FEATURE ARTICLE Partners in Crime: JCalifornia's Role in the $335 Billion Savings and Loan Heist by Carl K. Oshiro*

Introduction Proponents of the dual system main- which would have given state-chartered tained that it allowed for experimenta- institutions the power to offer adjustable Since 1985, over 700 savings and tion and innovation in the S&L industry. rate mortgages. Through 1982, the loan institutions have failed in the Unit- However, the dual system also enabled Financial Code set strict limits on the ed States. An additional 300 to 800 the industry to weaken government types and amount of investments state- S&Ls are expected to fail in the years supervision by encouraging competition chartered S&Ls could make. ahead. Recently, the General Accounting among regulators. The S&L crisis took The S&L industry found the federal Office revised its estimate of the cost of root in California precisely because of government to be more receptive. In the S&L disaster to $335 billion.' This is such competition. Concerned about the 1982, the U. S. Supreme Court held that more than $1,000 for each man, woman, large-scale conversion of state S&Ls to federally-chartered institutions were and child in the country. federal charters in the early 1980s, state exempt from the Wellenkamp decision The California legislature, California officials sought to entice them back by In 1981, the FHLBB authorized all fed- savings and loan industry, and state reg- repealing statutory restrictions and erally-chartered S&Ls to offer adjustable ulators bear a major responsibility for weakening the state's ability to supervise rate mortgages.' The Garn-St. Germain this massive calamity. To attract more these institutions. Depository Institutions Act of 1982 state-chartered S&Ls, they dismantled expanded the powers available to federal state laws which regulated the conduct The Race to the Bottom thrifts."' Under the Act, federal S&Ls of these institutions and opened the way Both state and federal S&Ls came were allowed to make commercial loans for widespread fraud and mismanage- under extreme pressure in the late 1970s and restrictions on real estate invest- ment. This article describes how the and early 1980s. Deregulation of interest ments were eliminated. State of California recklessly gambled rates paid on consumer deposits caused The advantages of a federal charter on deregulation, how that policy failed, the cost of funds to increase sharply for were immediately obvious to most S&Ls and why the actions of state officials are S&Ls. Instead of paying the historic in California. Many converted from state now costing federal taxpayers billions of passbook rates of 3-5%, they were pay- to federal charters, with devastating dollars. ing 10-12% to stay competitive with results on the DSL. During the 198 1-82 The Dual System money market mutual funds.' At the fiscal year, 50 of the 93 institutions regu- same time. S&L portfolios consisted of lated by the Department either converted Since the 1930s, the savings and loan thirty-year mortgages, fixed at rates of 6- to or merged with federal institutions, industry has been subject to a dual sys- 10%. The result was that the S&Ls were resulting in the loss of 68% of the assess- tem of regulation. Under this system, awash in red ink.' ment funds used to run the Department." S&Ls may be chartered as either a state S&Ls sought several ways out of this The flight of state-chartered institu- or federal institution. In California, dilemma. First, they attempted to reduce tions was so serious that the Depart- state-chartered S&Ls are authorized by ment's survival as an independent agen- 2 the amount of fixed-rate mortgages in the Savings Association Law and are their portfolios by enforcing "due on cy was threatened. In 1982, the regulated by the California Department sale" clauses. Enforcement of these Legislative Analyst recommended that of Savings and Loan (DSL). Virtually clauses in loan agreements prevented the Department of Savings and Loan be2 the entire budget for the Department is buyers from assuming the low, fixed-rate merged with Department of Banking. collected through an annual assessment mortgages from sellers. Second, S&Ls While DSL was able to fend off such a levied on state-chartered institutions. requested authority to offer adjustable merger, its staffing continued to Until 1989, federally-chartered S&Ls rate mortgages (ARMs) to reduce the decrease. According to former Savings were regulated by the Federal Home risk of higher interest rates. Unlike and Loan Commissioner William Craw- Loan Bank Board (FHLBB). Federally- fixed-rate mortgages, the rates for ford, "In 1983 the Department hit bot- chartered institutions were also members ARMs would rise and fall with the level tom with 42 employees on duty [down of the Federal Savings and Loan Insur- of interest rates paid by financial institu- from 175 employees in 1977] and most ance Corporation (FSLIC), which guar- tions. Third, S&Ls sought authority to of its reporting and monitoring system anteed consumer deposits. State-char- diversify their investments. Instead of dismantled."'" tered S&Ls could also join the FSLIC. investing exclusively in home mort- AB 3539. In 1982, AB 3539 (Nolan) Under California law, all state-chartered gages, S&Ls wanted permission to was introduced to stop the conversion of S&Ls were required to be insured by the invest in a wide range of ventures, some state institutions and woo them back FSLIC before they could accept of which would pay high returns. from federal charters by eliminating deposits.' S&Ls met with little success at the many of the restrictions on the types and state level. In 1978, the California amounts of investments for state-char- Supreme Court held in Wellenkamp v. tered S&Ls. Most significantly, AB 3539 7 *The author is the Northern Califor- Bank of America that due on sale claus- allowed S&Ls to invest as much as es were "unconscionable," and therefore 100% of their assets in service corpora- nia Supervising Attorney of the Center could not be enforced. In 1980, Gover- tion subsidiaries, which, in turn, could Jor Public Interest Law. nor Brown vetoed SB 1937 (Foran), invest in virtually any activity. The bill

