As I discuss in my forthcoming book Scoundrels: Political Scandals in American History, the savings and loan (S&L) crisis has been almost forgotten, but in its day, it attracted its fair share of media coverage. From 1986 until 1995, more than 1,000 of the 3,234 savings and loans associations in the United States failed. The failures were attributed to numerous causes, including poor management and lax regulatory oversight. The S&L crisis of that era is the story of an evolving industry that relied on the good graces of members of Congress who were overly anxious to assist their constituents, resulting in billions of dollars of taxpayer bailouts—estimated at between $150 billion and $175 billion—for an industry that should have been scrutinized to a greater degree.
S&Ls—sometimes referred to as thrift banks, savings banks, or savings institutions—resemble commercial banks in some respects. S&Ls provide traditional services such as deposits, loans, mortgages, debit cards, and checks, but they focus on residential customers whereas commercial banks generally focus on corporations and large businesses. S&Ls initially were established to service individuals’ needs, especially the needs of customers in communities where the S&Ls were built. Commercial banks typically are managed by a board of directors hired by stockholders who are far away from the individual customer base. S&Ls, however, either are owned by depositors and borrowers or they are governed by a consortium of stockholders who possess a controlling share of the S&L stock.
As S&Ls were conceived in England during the eighteenth century, they were, in effect, “the poor man’s commercial bank.” An S&L was a not-for-profit cooperative designed to aid working class men in buying a home. S&L owners and operators invested time and money in the local community. The creation of S&Ls in England, and later the United States, reflected the increasing demand for affordable housing, especially in the years following World War II.
S&Ls grew by leaps and bounds, with apparently no end in sight. To attract depositors, S&Ls sometimes engaged in rate wars with commercial banks. As the wars increased, Congress stepped in to set rate limits in 1966. A decade later, S&Ls faced unprecedented challenges owing to stagflation, an unusual phenomenon. Traditional economic theory posits that high interest rates, accompanied by inflation, occur when the economy is growing and the demand for loans is rising. Conversely, low growth reduces demand, hence it results in lower inflation. During the 1970s, however, the American economy was caught in a period of slow growth, high interest rates, and inflation. The resultant stagflation almost decimated S&Ls.
Regulators strictly controlled the rates that thrift banks could pay on deposits, which meant that in a time of rising interest rates, depositors had an incentive to withdraw their funds in search of an investment that paid a higher dividend. In the meantime, customers who wanted to qualify for a mortgage found it difficult to do so because the low economic growth often translated into lower wages at precisely the time that higher interest rates required them to pay more for a home. These economic conditions reduced the demand for single-family home mortgages, which in turn undercut the bottom line for many S&Ls.
To remain solvent in this rough economic climate, S&L managers sought creative means of increasing revenue. Some S&L’s offered interest-bearing checking accounts and alternative mortgages. Lobbyists for the industry insisted that S&Ls were over-regulated, and that relief must be provided if the industry hoped to survive. As the 1970s progressed, S&Ls increasingly failed.
The Federal Savings and Loan Insurance Corporation (FSLIC), an institution dating from the Great Depression, administered deposit insurance for S&Ls. As the institutions failed, FSLIC supplied replacement funds, but the agency’s resources were limited. By 1983, FSLIC had $6 billion in capital to insure S&Ls, but the cost of providing funds for failed institutions was approximately $25 billion. Realizing that Congress would not provide additional funds, regulators had few viable options. They were forced to allow insolvent S&Ls to operate in hopes that the institutions would eventually generate enough revenue to stay in business. It was a bold gamble on the financial health of weak, often poorly managed, and undercapitalized institutions.
Even as regulators struggled with the problem of how to handle insolvent S&Ls, Congress debated the virtues of deregulating the industry so that institutions could offer a larger array of services. It was a curious response to a looming problem. Rather than fret over the means of bailing out bankrupt S&Ls, Congress debated whether it should allow the institutions to expand their services in hopes of outgrowing their financial woes.
In the early 1980s, Congress enacted new statutes to provide a lifeline to S&Ls. The first new law, the Depository Institutions Deregulation and Monetary Control Act of 1980, signed by President Jimmy Carter on March 31, 1980, was designed, in the words of the statute, “to facilitate the implementation of monetary policy, to provide for the gradual elimination of all limitations on the rates of interest which are payable on deposits and accounts, and to authorize interest-bearing transaction accounts.” In the Garn–St. Germain Depository Institutions Act of 1982, Congress deregulated S&Ls and allowed them to provide adjustable-rate mortgages. The industry hailed the laws as exactly what thrift banks needed to overcome their problems. With reduced regulatory oversight, the ability to offer more services, and the elimination of the minimum number of stockholders required to form an S&L, even undercapitalized, poorly managed institutions were free to pursue new business.
