Island in 1910 was the trend to obtain business-growth capital from sources other than bank loans. Here, seventy years later, the same trend was developing again in a slightly different form. Capital, especially for small companies, was now corning from bonds which Drexel had found a way to mass market. In fact, Drexel was even able to use those bonds to engineer corporate takeovers, an activity that previously had been reserved for the mega-investment houses. By 1986, Drexel had become the most profitable investment bank in the country.

Here was $180 billion that no longer was being channeled through Wall Street. Here was $180 billion that was coming from people’s savings instead of being created out of nothing by the banks. In other words, here was growth built upon real investment, not inflation. Certain people were not happy about it.

Glenn Yago, Director of the Economic Research Bureau and Associate Professor of Management at the State University of New York at Stony Brook, explains the problem:

It was not until high yield securities were applied to restructuring through deconglomeration and takeovers that hostilities against the junk bond market broke out … The high yield market grew at the expense of bank debt, and high yield companies grew at the expense of the hegemony of many established firms. As Peter Passell noted in The New York Times, the impact was first felt on Wall Street, where sharp elbows and a working knowledge of computer spreadsheets suddenly counted more than a nose for dry sherry or membership in Skull and Bones.

The first line of attack on this new market of high-yield bonds was to call them junk. The word itself was powerful. The financial media picked it up and many investors were frightened away.

The next step was for compliant politicians to pass a law requiring S&Ls to get rid of their junk, supposedly to protect the public. That this was a hoax is evident by the fact that only 5% ever held any of these bonds, and their holdings represented only 1.2% of the total S&Ls assets. Furthermore, the bonds were performing satisfactorily and were a source of much needed revenue. Nevertheless, The Financial Institutions Reform and Recovery Act, which was discussed previously, was passed in 1989. It forced S&Ls to liquidate at once their junk bond holdings. That caused their prices to plummet, and the thrifts were even further weakened as jL>y took a loss on the sale. Jane Ingraham comments:

Overnight, profitable S&Ls were turned into government-owned basket cases in the hands of the Resolution Trust Corporation (RTC). to add to the disaster, the RTC itself, which became the country’s largest owner of junk bonds … flooded the market again with $1.6 billion of its holdings at the market’s bottom in 1990 …

So it was government itself that crashed the junk bond market, not Michael Milken, although the jailed Milken and other former officials of Drexel Burnham Lambert have just agreed to a $1.3 billion settlement of the hundreds of lawsuits brought against them by government regulators, aggrieved investors, and others demanding justice.

Incidentally, these bonds have since recovered and, had the S&Ls been allowed to keep them, they would be in better financial condition today. And so would be the RTC.

With the California upstarts out of the way, it was a simple matter to buy up the detested bonds at bargain prices and to bring control of the new market back to Wall Street. The New York firm of Salomon Brothers, for example, one of Drexel’s most severe critics during the 1980s, is now a leading trader in the market Drexel created.

Real Problem Is Government Regulation

So the real problem within the savings-and-loan industry is government regulation which has insulated it from the free market and encouraged it to embark upon unsound business practices. As the Wall Street Journal stated on March 10,1992:

If you’re going to wreck a business the size of the U.S. Thrift industry, you need a lot more power than Michael Milken ever had. You need the power of national political authority, the kind of power possessed only by regulators and Congress. Whatever hold Milken or junk bonds may have had on the S&Ls, it was nothing compared with the interventions of Congress.

At the time this book went to press, the number of S&Ls that operated during the 1980s had dropped to less than half. As failures, mergers, and conversion into banks continue, the number will decline further. Those that remain fall into two groups: those that have been taken over by the RTC and those that have not Most of those that remain under private control — and that is a relative term in view of the regulations they endure — are slowly returning to a healthy state as a result of improved profitability, asset quality, and capitalization. The RTC-run organizations, on the other hand, continue to hemorrhage due to failure by Congress to provide funding to close them down and pay them off. Losses from this group are adding $6 billion per year to the ultimate cost of bailout. President Clinton was asking Congress for an additional $45 billion and hinting that this should be the last bailout — but no promises. The game continues.