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also allowed state-chartered S&Ls to association while creating jobs and -repealed the requirement that at least directly invest in real estate projects. increasing the housing stock in Califor- two-thirds of the board of directors of a Its author, Assemblymember Pat nia. state-chartered association be California Nolan (R-Glendale), cited three reasons -It would be in the public interest to residents; for the legislation. First, he claimed it maintain the state-chartered system as an -allowed an association, with the con- would "eliminate artificial and archaic attractive environment for savings and sent of the Savings and Loan Commis- limitations on the authorized investment loans within which to operate, allowing sioner, to conduct business outside of portfolio of state-chartered S&L associa- the state to play a meaningful role in the California; tions and provide them with the authori- supervision of this important industry.'7 -eliminated restrictions on the types ty to fully utilize their statutory invest- There was only token opposition to of loans state-chartered S&Ls could ment and loan powers." Second, he the measure. Initially, AB 3539 was make on nonresidential real estate; contended that "AB 3539 does not take opposed by the California Bankers Asso- -allowed state-chartered S&Ls to bor- S&Ls away from their primary obliga- ciation, which objected to the elimina- row funds from any source without limi- tion to housing finance. It will guarantee tion of the 20% maximum limit on con- tation and use any of their own assets to that S&Ls will be able to stay in the sumer loans and commercial paper guarantee their debts; and housing market by providing them with because it would place commercial -allowed state S&Ls to organize as 23 the tools to stay afloat during these tur- banks at a "competitive disadvantage.' savings banks. bulent times." Third, by benefiting only Bank of America, Crocker National According to the analysis prepared by state-chartered S&Ls, AB 3539 "may Bank, and Wells Fargo Bank also the Assembly Finance and Insurance persuade those associations which are opposed the lifting of the investment Committee, the purpose of AB 1434 was considering converting to federal char- restriction on service corporations, fear- to "allow savings associations to effec- ters to retain their state-chartered ing that S&Ls could use such corpora- tively compete with federal associa- status."'" tions" and "permit management greater tions to compete for consumer and com- ' 4 AB 3539 was sponsored by the mercial lending.'" However, CBA and use of business judgment. The analy- California Savings and Loan League the individual banks withdrew their sis described AB 1434 as providing (now called the California League of opposition before the bill reached the "savings associations with an exceeding- Savings Institutions) and supported by Governor's desk. ly flexible framework within which to five S&Ls, including Mt. Whitney Sav- With strong support from the S&L operate and should certainly accomplish ings & Loan (Exeter), Seaside Savings industry, vigorous endorsement by state the objectives of the industry and regula- & Loan (Mission Viejo), State Savings regulators, and only mild opposition tors." Despite opposition from banks & Loan (Stockton), Lincoln Savings & from banks, AB 3539 sailed (which opposed the savings bank provi- Loan (Monterey Park), and Sun Savings through the Senate by a vote of 22-1, sion), AB 1434 passed 38-0 in the Sen- & Loan (San Diego).' The League through the Assembly 67-1, and was signed by the ate, 77-0 in the Assembly, and was claimed that the existing statutory ceil- - Governor.2" signed by the Governor."7 ings on investments were outmoded and Throughout this period, the focus of that S&Ls "needed versatility" in their AB 2574. Following the enactment of AB 3539, the state legislature passed AB state and federal policymakers was on investment powers in order to survive.' giving S&L managers 2574 (Sebastiani). The bill "cleaned up" greater leeway in A strong supporter of AB 3539 was running their institutions. Policymakers AB 3539 and eliminated the requirement the outgoing California Savings and spoke of "flexibility," "deregulation," that the Department of Savings and Loan Loan Commissioner Linda Tsao Yang. "business judgment," "entrepreneur- conduct She advised the Governor that the fol- biennial solvency examinations ship," and "higher earnings." No one of lowing benefits would result from the state-chartered savings and loan asso- spoke of "risk," "losses," "abuse," or legislation: ciations. "fraud," or what these might do to the -The elimination of restrictions on the AB 2574 was sponsored by the Cali- public at large. authority of savings and loans to make fornia Savings and Loan League and Nor was there much discussion about the types of loans and investments speci- supported by DSL and the Department the need for more auditors, appraisers, fied by this bill would facilitate the use of Finance. The only cautionary word and examiners to supervise S&Ls' use of of business judgment by the manage- came from the Assembly Office of these expanded powers. In 1983, the ment of state-licensed savings and loan Research, which stated: "According to Department of Savings and Loan associations. the Senate Banking and Commerce employed a total of 42 people, far less -Savings and loan associations need Committee, the Senate amendments sig- than was needed to oversee the rapid to have the flexibility to structure invest- nificantly alter the restrictions on the expansion in the California S&L indus- ment portfolios which in the judgment of investments savings and loan associa- try. their investment advisors will bring the tions can make. These, combined with State Applications Soar. The induce- highest rate of return within the confines the relaxed examination requirement, ments worked. In 1983 and 1984, DSL of prudent investment practices. The might encourage savings and loan asso- received a total of 210 new applications removal of arbitrary percentage of assets ciations to make investments that could, for state-chartered institutions in Califor- limitations may allow savings and loan in times of economic hardship, threaten nia.2 The new S&L Commissioner, associations to obtain a greater return on the solvency of the associations."