Deregulation had the desired effect. S&Ls grew rapidly between 1982 and 1985—more than twice as fast as commercial banks during that same time. Compared with commercial banks, S&Ls benefited from less regulation; indeed, they had enormous incentives to maximize profits by participating in risky, high-yield investments. In fact, the only way that S&Ls could grow as rapidly as they did was to pursue risky financial opportunities. Times were good, though, and few S&L managers thought the bubble would burst.
Unfortunately, all bubbles eventually burst. As S&Ls increasingly funded home mortgages for customers who were less financially stable than a traditional borrower, the institutions became vulnerable to any market deviations or interest rate fluctuations. Predictably, their losses mounted, and they failed in ever larger numbers. L. William Seidman, a former chairman of the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation (RTC), remarked that the “banking problems of the ‘80s and ‘90s came primarily, but not exclusively, from unsound real estate lending.”
As the 1980s progressed, the mounting problems with S&Ls became readily apparent to anyone who examined the failures. Many institutions held portfolios replete with risky investments. Managers often had little appreciation of how undercapitalized their thrift banks had become, nor did they understand the role of new technology in allowing other types of financial institutions to compete directly with S&Ls. The lack of effective regulation and the willingness of some S&L operators to take advantage of loopholes in existing regulations ensured that a financial collapse was increasingly likely.
From 1986 through 1989, FSLIC closed almost 300 S&Ls, requiring the agency to reimburse depositors for the loss of $125 billion in assets. Later, the RTC, another agency created to oversee S&Ls, was forced to reimburse depositors for an additional 747 S&Ls from 1989 until 1995. When state insurance funds failed, the federal government had to bail out some state S&Ls as well.
Although more than 1,000 institutions failed in the 1980s and 1990s, the failures seldom made the news. Eventually, some S&Ls captured headlines owing to the unmitigated venality and high-profile activities of the participants. As an example, a federally chartered S&L, the Midwest Federal Savings & Loan, failed in 1990. It became infamous when the chairman, Hal Greenwood Jr., and his daughter, Susan Greenwood Olson, along with former executives Robert A. Mampel and Charlotte E. Masica, were convicted on racketeering charges. Midwest’s collapse cost taxpayers $1.2 billion.
The collapse of the Silverado S&L attracted press attention in 1988 because Neil Bush, son of Vice President George H. W. Bush, served on the institution’s board of directors. Critics charged that Neil Bush had accepted a loan from Silverado, but he insisted that he was innocent of any improprieties. A subsequent investigation found that Bush had, in fact, engaged in “breaches of his fiduciary duty involving multiple conflicts of interest.” Bush did not face criminal charges, but he and his fellow directors fought a civil suit filed by the FDIC, eventually settling the case. Silverado directors also settled an RTC lawsuit, this time for $26.5 million. In the final accounting, the Silverado S&L failure cost taxpayers $1.3 billion.
Arguably, the worst S&L failure—and certainly the most infamous—concerned the Lincoln S&L. Five United States senators were accused of improperly contacting the Federal Home Loan Bank Board (FHLBB), the agency that regulated the S&L industry (and administered FSLIC) at the time. The senators acted on behalf of Charles H. Keating Jr., chairman of the Lincoln Savings and Loan Association. Lincoln failed in 1989, costing American taxpayers more than $3 billion, and leaving 23,000 Lincoln customers holding worthless bonds.
The debacle originated in 1985, when FHLBB chairman Edwin J. Gray instituted a new rule allowing S&Ls to hold no more than ten percent of their assets in “direct investments,” which limited their ability to own certain financial instruments. The purpose of the rule was to prevent S&Ls from continually taking on risky investments, declaring bankruptcy, and requiring taxpayer-funded bailouts.
Keating was an especially aggressive S&L officer. He had taken advantage of a multitude of risky deals to build Lincoln Savings into a powerhouse institution. Along the way, Keating had knowingly violated the FHLBB’s rules, including Gray’s prohibition on holding more than ten percent of the S&L’s assets in direct investments. Keating was politically well connected, and he sought to use those connections to repel a FHLBB inquiry into Lincoln’s practices.
With an eye toward staffing the FHLBB was friendly regulators, Keating had persuaded President Ronald Reagan to appoint a real estate developer and Keating confederate, Kee H. Henkel Jr., to the bank board using a recess appointment. Keating also commissioned a study from Alan Greenspan, who was then a private economist but later served as chairman of the Federal Reserve Board, to demonstrate that direct investments by S&Ls were safe and secure.
The measures were insufficient to insulate Lincoln Savings from the regulators’ scrutiny. Henkel was forced to resign from the FHLBB when news broke that he had financial ties to Lincoln, having accepted loans from the institution. Frustrated with the results of his maneuvers, Keating knew that he must take additional steps to hobble the regulators.
