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Reagan Made S&L Crisis Vastly Worse

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. February 6 is the 100th anniversary of the birth of Ronald Reagan. It was under President Reagan’s watch that the S&L crisis, the saving and loan banks crisis, which during the presidency of George H. W. Bush wound up in a government bailout to the tune of about $150 billion–. Many people believe the roots of this crisis were the deregulation efforts of President Reagan. Now joining us to talk about the Reagan presidency and the centenary of his birth and the S&L crisis is someone who knows all about that, is Bill Black, coming to us from Kansas City, Missouri. Bill was a deputy staff director of the national commission to investigate the cause of the saving and loan crisis. He’s now a professor of law, assistant professor of law, at the University of Missouri–Kansas City, and an expert on white collar criminology, and the author of the book The Best Way to Rob a Bank is to Own One. Thanks for joining us, Bill.


JAY: Alright. So you know better than most what that saving and loans crisis was about. So what was President Reagan’s role in all of that?

BLACK: Well, the savings and loan crisis was a tragedy in two parts, and President Reagan inherited the first part. So the first part was the interest rate crisis, when chairman [Paul] Volcker decided to break the back of inflation by dramatically raising interest rates. And savings and loans borrowed very short, as we say–deposits were short-term. Their assets were very long-term. So when interest rates surged, savings and loans lost money and became deeply insolvent. Carter’s administration is when Paul Volcker first raised interest rates, in ’79, and he persisted with this through mid 1982. And, of course, President Reagan comes in during the midst of all of this, so he’s certainly not responsible in any way for the first phase, of the interest rate.

JAY: Before we go to phase two, just really quickly remind everyone, and those who don’t know, what exactly were or are savings and loans. What did they do?

BLACK: Savings and loans, especially in the era of the savings and loan debacle, made home loans to people. And they mostly kept those home loans that they made, instead of selling them into the secondary market. We call that, in economics, they held them in portfolio.

JAY: Unlike what happened in the more recent subprime, where they would bundle all these mortgages and then sell them, and sometimes two and three and four times.

BLACK: And sometimes 20 times, yes.

JAY: So Reagan gets in. Interest rates are high. The saving and loans banks are in trouble. And then what?

BLACK: Then it’s the usual case of fighting the last war. Their emphasis was on interest rate risk, and they decided at a time of mass insolvency that what they ought to do is deregulate and de-supervise at the same time. So those are different, important concepts. The rules cannot change at all, but if you stop enforcing them–that’s what de-supervision is–essentially the rules have ceased to exist. And so the Reagan administration at all times, its highest priority with regard to savings and loans was covering up the scale of the crisis. And again, that was around $150 billion in terms of loss of market value on their home loans when interest rates surged. And so President Reagan, of course, his first priority was getting the tax cut. And he–one of the concerns about that was the deficit. And so they didn’t want to admit that the deficit was really $150 billion worse than it was being reported because of this mass insolvency by savings and loan. So instead they gimmicked the accounting rule–which should sound familiar, because that’s been done again in this crisis–so that the savings and loans wouldn’t have to recognize their losses, and they passed substantial deregulation at the federal level. But if you’re thinking on a scale of one to ten, where one was minimal deregulation and ten was complete deregulation, that federal deregulation, which was the Garn–St. Germain Act of 1982, maybe it was around a four. A problem that got worse was twofold. First, they model that federal deregulation on the state of Texas deregulation, which was the worst conceivable model they could imagine. But they looked at Texas–they were economists. The chairman of the federal agency was Dick Pratt. He was an academic economist. He hated regulation. And he said, I know, we’ll use economic techniques, what we call econometrics, and we’ll study which state is doing the best. And they did this study, and of course it came up with Texas. Now, why did it come up with Texas? Because Texas, by deregulating these commercial loans, had created the best possible environment in any of the states for accounting fraud. So of course the Texas S&Ls reported much better earnings. So it was the worst possible model for federal regulation that Dick Pratt could choose, and naturally that’s the one he chose. The second thing is what economists then called the competition in laxity or the race to the bottom. You could easily change between a federal and a state charter, and you could still have federal deposit insurance regardless of which charter you had. And the charter determined what you could invest in, other words how big the deregulation was. And so that created a competition between the federal government and the states as to who could be the weakest regulator. And then the savings and loans would change their charter and go to wherever it was weakest. And that dynamic–which, by the way, economists knew about and praised, because they said this dynamic causes deregulation and we know deregulation is the greatest thing possible–well, it led to California sweeping the table by saying, you can put 100 percent of your savings and loan assets in anything.