-' Lawrence Taggart, welcomed these their investments, thereby making more The bill passed 37-0 in the Senate and applications. In testimony before the funds available for mortgage lending. 69-0 in the Assembly,2 and was signed by House Government Operations Commit- -Elimination of the percentage of the Governor.- tee in 1989, Taggart stated that he felt assets limitation on real estate owned by AB 1434 (Bane). In 1983, the Califor- that it was his "job...to encourage the a savings and loan association may nia legislature recodified the entire Sav- Nolan Bill [AB 3539]. I even went out prompt an increase of residential con- ings Association Law, incorporating and encouraged people to commit to new struction financed and developed by sav- additional incentives for state-chartered institutions.....27 ings and loan associations, which could institutions. Among other things, AB Many of newly chartered institutions prove to be highly profitable for the 1434: used their expanded powers to invest in

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high-risk projects. A review of the lend- 1982, and fighting any new attempts to graphically local deposit base and ing activities of 29 failed California cut back by reregulation on the expan- were prudently lent within that S&Ls by William Black, General Coun- sive powers afforded by the state. "We same geographic market place, a sel of the Federal Home Loan Bank of have to be alert and concerned about any market place known to the lender. San Francisco, shows that from 1982 to attempts in the future to reregulate the By contrast, Sun generated the 1986 the percentage of home loans made industry," Mr. Martin warned. 6 majority of its deposits as bro- by these institutions declined steadily, kered funds in short-term jumbo Crash and the percentage of direct investment The C.D.s, paying broker's fees for and acquisition, development, and 0land Even as Commissioner Taggart and the initial deposits and premium (ADL) loans increased dramatically. the League were defending the Califor- rates for the privilege of holding Mr. Black's review also shows that nia S&Ls, many were in trouble. From these volatile, short-term funds. by 1985, many of these riskier loans January 1, 1983 (the effective date of Sun then had to place these were in deep trouble. From 1982 to AB 3539) to September 1, 1990, S&L funds at work. As a new and 1984, slow loans"0 and real estate owned regulators took control of 77 insolvent small association, it neither had a by the 29 S&Ls were stable at less than S&Ls in California, all but seven of significant share of the local lend- 5% of their assets. Beginning in 1985, which were state-chartered institutions." ing market, not did it have the these rates shot up as borrowers default- Among the thrifts that failed during this resources to single-handedly ed on their payments and property was period were the five S&Ls that actively underwrite a large volume of foreclosed. By 1986, slow loans and real supported the Nolan Bill. local loans to profitably occupy estate owned represented nearly 25% of Mt. Whitney Savings and Loan. Mt. its brokered deposit base. the assets of these institutions. 0 Whitney Savings and Loan (Exeter) was Despite overall increases in staff, the placed into FSLIC conservatorship in Department of Savings and Loan did not 1986 and finally liquidated in 1988. Sun's need to make loans creat- have the resources to effectively regulate According to the Los Angeles Times, ed a demand for two products: the large number of S&Ls wielding "Mt. Whitney's financial difficulties participation interests primarily extensive new powers. In 1989, James began in 1982, when its previous man- underwritten and serviced by oth- Cirona, President of the Federal Home agement began soliciting high-cost jum- er lenders and loans privately Loan Bank of San Francisco, testified bo certificates of deposit that were brokered to Sun. that even with increased staffing, the invested in lower paying government While there is nothing inherent- ratio of professional staff per billion dol- securities and questionable loans."" Mt. ly wrong with loan participations, lars in assets held by state-chartered Whitney's problems were also attributed a participating lender is often S&Ls fell during this period.' to "losses on poorly underwritten and dependent upon the lead and ser- "lam Pitchingfor You." By 1983, speculative construction loans."" vicing lender for detailed under- federal regulators were growing con- In 1987, the Federal Home Loan writing, experience with the bor- cerned about the expanded powers Bank of San Francisco reported to rower, local appraisers and granted to California S&Ls. To curb the Congress that Mt. Whitney's insolvency knowledge of the local geograph- growth of these institutions, the Federal would result in a loss to the FSLIC of ic market. If this dependence is Home Loan Bank Board imposed a $35 million." It also reported that the misplaced for any reason, the moratorium on federal insurance for FSLIC had filed complaints against fif- results are obvious. California thrifts and began the process teen insiders, seeking recovery of $17 Many of Sun's participations of adopting rules which set limits on million." were good, performing loans. investment authority and