Congress Is Paralyzed, with Good Reason

Congress seems disinterested and paralyzed with inaction. One would normally expect dozens of politicians to be calling for a large-scale investigation of the ongoing disaster, but there is hardly a peep. The reason becomes obvious when one realizes that savings-and-loan associations, banks, and other federally regulated institutions are heavy contributors to the election campaigns of those who write the regulatory laws. A thorough, public investigation would undoubtedly turn up some cozy relationships that the legislators would just as soon keep confidential.

The second reason is that any honest inquiry would soon reveal the shocking truth that Congress itself is the primary cause of the problem. By following the socialist path and presuming to protect or benefit their constituency, they have suspended and violated the natural laws that drive a free-market economy. In so doing, they created a Frankenstein monster they could not control The more they tried to tame the thing, the more destructive it became. As economist Hans Sennholz has observed:

The real cause of the disaster is the very financial structure that was fashioned by legislators and guided by regulators; they together created a cartel that, like all other monopolistic concoctions, is playing mischief with its victims.

A Cartel Within a Cartel

Sennholz has chosen exactly the right word: cartel. The savings-and-loan industry, is really a cartel within a cartel. It could not function without Congress standing by to push unlimited amounts of money into it. And Congress could not do that without the banking cartel called the Federal Reserve System standing by as the lender of last resort to create money out of nothing for Congress to borrow. This comfortable arrangement between political scientists and monetary scientists permits Congress to vote for any scheme it wants, regardless of the cost. If politicians tried to raise that money through taxes, they would be thrown out of office. But being able to borrow it from the Federal Reserve System upon demand, allows them to collect it through the hidden mechanism of inflation, and not one voter in a hundred will complain.

The thrifts have become the illegitimate half-breed children of the Creature. And that is why the savings-and-loan story is included in this study.

If America is to survive as a free nation, her citizens must become far more politically educated than they are at present. As a people, we must learn not to reach for every political carrot dangled in front of us. As desirable as it may be for everyone to afford a home, we must understand that government programs pretending to make that possible actually wreak havoc with our system and bring about just the opposite of what they promise. After 60 years of subsidizing and regulating the housing industry, how many young people today can afford a home? Tinkering with the laws of supply and demand, plus the hidden tax called inflation to pay for the tinkering, has driven prices beyond the reach of many and has wiped out the down payments of others. Without such costs, common people would have much more money and purchasing power than they do today, and homes would be well within their reach.


Our present-day problems within the savings-and-loan industry can be traced back to the Great Depression of the 1930s. Americans were becoming impressed by the theories of socialism and soon embraced the concept that it was proper for government to provide benefits for its citizens and to protect them against economic hardship.

Under the Hoover and Roosevelt administrations, new government agencies were established which purported to protect depos-lts in the S&Ls and to subsidize home mortgages for the middle class. These measures distorted the laws of supply and demand and, from that point forward, the housing industry was moved out of the free market and into the political arena.

Once the pattern of government intervention had been established, there began a long, unbroken series of federal rules and regulations that were the source of windfall profits for managers, appraiser, brokers, developers, and builders. They also weakened the industry by encouraging unsound business practices and high-risk investments.

When these ventures failed, and when the value of real estate began to drop, many S&Ls became insolvent. The federal insurance fund was soon depleted, and the government was confronted with its own promise to bail out these companies but not having any money to do so.

The response of the regulators was to create accounting gimmicks whereby insolvent thrifts could be made to appear solvent and, thus, continue in business. This postponed the inevitable and made matters considerably worse. The failed S&Ls continued to lose billions of dollars each month and added greatly to the ultimate cost of bailout, all of which would eventually have to be paid by the common man out of taxes and inflation. The ultimate cost is estimated at over one trillion dollars.

Congress appears to be unable to act and is strangely silent. This is understandable. Many representatives and senators are the beneficiaries of generous donations from the S&Ls. But perhaps the main reason is that Congress, itself, is the main culprit in this crime. In either case, the politicians would like to talk about something else.

In the larger view, the S&L industry is a cartel within a cartel. The fiasco could never have happened without the cartel called the Federal Reserve System standing by to create the vast amounts of bailout money pledged by Congress.