Following the 1986 congressional elections, the Republicans no longer controlled the United States Senate, but that was not a problem. Keating had contacts in both political parties. He approached Senator Alan Cranston, an influential Democrat from California, to ask that the senator remove Ed Gray from the FHLBB. If Keating could not persuade agency personnel to see things his way, he would facilitate a change in personnel. Lincoln Savings was in California, which meant that the S&L was technically a Cranston constituent. Keating spread his money around, donating $39,000 to Cranston’s 1986 reelection campaign as well as $850,000 to organizations allied with Cranston’s various pet projects. Moreover, Keating contributed $85,000 to the California Democratic Party.
Keating’s efforts did not stop with Cranston. He also contributed $55,000 to the 1988 reelection campaign of Senator Dennis DeConcini of Arizona. Because Keating lived in Arizona, he was DeConcini’s constituent. Later, after Keating came under fire for his actions on behalf of Lincoln, the senator returned the contribution.
Senator John Glenn of Ohio, a legendary former astronaut-turned-lawmaker, received $34,000 in donations from Keating and his allies for his 1984 reelection campaign, followed by $200,000 donated to a political action committee that Glenn owned. Keating operated an Ohio-based business, which provided the necessary link to claim Glenn as his senator.
Senator John McCain, an Arizona Republican, had known Charles Keating socially since 1981. Over a five-year period starting in 1982, Keating and his associates had contributed $112,000 to McCain’s campaign fund. Aside from the campaign, McCain’s family members had invested in a real estate deal with Keating. McCain had traveled on Keating’s private jet and stayed as a visitor at a Keating vacation home. When the trips became public news, McCain quickly reimbursed Keating for the travel costs.
Keating also contributed $76,000 to Donald Riegle, a Michigan Democrat, for Riegle’s 1988 Senate campaign. Because Keating owned a hotel in Michigan, he could claim to be Riegle’s constituent. The senator eventually returned the contribution.
These five senators became known as the “Keating Five” because of their cozy relationship with the financier, and because they were willing to intervene with the FHLBB on Keating’s behalf. Of course, Charles Keating had not contributed funds to the senators’ reelection committees and cultivated the relationships because he enjoyed their company or marveled at their sparkling wit. He knew that one day he might need a favor.
The day came when Keating called in the favor. Facing the possibility that the FHLBB would seize Lincoln S&L for insolvency, Keating told Ed Gray that “some senators out west are very concerned about the way the bank board is regulating Lincoln Savings.” It was a thinly veiled threat, but one that Keating intended to follow through with if Gray and his associates at the FHLBB did not relax their scrutiny. When Gray appeared unfazed by the comment, Keating assured him that “you’ll be getting a call.”
DeConcini was amenable to intervening on Keating’s behalf, but McCain initially balked. Recognizing the political peril, the Arizona senator did not want to besmirch his public reputation or face legal recriminations. An angry Charles Keating insisted that his long-time friend owed him assistance. Keating and McCain exchanged heated words, but the senator relented.
On April 2, 1987, Ed Gray met with senators DeConcini, Glenn, Cranston, and McCain in DeConcini’s office. The senators’ staffers were not present. When DeConcini mentioned “our friend at Lincoln,” Gray told them that he was not personally involved in the Lincoln S&L case, but that he could put the senators in touch with the appropriate FHLBB regulators.
Exactly a week later, the Keating Five met with the FHLBB regulators in DeConcini’s office. “We wanted to meet with you because we have determined that potential actions of yours could injure a constituent,” DeConcini said at the outset. Recognizing that the meeting could be characterized as lawmakers unduly influencing federal regulators, the senator hastened to add that “I wouldn’t want any special favors for them.” After stumbling through more excuses, he explained that “I don’t want any part of our conversation to be improper.” Everyone understood the disingenuousness of DeConcini’s remarks.
Following the Arizona senator’s dithering, John Glenn got to the point. “To be blunt,” he said, “you should charge them or get off their backs.”
It was an awkward moment. Finally, the FHLBB representatives broke the silence. To ensure that the senators understood how risky their position was, the regulators said that they were pursuing a criminal investigation against Lincoln Savings & Loan. The meeting suddenly took on a new, ominous tone. Five United States senators were interceding into a pending criminal case against a constituent. John McCain understood how vulnerable he was. After the session concluded, he severed all ties with Charles Keating and his businesses.
FHLBB regulators subsequently wrote a report recommending that the United States government seize Lincoln owing to the institution’s unsound financial practices. Ed Gray’s tenure was ending, so he deferred action on a criminal referral to the United States Department of Justice (DOJ). Later, Gray’s successor, M. Danny Wall, expressed sympathy for Lincoln. Consequently, he refused to act on the report. In May 1988, the FHLBB negotiated an agreement with Keating and did not refer a criminal case to DOJ.