raised capital Seaside Savings and Sun Savings & Many were not. Many of Sun's Loan. Seaside Savings merged into Sun and net worth requirements for new participations were with other late 1982. In 1986, federal deposit insur- Savings & Loan in ultimately troubled and now- S&Ls seeking Sun was closed by the FSLIC and liqui- 32 In late 1983, the FHLBB and closed associations, including ance. dated. In testimony before a subcommit- FDIC proposed new rules to limit feder- Eureka Savings and Loan, State tee of the House Government Operations Savings and Loan Association of al insurance for brokered deposits." Committee, David Lundin, outside fee In both instances, Commissioner Tag- Utah, and Hawaii and First Sav- counsel to the Bank Board and FSLIC, ings and Loan Association of gart rallied to the defense of his state- at Sun as fol- described the problems Orland Park, Illinois. chartered thrifts. He criticized the Board lows: Eureka, now closed by regula- for trying to preempt liberal California First, Sun was a new, publicly tors, was operated by the Kidwell laws and said that the Board was traded savings and loan associa- "attacking the wrong thing" with its rule brothers. Its failure has been 34 tion in the newly-deregulated on brokered deposits. At a gathering of marketplace of the 1980s. Much attributed in part to losses arising nearly 100 angry organizers of new of Sun's management can best be from loans to Las Vegas casinos S&Ls in Los Angeles, Commissioner and to William Oldenberg. 5 described as aggressively incom- Taggart said, "I am pitching for you." petent. They did, however, State Savings and Loan was The California League of Savings respond to market pressures to owned and controlled by Mr. Institutions (formerly the California stimulate rapid and profitable Oldenberg. That failure has been Savings and Loan League) was equally growth-at least in the short run. attributed in part by [sic] self- opposed to efforts to curb the expanded Growth in the thrift industry dealing by Mr. Oldenberg, powers. In 1983, Ray Martin, the results from an ability to generate including the sale of parcel of League's newly elected chair, identified deposits and make profitable Bay Area property which he had two major priorities for the year: helping loans. Traditionally in the thrift personally acquired for $800,000 thrifts to develop the new powers given industry deposits were nurtured which was then sold to State for them in the Garn-St. Germain Act of over a period of time from a geo- $55 million. I

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First of Orland Park was closed Lincoln Savings and Loan. Lincoln and greed; we are handling49 much by regulators in late 1986. Sever- Savings & Loan (Monterey Park) was larger sums of money. al among its controlling group acquired in 1984 by American Continen- In 1989, the U.S. General Accounting have been indicted by a Federal tal Corporation. Lincoln was placed in Office reported that in investigating 26 Grand Jury in the Northern Dis- FSLIC receivership in August 1989. failed thrifts (eight of which were in Cal- trict of Illinois. Under the direction of Charles Keating, ifornia), all had changed from traditional Sun also relied upon loan bro- Jr., Lincoln Savings invested heavily in to high-risk activity." GAO also found kers to provide borrowers of the junk bonds and risky real estate projects. evidence of insider abuse and fraud at brokered deposits....[Some] bro- The collapse of Lincoln Savings-the each and every one of these failed insti- kers extract large up-front fees details of which are currently unfolding tutions.' The GAO found that insider for loans promised and never through civil litigation, criminal prose- abuse flourished because of: made. Some facilitate their cutions, and state and federal regulatory -Inadequate supervision by directors clients' frauds by not disclosing enforcement actions-is expected to be of the thrift and dominance by one or adverse credit information or one of the largest S&L failures in U.S. more individuals. even prior criminal convictions history, costing taxpayers as much as $2 -Breach of fiduciary duty to the thrift for bank fraud. Others are more billion. 6 by officers and directors. GAO found overt and may simply bribe bank On September 19, 1990, Mr. Keating that 77% of the S&Ls examined violated officers as needed to obtain loans was indicted on 42 counts of state securi- conflict of interest regulations or and related brokerage fees. ties fraud arising from the sale of $200 engaged in related unsafe practices. A highly disproportionate share million in uninsured bonds to Lincoln -Inadequate underwriting or adminis- of the loans brokered to Sun were customers. 7 The bonds were rendered tration of loans. non-performing loans and result- virtually worthless when American Con- -Noncompliance with loan terms. ed in losses to the Association tinental declared bankruptcy and Lincoln -Excessive compensation and expen- and ultimately to the FSLIC. Savings was seized by federal regula- ditures. Among these loans were ones to tors. -Extensive and imprudent participa- Morris Shenker and the Dunes The Best Way to Rob a Bank is to tion in acquisition, development, and Hotel and Casino, where Sun's Own a Bank. The new powers granted construction transactions, often with President and CEO claims to to S&Ls and lack of effective supervi- related parties. GAO cited one Califor- have won much of his $200,000 sion by state regulators opened the way nia thrift that lent $40 million to one bor- which was deposited to the secret for fraud and abuse by S&L managers. rower principally to build condominiums account. In 1987, the new Savings and Loan and a shopping center. No feasibility These participations and bro- Commissioner, William J. Crawford, studies were done. Examiners stated that kered loans were a major con- reported to the House Subcommittee on studies would have shown that the area tributing cause to Sun's failure. It Commerce, Consumer, and Monetary was already heavily overbuilt before the is currently estimated that this Affairs that over the previous two and loans were ever made. The thrift was failure alone will cost the FSLIC one-half years, he had been forced to expected to lose over $10 million on the approximately $114 million dol- project. 