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California's Role in the $335 Billion Savings and Loan Heist by Carl K

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California's Role in the $335 Billion Savings and Loan Heist by Carl K 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 The California Regulatory Law Reporter Vol. 10, No. 4 (Fall 1990) 1 _%FEATURE ARTICLE 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.
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