Despite their precarious positions, Cranston, DeConcini, and Glenn continued their efforts on Keating’s behalf even after they knew about the possible criminal charges. The senators set up multiple meetings with influential members of Congress, including House Majority Leader Jim Wright, who later became speaker of the House and experienced his own problems with the S&L issue. The senators’ actions blurred the thin line between conscientious constituent services and improper influence peddling.
It was many years before the S&L crisis became a salient political issue. The complex nature of the transactions and the closed-door meetings with tight-lipped participants ensured that the facts were easily concealed. An aggressive press corps eventually brought the facts to light.
When the stories emerged, the Senate Ethics Committee investigated the Keating Five and arranged for varying punishments. Cranston received the harshest penalty: The ethics committee publicly reprimanded him. The committee also criticized Riegle and DeConcini for acting improperly but stopped short of issuing a public reprimand. John Glenn and John McCain escaped punishment for improper actions, but committee members concluded that the two men had exercised poor judgment.
Of the five, Glenn and McCain successfully ran for reelection, and McCain eventually became the Republican nominee for president of the United States in 2008. Looking back on the affair, McCain called the Keating Five investigation the low point of his life. In the meantime, according to public opinion polls, the S&L crisis reinforced citizens’ views that members of Congress could not be trusted to act appropriately in the public interest.
Even as the Keating Five faced ethics complaints in the Senate, House Speaker Jim Wright faced his own set of challenges involving S&Ls. Like his Senate colleagues, Wright had accepted campaign contributions from Charles H. Keating Jr. It did not stop there. Wright assisted other constituents in their efforts to manipulate the actions of the FHLBB.
Ed Gray vividly recalled the day when Wright called to say he wanted to “come talk with you” about a constituent, “my friend Tom Gaubert,” a man sometimes described as an “S&L kingpin.” No stranger to political pressure, Gray reflected that “I have been in government long enough to know that you don’t have to ask the question explicitly to know what the message is, and I knew what the message was. My impressions were that he was interfering with the regulatory process on behalf of friends, and I thought this was a violation of his job as one of the highest-ranking members in the United States government.”
Wright’s critics charged that the speaker intervened in numerous instances to assist S&L owners and operators, ostensibly because they were his constituents. As a result, he delayed or deterred regulatory oversight that might have prevented bankruptcies costing taxpayers billions of dollars. After S&Ls failed in increasing numbers and the failures captured headlines, the issue gradually became a scandal. Jim Wright became the face of that scandal, although it was not his S&L interventions alone that sealed his political fate.
He became the focus of ethics investigations alleging that he had used bulk purchases of a book he had written to circumvent House rules on outside earnings by members. Wright also allegedly used improper influence to have the FSLIC deputy director, William K. Black, fired. Having accepted numerous campaign contributions from S&Ls, the speaker apparently acted at the behest of several savings and loans officers. Rather than face a formal inquiry from the House Committee on Standards of Official Conduct, however, Wright resigned from Congress in June 1989 after two-and-a-half years of service as the speaker.
The story of the rise and fall of S&Ls, and the members of Congress who sought to protect the industry, is clearly a story of venality and influence peddling. The moral to the story goes beyond those surface features, however. It is an indictment of the American campaign finance system.
It is a cliché to argue that financing political campaigns is expensive, time-consuming, and broken, but well-worn observations are no less true because of their familiarity. It costs millions upon millions of dollars to win a seat in Congress. Most contributors do not write checks based on disinterested motives. At a minimum, a campaign contributor expects that his or her phone calls will be answered promptly. In some instances, the contributor seeks more than a return phone call.
Elected officials are expected to provide superior constituent service if they hope to remain in office for multiple terms. Yet the line between effective constituent service and an improper quid pro quo relationship can be exceedingly thin. Every member of Congress wrestles with this question. How much should a representative do for a constituent, especially a large campaign donor, and when should the member refuse to act regardless of the size of the check? The need to collect huge sums of money from contributors without selling access to the elected office places a public official in an untenable situation. The joke is that under the nation’s campaign finance laws, member of Congress cannot be bought—but they can be rented for a little while.
This conclusion does not relieve elected officials from responsibility for their actions. Ethical practice requires individual responsibility and moral autonomy. It does suggest that elected officials must seek a middle path. On one hand, if they refuse to accept money from big-money donors, corporations, and political action committees, they place themselves at a severe electoral disadvantage. On the other hand, if they accept funding from multiple big-money sources, they can expect to be inundated with requests for favors after the election. If federal campaigns continue to be financed through private contributions from well-funded sources, scandals such as the S&L crisis of the 1980s and 1990s will remain a distinct possibility.