42 close thirty state-chartered, federally lars. insured S&Ls; and that in almost every -Loans to borrowers exceeding legal In 1989, Sun's President Daniel Dier- closure, insider misconduct played a sig- limits. Examiners found that 88% of the dorff was convicted of two felony counts nificant or even a determining role." In failed thrifts violated a federal regulation of misuse of the institution's funds and testimony before the subcommittee, limiting the amount of money thrifts can sentenced to eight years in prison." Commissioner Crawford stated: lend to a single borrower. State Savings and Loan (American The controls, historically, were -Sloppy and intentionally deceptive Savings and Loan). In 1983, State Sav- set out to protect the cash and recordkeeping. ings and Loan (Stockton) merged with GAO found that because of the dual securities in a financial institu- First Charter Financial Corporation to regulatory system, federal officials were tion. They always wanted to pro- uncertain about their authority to curb form American Savings and Loan, the tect against the officers stealing largest S&L in the country."4 Under the the use of expanded powers granted to the cash, and the tellers stealing direction of Charles Knapp, American state-chartered S&Ls. The GAO report the cash; somebody Savings became one of most aggressive converting states: institutions in the use of its expanded securities, bearer securities to Bank Board officials also told powers. The Los Angeles Times report- their personal use. We build thick us that before 1985 they viewed vaults; we have cameras; we have ed: "Fueled by high-rate deposits from their authority to issue regula- Wall Street 'money brokers,' Knapp time clocks on the vaults; we tions to restrain state-chartered financed real estate ventures and securi- have dual control-all these con- thrifts from engaging in high-risk ties purchases. In 1984, he was ousted by trols to protect against somebody activities as "questionable." The regulators after the Securities and stealing the cash. officials said that Bank Board Exchange Commission forced FCA Well, you can steal far more officials at that time were hesitant [American's parent] to restate its earn- money, and take it out the back to act in certain instances, espe- door. The best way to rob a bank ings to show a huge loss, which14 trig- cially where state law gave thrifts gered a $7-billion run on deposits." is to own one. If you have 100 specific powers which federal Knapp's successor, William Popejoy, percent control, you can make laws did not address. was unable to turn American Savings yourself the chairman of the audit Twenty of the 26 failed institu- around and, in 1988, it was sold to committee, the chairman of all tions reviewed were state-char- Robert Bass. The deal included $1.7 bil- committees ....The system of tered. While the Bank Board lim- lion in federal subsidies to entice the internal control doesn't work. ited federally chartered thrifts Texas billionaire to take over the insol- We've gone upscale where we from making certain "direct vent institution. have got temptation, opportunity, investments" (such as equity

The California Regulatory Law Reporter Vol. 10, No. 4 (Fall 1990) FEATURE ARTICLE

securities, real estate, service cor- 54 percent of all of the losses in -restricts nonresidential real estate porations, and operating sub- the national system went to pay loans to 400% of a S&L's capital;' sidiaries, etc.), state-chartered for losses incurred by State-char- -restricts transactions between affili- thrifts often were authorized to tered thrifts in just two states, the ated entities and prohibits below-market make such direct investments States of California and Texas rate loans to S&L insiders;65 under state law. Moreover, alone. And that figure grew in -prohibits the use of brokered FSLIC did not have regulations 1988. Fully 70 percent of all of deposits by S&Ls failing to meet the which placed limitations on the the payouts from the insurance new capital requirements; ' type and amount of direct invest- fund went to cover losses by -protects S&L employees who report ments insured thrifts could State-chartered thrifts in those violations to federal regulators;67 and make.52 same two States, Texas and Cali- -establishes new civil and criminal As federal officials questioned their fornia. penalties for fraud and abuse." legal authority over state-chartered FIRREA put a stop to those In addition, FIRREA establishes a S&Ls, the unsupervised use of the abuses. The statute generally stringent new test to ensure that S&Ls expanded powers led to even more loss- restricted State thrifts to activities maintain a strong commitment to resi- es for the FSLIC. In February 1989, the permissible for Federal thrifts, dential lending.' Institutions that fail to Office of Management and Budget esti- creating exceptions only for State meet this test may be required to convert mated that the cost of resolving the S&L thrifts that fully satisfy all appli- to commercial banks. Beginning July 1, crisis would cost the federal government cable capital standards and in turn 1991, at least 70% of a S&L's portfolio $158 billion; in September 1990, that can meet a second test, namely to must consist of loans for the purchase, figure was revised to an astounding convince the FDIC that the activ- refinancing, construction, improvement, $335 billion." ity in question poses no signifi- or repair of domestic residential housing cant risk of loss to the deposit and related investments. Effective imme- FIRREA insurance fund." diately, S&Ls that fail this Qualified By 1989, members