Troubled Temples of Thrift

By George Russell

A frantic support operation was going on in Washington last week, but it may not be enough to prop up a large part of the $1.1 trillion U.S. thrift industry. By a 402-to-6 vote, the House of Representatives approved a $5 billion cash infusion for the Federal Savings and Loan Insurance Corporation, backstop for the country's 3,200 federally insured savings and loan associations. That would almost, but not quite, bring the FSLIC back to being merely broke; last year the fund was $6 billion in the red by normal accounting methods. Normal accounting, however, has long since gone by the boards in managing the ugly thrift crisis, which after years of alarmed attention is still getting decidedly worse. So bad is the problem, warns Lowell Bryan, a director of the McKinsey & Co. management-consulting firm, that "our entire credit system has become unsound."

Bryan may overstate the case, but there is no denying the horrendous plight of the thrift institutions -- or rather of the one-quarter or so of the industry that is foundering by normal accounting standards. Last year the profits of all U.S. thrifts totaled $895 million, down from $3.85 billion in 1985. A year ago the 370 or so weakest institutions were hemorrhaging at the rate of $2.2 billion a year. Now those losses are running closer to an estimated $3.8 billion annually.

Yet, astonishingly, U.S. legislators have been helping keep the red ink flowing. Reason: Congress has withheld from the FSLIC the amounts of cash needed to pay off the depositors of the insolvent S and Ls and thus wind down the problem once and for all. Though the FSLIC has shut down, merged or taken over 108 institutions since the beginning of 1986, the agency has had to allow some of the sickliest thrifts to stay in business through the device of lenient accounting practices. Complains William Black, deputy director of the FSLIC: "We are the only shop that keeps insolvent institutions open."

The latest round of the thrift fiasco began in 1980, when Congress last tried to make life easier for the savings institutions. At that time the industry was still reeling from the inflationary spiral that sent interest rates soaring and left the thrifts with billions of dollars of low-interest 30-year mortgages on their books. Congress tried to remedy the situation by allowing the thrifts to expand their business far beyond those traditional instruments into stock and bond investment as well as business loans, particularly in commercial real estate. At the same time, thrift deposits continued to receive federal guarantees. The result was that even though numerous thrifts were weak, the industry was encouraged to grow madly rather than face a shake-out.

For some thrifts, the new arrangement proved a bonanza. Columbia Savings & Loan Association of Beverly Hills (assets: $9.7 billion) has earned a rate of return on capital that has ranged between 44% and 114% annually for the past four years, vs. 11% to 13% for the 500 biggest companies traded on the New York Stock Exchange. Columbia invested heavily in high-yield, high-risk junk bonds and volatile mortgage-backed securities, which provide greater profits at lower cost than traditional home mortgages. That kind of speculative strategy works well when interest rates are declining, but it could be disastrous in the event of an interest-rate upturn, which is now occurring. In all, thrifts have absorbed more than 25% of the $100 billion in junk bonds currently afloat in the U.S.

The 1980 reform that allowed the thrifts to expand their business proved a major disaster in the Southwest, where a sizable number of thrifts stampeded into risky real estate loans and other questionable investments. In many cases the institutions also succumbed to old-fashioned peculation. A spectacular case in point was the Vernon Savings & Loan Association of North Dallas, which was shut down in March with a deficit of more than $350 million. Vernon was purchased in 1982 by Don Dixon, 48, a North Dallas real estate developer. In six years Dixon pushed Vernon's assets from $82 million to $1.7 billion through wildly risky loans and real estate ventures. Two weeks ago the FSLIC charged that Dixon and six former Vernon executives "looted, wasted and dissipated" at least $140 million of the thrift's assets.

To close down the worst of the remaining money-loser thrifts would cost tons of money -- by one estimate, perhaps $23 billion. FSLIC resources have long been inadequate to the task. Hence there has been considerable pressure in Washington for the past year to add not merely $5 billion but $15 billion over five years to FSLIC capitalization. But there has been strong opposition from the thrift industry itself, mostly from the healthiest 60% of the institutions. Reason: the cash infusion would eventually have to be paid back by the thrifts, which are already paying about $3.5 billion a year to replenish the deposit guarantee fund. Says a spokesman for the U.S. League of Savings Institutions, a powerful industry lobbying group: "All we're asking for is a plan that doesn't overtax the industry."

The reply might be that the industry is already overtaxed and that in the long run the failure to close down the worst of the thrifts will be paid for by the U.S. taxpayer. Spending additional money now might save still more money later. But an amendment to the FSLIC replenishment measure that would have boosted the total to $15 billion was voted down, 258 to 153. A similar relief bill passed by the Senate in March would allow the FSLIC to be topped up with as much as $7.5 billion. The two measures must be reconciled in conference.

Meanwhile, worries are growing about an upward surge in interest rates, which could quickly affect thrifts that are still playing a go-go game. In California last month, the often troubled Financial Corp. of America, parent of American Savings & Loan (assets: $34 billion), the largest U.S. thrift, announced an 81% drop in net income, to $9.2 million, in the first three months of this year. F.C.A. is hardly alone in its plight, but at the moment the full extent of the thrift debacle is still concealed behind oodles of creative accounting.

CHART: TEXT NOT AVAILABLE

CREDIT: TIME Chart by Joe Lertola

CAPTION: FALLING PILLARS

FSLIC total reserve fund in billions of dollars

DESCRIPTION: Building labeled THRIFT with pillars representing years from 1982 to 1986.

With reporting by Jay Branegan/Washington and Frederick Ungeheuer/New York