Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, October 17, 1993 TAG: 9310150028
SECTION: BUSINESS PAGE: F-1 EDITION: METRO
SOURCE: Mag Poff
DATELINE: LENGTH: Long
At least that's the warning from authors of a study written for the Hoover Institution, a public policy think tank at Stanford University.
The reason, according to authors Kenneth E. Scott and Barry R. Weingast, is that the root cause of the thrift crisis still is hanging over our heads.
The cause, they contend, is us - our public apathy that allows Congress to respond to vocal pressure groups rather than find solutions that lack a constituency.
Like many analysts, the authors believe that deposit insurance - like any other type of insurance - changes behavior.
Depositors, from the individual with a few hundred dollars in the bank to large corporate customers, no longer have reason to pay attention to the financial condition of the banks and thrifts with which they do business.
Government-subsidized insurance removes the threat of a run on the bank, the authors said, a factor that has tempered the behavior of the bank itself.
Because of the insurance, stockholders of an institution squeezed by the economy have support for assuming high risk in trying to overcome the problems.
Since the 1930s, the authors said, "We start with badly designed systems." Banks and thrifts operate with "high levels of unnecessary risk."
Banks are barred from the protection of diversifying their business, both in products and in geography. Regulation and supervision also are inadequate, the study says.
Then, on top of those factors, came the shock of soaring interest and inflation rates of 1979-81 "that put tremendous stress on the system's already flawed structure," the authors said. Long-term Treasuries earned 15 percent and the prime rate shot up to 22 percent, while people paid 18 percent for 30-year mortgages. But most mortgages on the books of thrifts still returned about 9 percent.
"The savings and loan industry, then, was wiped out by the effects of interest rate escalation" because thrifts never were as well capitalized as banks.
Although the entire industry was in fact rendered insolvent, the authors continued, failed thrifts remained open for an average of three more years. During this time, they either passively hoped for better times or actively sought to recover by taking high risks, such as lending money for projects with a possibility of failure.
Enter the political side of the equation. Here's how the authors view it:
In September 1985, the bailout problem was estimated at $15 billion. Regulators approached Congress for that amount.
How did the insolvent thrifts remain in business for years, falling into a downward spiral and taking risks in threatened real estate? How did the problem grow to $240 billion?
"We contend that politics allowed it to grow."
Legislation two years later was too little too late because the problem was out of control.
There were several reasons for this outcome, the study says.
Congress delayed because many agencies cry "wolf." That's something Washington officials hear regularly.
And the year, 1985, was one of austerity - deficits were mounting and Congress was decrying the loss of critical programs.
But the main piece of the puzzle, the study says, was political constituencies.
The authors said the nature of a problem is irrelevant if the public views it differently. This encourages elected officials to ignore the objective facts in favor of what constituents believe.
Who would not spend $15 billion to avoid spending $240 billion, the study asks? But the public did not see the problem and was silent.
Depositors were indifferent because their money was insured.
Weak thrifts were vocal in trying to avoid being closed. Strong thrifts didn't want to be taxed to bail out the weak ones.
Then-President Reagan wanted to avoid blame and did nothing. "Members of Congress, even if they were willing to go beyond the interests of their regulated constituents, could not reap much credit for doing something," the Hoover study says.
Congress ultimately bailed out the savings and loan industry. But where does that leave us?
"Despite the most costly financial debacle of the century, unique among developed countries, Congress has been unable to restructure and reform the nation's larger banking system.
"The absence of structural reform leaves us with an unnecessarily weak set of depository institutions, vulnerable to a repeat performance," the study contends.
"As long as no one blames Congress for this failure, however, it can avoid facing hard questions, merely providing incremental legislation on a last-minute bailout."
Thus, they said, "One of the worse financial disasters to befall a major nation could well repeat itself."
The authors' broad program for reform proposes:
Removing the needless weakness in our financial institutions created by legal barriers to branching and diversification of assets.
Removing the perverse incentives to take risks created for bank management by insurance.
Providing sufficient funds for a policy of mandatory and prompt resolution of insolvent banks and thrifts.
Saying it could happen again to banks and thrifts, pension funds and the like, the authors lay the problem at our door.
"This unfortunate possibility is due to general public ignorance of the political and economic forces bearing on a given industry.
"That ignorance, in turn, allows elected officials to devise programs that benefit certain constituents while hiding some of the costs in the form of future liabilities.
"Of course, the general taxpayer may well have to pay for the liabilities" if they ultimately come about.
Mag Poff covers banking, personal finance, insurance and advertising for the Roanoke Times & World-News.
by CNB