of Congress were FIRREA significantly expands the Thrift Lender (QTL) test may obtain aware that the dual regulatory system for role of federal regulators in overseeing advances from Federal Home Loan thrifts had contributed to the massive the S&L industry. The FHLBB, which Banks only for the purpose of funding losses to the FSLIC. To stem these loss- was responsible for chartering federal residential housing. Beginning in August es, Congress passed the Financial Insti- S&Ls and overseeing the FSLIC, was 1990, S&Ls which are not QTLs will be tutions Reform, Recovery and Enforce- abolished. FIRREA created a new agen- be forced to limit their activities to those ment Act of 1989 (FIRREA)" The Act cy, the Office of Thrift Supervision permissible to national banks and will no represents a complete rejection of the (OTS), to be the primary regulator of longer be eligible for any new advances dual system of thrift regulation. Recent- both federally-chartered and state-char- from the Federal Home Loan Banks. ly, Senator Don Riegle, Jr., Chair of the tered S&Ls." To replace the FSLIC, the Two years later, S&Ls which are not Senate Banking Committee, described Act established a Savings Association QTLs will be required to divest them- one of FIRREA's chief objectives as fol- Insurance Fund (SAIF), administered by selves of all investments, cease engaging lows: the Federal Deposit Insurance Corpora- in activities not permitted to national [The Act] also placed important tion (FDIC). 7 The FDIC is granted sub- banks, and repay all outstanding new restrictions on State powers. stantial new powers over both state and advances owed to the Federal Home Prior to FIRREA's enactment, federal institutions to protect the safety Loan Bank system."' It is far too early to know whether State law alone provided the only of the SAIF" these reforms will ultimately result in a limitations on the powers of The Act sets stiffer capital require- State-chartered thrifts.... In sever- healthy S&L industry. As of June 1990, ments for S&Ls." An S&L that fails to al states, those limitations were the S&L industry was showing neither not very substantial. The States meet these requirements must submit a dramatic improvement nor precipitous of Texas and California, in partic- business plan to OTS addressing (1) the decline. As a whole, the industry is still ular, removed virtually all restric- need for increased capital, (2) how such in poor condition. Of the 2,949 S&Ls tions on the investment activities capital is to be acquired, and (3) the operating in the United States at the end of State-chartered thrifts within types of activities in which the S&L of 1988, over 400 were in government their States, all of them neverthe- plans to engage. The plan must be control. Of the S&Ls not in government less connected to the Federal approved by OTS. After January 1, control, about 20% are undercapitalized deposit insurance system. This 1991, OTS is required to restrict the or insolvent, 33% are squeaking by, and permitted California and Texas asset growth of any S&L that fails to less than half are healthy.7' thrifts to raise deposits and invest meet the capital standards.' them in virtually anything, know- To address the abuses prevalent in the ing that the Federal deposit insur- S&L industry, FIRREA also: Conclusion ance system would pick up any -requires that the loan-to-one-bor- The last time the savings and loan loss that might result. Many rower restrictions for national banks industry was in such serious distress was thrifts exploited this opportunity apply to all S&Ls;' in the 1930s. In 1934, Congress enacted to the hilt, raising brokered -prohibits S&Ls from investing in the National Housing Act to restore pub- deposits and investing them in junk bonds and requires that S&Ls lic confidence by creating the FSLIC to such things as racetracks, wind- remove them from portfolios by July I, insure consumer deposits. 72 For deposit mill farms, junk bonds, raw land, 1994; 2 insurance to work, S&L regulators must and other things of that sort. The -prohibits S&Ls from directly invest- be extremely vigilant to prevent, detect, consequences of such abuses for ing in real estate and other ventures, and and immediately halt those practices the Federal deposit insurance sys- restricts investment in service corpora- which pose a threat to an institution's tem were catastrophic....In 1977, tions:6' solvency. Without such vigilance, S&L

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managers will gamble with consumer tinued up to $1,194,660 in the 1985-86 Finance, Insurance, and Commerce deposits. Heads-they win; tails-the period just before the crash.' Committee (May 4, 1982). federal taxpayer loses. FIRREA marks the end of Califor- 15. See Analysis of AB 3539 pre- In the 1980s, deposit insurance nia's reckless policy of deregulation. pared by the Assembly Finance, Insur- encouraged the California legislature Instead of expanding its control over the ance, and Commerce Committee (Apr. and state regulators to gamble with con- S&L industry, state officials ended up 28, 1982) at 3. sumer deposits. Fearing the loss of state- losing all meaningful control to the fed- 16. Statement of Assemblymember chartered institutions to the federal gov- eral government. 