JAY: So that means that there’s no oversight about level of risk whatsoever and no oversight how much backup you have for the loans you have out there.

BLACK: Right. So what happened is that the states had lost virtually all their examiners and supervisors before they engaged in this competition. So they suddenly had huge numbers of institutions growing immensely rapidly and no regulators to look at them. And what did they do? They decided, hey, let’s bring even more savings and loans in by creating new ones, which were called "de novos". So the California commissioner got 200 applications to start new S&Ls. Remember, this is in a complete crisis. The industry is dying. It has enormous overcapacity. And 200 folks rush to come into the industry. Why? Because they were almost all real estate developers, and they all wanted a cash cow, and every real estate developer’s dream is to control a lending institution. The California commissioner said no to zero of the 200 applications, even though they had enormous conflicts of interest. And it’s no surprise that as a result of the savings and loan crisis about 45 percent of total losses occurred in Texas.

JAY: Now, admirers of President Reagan might say, what’s all this got to do with him? A lot of this happened at the state level.

BLACK: Right, because he had no conception of what this would create as a dynamic, a competitive dynamic, at the state level, and because the administration opposed our efforts to act against these incredibly permissive state environments.

JAY: So do you draw links, then, between this deregulatory culture and today? In other words, are the roots of this crisis to be found in Reagan’s legacy?

BLACK: To be fair to Reagan, the roots could be found far more–the intellectual roots–in the Carter presidency. President Carter had far more substantive deregulation then did President Reagan. Carter famously deregulated large aspects of civil aviation and of trucking. As I said, President Reagan got maybe a four on the scale of deregulation. Carter had tens on the scale of deregulation in much–in some ways much bigger areas than savings and loans: trucking and aviation affected everybody’s lives all the time; not everybody used a savings and loan, although all of us got to pay as taxpayers. So what happens next is the disaster. It’s not that President Reagan kicked off the savings and loan crisis; it’s that he made it vastly worse, because savings and loans were recovering from the interest rate crisis as interest rates fell sharply through the 1980s. But by bringing in all these new real estate developers with conflicts of interest who were frequently fraudulent, this created a circumstance where pretty soon there were 300 of these savings and loans that were growing at an average rate of 50 percent. And this is what we clamped down on in what became known as reregulation–and that was the greatest swear word the administration could use. Now, they weren’t alone. The Democrats were heavily in favor of the deregulation in the savings and loan industry. The Garn–St. Germain Act passed the House and the Senate, in each case with only one dissenting vote. So both parties overwhelmingly supported this legislation. And when we started reregulating, well, the Keating Five, four of those five senators that tried to prevent us from taking enforcement action against the largest violation of our rules we ever found–by Lincoln Savings–four of those senators were Democrats. The only Republican, of course, was John McCain. Speaker [Jim] Wright, the Democratic speaker of the House, a very powerful speaker, extorted our agency to try to get special favors for the second-worst fraud in America in savings and loans–that was Vernon Savings, know to us regulators as "Vermin". When we are finally able, after this political opposition, to close Vernon Savings, 96 percent of its loans were in default.

JAY: Well, I guess that explains why this celebration of Ronald Reagan’s economic policies is essentially a bipartisan affair.

BLACK: Well, sadly, it is. This became the Rubin wing of the Democratic Party, which helped set the stage for the current crisis and is preventing, in the Obama administration, effective responses or sending any of the crooks to prison. Let me give you what the Reagan administration also did. When we tried to crack down on these crises, this wave of fraud that we had documented–and, again, we’re making criminal referrals; people are starting to go to prison; we’re bringing enforcement actions and civil actions and establishing widespread fraud–what was the reaction of the administration? It attempted to appoint on–and, by the way, it gets tempted to do so on a recess appointment basis, which means there’s no advice and consent of the Senate–two board members picked by Charles Keating. We only had–our agency was run by three board members, which means President Reagan’s administration attempted to give Charles Keating majority control over the federal agency that was supposed to regulate savings and loans.

JAY: And just quickly remind everybody Keating’s role in all this.

BLACK: Keating was the most notorious of the frauds, even worse than Vernon Savings, but had exceptional political power because of his large contributions. So he was the person that was able to get a majority of the members of the House to cosponsor a resolution telling us not to go forward with reregulation. And, by the way, most of the leadership of both parties in the House cosponsored that resolution. If we had given in to that political pressure, those institutions would’ve continued, those frauds would have continued to grow at 50 percent a year, and you would have been dealing with not a $150 billion crisis but a crisis well over $1 trillion.

JAY: Thanks very much for joining us, Bill.

BLACK: Thank you.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

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