4 Instead of strengthen- Nolan regarding AB 3539 before the ernment, state officials bet that ing the S&L industry, the California leg- Assembly Finance, Insurance, and Com- deregulation would win those institu- islature assisted in its destruction. merce Committee (May 4, 1982). tions back to state "control". That gam- Instead of serving the California public, 17. Department of Savings and Loan, ble worked for awhile, but the staggering state officials betrayed their public trust Enrolled Bill Report regarding AB 3539 losses which ensued forced the federal and added billions of dollars to the bur- (June 16, 1982) at 2. The State Banking government to assume control over both den paid by federal taxpayers. Department also supported the measure, state and federally-chartered institutions. stating that the "current investment The California legislature's servile restrictions are not necessary" and "the compliance with the deregulation ambi- FOOTNOTES health of the banking industry should not tions of the industry was not merely the be impacted." State Banking Depart- consequence of Republican deregulation 1. Seidman Totals Costs of S&L ment, Enrolled Bill Report regarding AB ideology. As noted above, the votes were Bailout; Election Year Congress Talks of 3539 (June 16, 1982) at 2. nearly unanimous. The savings and loan New Taxes, Wall St. J., Sept. 20, 1990, at 18. Letter from George R. Cook, Vice industry gave prodigious sums in cam- A-2. President, State Government Relations, paign contributions to California legisla- 2. Financial Code § 5000 et seq. California Bankers Association, to The tors while these measures were consid- 3. Financial Code §§ 8030-38. Honorable Patrick J. Nolan, re Assembly ered, and afterwards. Common Cause 4. Financial Code § 5606. Bill 3539 (Apr. 30, 1982) at 1. The CBA reports that, over the ten-year period of 5. U.S. League of Savings Institu- letter also stated that the elimination of 1979-1989 during which the deregula- tions, Savings Institutions Sourcebook the 10% assets limitation on investment tion steps proceeded, the industry con- (1989) at 24. in real property "bothers us," but did not tributed $4,117,239 to elected state offi- 6. In 1981, on a nationwide basis, the request an amendment of that provision. cials. This California total is over S&L industry suffered a $4.6 billion Id. at 3. Later, the CBA dropped its one-half the total amount in reported after-tax loss, for a negative 15.39% opposition entirely when the bill reached contributions to the entire United States return on equity. Id. at 52, 55. the Governor's desk. Enrolled Bill Congress over the same period. Over 7.21 Cal. 3d 943 (1978). Memorandum on AB 3539 (June 21, one-quarter of the state total came from 8. Fidelity Federal Savings & Loan 1982) at 1. savings and loans subsequently rendered Ass'n v. De La Cuesta, 458 U.S. 141 19. Id. insolvent, including American Savings (1982). 20. Chapter 300, Statutes of 1982. and Loan ($327,342), Columbia Savings 9. FHLBB, Adjustable Mortgage 21. Assembly Office of Research, and Loan ($240,460), Mercury Savings Loan Instruments, 46 Fed. Reg. 24,148 Concurrence in Senate Amendments to and Loan ($189,838), and Lincoln Sav- (Apr. 30, 1981). AB 2574 (Aug. 19, 1982) at 2. ings and Loan ($165,251). 10. 12 U.S.C. §§ 1461-64, repealed 22. Chapter 845, Statutes of 1982. During this ten-year period, Assem- by the Financial Institutions Reform, 23. Assembly Office of Research, blymember Tom Bane, who authored Recovery and Enforcement Act of 1989, Concurrence in Senate Amendments to AB 1434, received $513,000 from the Pub. L. No. 101-73, § 301, 103 Stat. AB 1434 (Sept. 9, 1983) at 2-3. S&L industry-more than twice the sum 277-343 (1989). 24. Analysis of AB 1434 prepared by received by California Senator Pete Wil- 11. Testimony of William J. Craw- the Assembly Finance and Insurance son, the largest recipient of any member ford, California Savings and Loan Com- Committee (Apr. 8, 1983) at 2. of Congress. Between 1981 and 1989, missioner, in Fraud and Abuse by Insid- 25. Chapter 1091, Statutes of 1983. Assembly Speaker Willie Brown ers, Borrowers, and Appraisers in the 26. See Testimony of Lawrence Tag- received $215,740 and Senate President California Thrift Industry: Hearings gart, former California Savings and pro Tempore David Roberti received Before the Subcomm. on Commerce, Loan Commissioner, in 1989 Crisis $214,417 from the industry. In 1986-87, Consumer and Monetary Affairs of the Hearings, supra note 13, at 152. See Governor George Deukmejian, who House Comm. on Government Opera- also Boom Now Underway in California appointed Lawrence Taggart as Director tions, 100th Cong., 1st Sess., 20-21 in Profitable, State-Chartered S&Ls, of the Department of Savings and Loan (June 13, 1987) (hereafter referred to as American Banker (Jan. 6, 1983) at 2. in 1983 and signed all three deregulation "1987 FraudHearings"). 27. Testimony of Lawrence Taggart, bills, received $130,000 from Charles 12. Office of the Legislative Analyst, 1989 Crisis Hearings, supra note 13, at Keating, his family, Lincoln Savings and Analysis of 1982-83 Budget, at 343, 159. He wasn't the only booster of the Loan, and associated entities. 345-46. new laws governing thrifts in California. The total industry contributions to 13. Statement of William J. Craw- The Los Angeles branch of a large law California officials stood at $735,434 in ford, California Savings and Loan Com- firm conducted seminars for persons 1979-80 when federal deregulation missioner, in Savings and Loan Crisis: interested in starting or acquiring a state- began. They shrunk to $480,979 in Field Hearings before the House Comm. chartered S&L, touting the benefits as 1981-82 as savings and loan institutions on Banking, Finance, and Urban Affairs, including: the ability to raise "virtually left state charter for federal deregulation, 101st Cong., Ist Sess., 426 (Jan. 12-13, unlimited amounts of capital," "unparal- and California elected officials became 1989) (hereafter referred to as the "1989 leled leveraging of funds," "flexible and less important. Then the amounts Crisis Hearings"). profitable loan opportunities," and the increased to $651,563 as the three bills 14. Statement of Assemblymember prestige of being a member of the described above were enacted, and con- Nolan regarding AB 3539, Assembly "financial institutions club." James R.

The California Regulatory Law Reporter Vol. 10, No. 4 (Fall 1990) FEATURE ARTICLE

Butler, Chairman, Financial Institutions 38. Regulators Close 2 State Thrifts, 56. 12 U.S.C. § 1462 etseq. Department, Jeffer, Mangels & Butler, Transfer Deposits, Los Angeles Times 57. 12 U.S.C. § 1817. Why Does it Seem Everyone is Buying (Feb. 27, 1988), Business Section at 4. 58. 12 U.S.C. § 1821. or Starting a California S&L? (1984), in 39. Banking Regulators Seized Mt. 59. 12 U.S.C. § 1464(t). 1987 Fraud Hearings, supra note 11, at Whitney Savings, Los Angeles Times 60. 12 U.S.C. § 1464(t)(6). 206-21. (Feb. 13, 1986), Business Section at 2. 61. 12 U.S.C. § 1464(a). 28. Testimony of William Black, 40. See Letter from William Black, 62. 12 U.S.C. § 1831e. General Counsel to the Federal Home General Counsel, Federal Home Loan 63. Id. Loan Bank Board, in 1987 Fraud Hear- Bank of San Francisco, to Honorable 64. 12 U.S.C. § 1464(c)(2)(B). ings, supra note 11, at 163. Loans for Douglas Barnard Jr. (Nov. 2, 1987), 65. 12 U.S.C. § 1468. one- to four-unit residential property fell Exhibit A, in 1987 Fraud Hearings, 66. i2 U.S.C. § 1831f. from over 45% of assets in 1982 to supra note 11, at 476. 67. 12 U.S.C. § 1878. under 30% in 1986. Meanwhile, direct 41. Id., Exhibit C, at 480. 68. 12 U.S.C. § 1818. investment and ADL loans increased 42. Prepared Statement of David E. 69. 12 U.S.C. § 1467a(m)(l). from about 7% of investments in 1982 to Lundin, Attorney, Finley, Kumble, & 70. 12 U.S.C. § 1467a(m)(3). 15% in 1986. Id. at 157-62. Mr. Black's Wagner, San Diego, California, in 1987 71. 136 Cong. Rec. 73 (June I1, review also shows that the percentage of Fraud Hearings, supra note 11, at 382- 1990) (statement of Sen. Riegle, Table direct investment and ADL loans by the 83. A). 29 California institutions was far above 43. S&L Official Pleads Against 72. 48 Stat. 1246 (1934). FSLIC was that of the national average. For exam- Lenient Dierdoiff Sentence, Los Angeles established in section 402 of the Nation- ple, in 1985, the 29 California S&Ls had Times (San Diego County Edition) (Jan. al Housing Act (12 U.S.C. § 1725), and 20% of their assets in those categories, 7, 1989), Metro Section, Part II, at I. See was abolished by FIRREA, Pub. L. No. compared to only 5% for S&Ls nation- also Wanted: "Bank Cops" Packing 101-73, Title VII, § 703(a), Aug. 9, wide. Id. at 160. Accountants' Tools, American Banker 1989, 103 Stat. 415. 29. Mr. Black defined "slow loans" as (Feb. 27, 1989) at 2. 73. For a more complete itemization those which are delinquent for sixty days 44. American Savings Ends Home of official contribution filings by the or more. Id. at 163. Savings' 28-Year Reign as Nation's Top savings and loan industry, see Clearance 30. Id. at 154. S&L: First in Deposits and Assets, Sale of the Decade: The Role of Califor- 3 1. Statement of James Cirona, American Banker (Feb. 28, 1984) at 1. nia Elected Officials in the S&L Scan- President, Federal Home Loan Bank of 45. The Renaissance of American dal, California Common Cause and Pub- San Francisco, 1989 Crisis Hearings, Savings & Loan; Its 1989 Profit is the lic Citizen (October 1990). supra note 13, at 294. Envy of the Industry, But It Took the 74. The California Department of 32. FHLBB, Regulation of Direct Resources of Robert M. Bass, the Lead- Savings and Loan is again an agency on Investment by Insured Institutions, 50 ership of Mario J. Antoci and $1.7 Bil- the decline. With a large number of Fed. Reg. 6,912 (Feb. 19, 1985), codi- lion from Taxpayers to Get There, Los state-chartered institutions either out of fied at 12 C.F.R. Part 563.96, which Angeles Times (Feb. 5, 1990), Business business or under government control, expired on July 13, 1990, pursuant to 12 Section at 1. its assessment base has again dropped C.F.R. Part 563.96(h). FHLBB, Net 46. Lincoln S&L Posts a $163.9 Mil- dramatically. The Department's total Worth of Financial Institutions, 49 Fed. lion Loss, Los Angeles Times (Sept. 28, staff is decreasing. The Legislative Ana- Reg. 47,852 (Dec. 7, 1984); this pro- 1990), Business Section at 2. lyst recently recommended that (1) the posed regulatory change was never for- 47. Keating Indicted for Fraud, legislature terminate the chartering pro- mally adopted. Jailed: Three Associates at Lincoln Also visions under the Savings Association 33. FDIC and FHLBB, Brokered Are Charged. A Grand Jury Says They Law, (2) existing state-chartered S&Ls Deposits: Limitations on Deposit Insur- Victimized Investors in the Sale of $200 be required to convert to federal charters ance, 48 Fed. Reg. 50,339 (Nov. 1, Million in Bonds, Los Angeles Times over time, and (3) in the interim, DSL be 1983); adopted 49 Fed. Reg. 13,003 (Sept. 19, 1990) at 1. merged with the State Banking Depart- (Apr. 2, 1984); codified at 12 C.F.R. 48. Briefing Memorandum, Califor- ment to form a new Department of Parts 330.13(b), 564.12(b). These rules nia Thrift Industry/Insider Misconduct Financial Institutions. Legislative Ana- were later invalidated in FAIC Securi- Hearing, in 1987 Fraud Hearings, supra lyst, Analysis of the 1990-91 Budget Bill, ties, Inc. v United States, 595 F.Supp. 73 note 11, at 450. at 249. (D.D.C. 1984), aff'd, 768 F.2d 352 (D.C. 49. Id. at 9 (emphasis original). Cir. 1985). 50. See General Accounting Office, 34. California S&L Chief Opposes Wrongdoing, Fraud Main Factor in Federal Efforts to Curb Power of State Thrift Industry Crisis: Report to Thrifts, BNA Daily Report (Mar. 27, Congress (Mar. 22, 1989), reprinted in 1984) at A-7. Investigation of Lincoln Savings & Loan 35. Insurance Delay Irks California Association: Hearings Before the House S&Ls; Associations Awaiting Regulato- Comm. on Banking, Finance and Urban ry Nod Meet to Trade Stories, American Affairs, 100th Cong., 1st Sess., 521 (Oct. Banker (Nov. 10, 1983) at 3. 26, 1989). 36. Give New Thrift Powers a 51. ld. at 485. Chance, Says Ray Martin, Head of Calif 52.1d at 505. League, American Banker (Oct. 4, 1983) 53. See supra note 1. at 3. 54. Pub. L. No. 101-73, 103 Stat. 183 37. Office of Thrift Supervision, (1989). Federal Agency Interventions Since 55. 136 Cong. Rec. 73 (June 11, 1980 (as of Aug. 31, 1990). 1990).

Thp C-lifornW- R,-an tory I -w Rpnort-. Vol 10 No 4 (F-11 1990)