PART 1: INSIDE JOB: THE LOOTING OF AMERICANS SAVINGS AND LOANS

INSIDE JOB 
The Looting of Americans 
Savings and Loans
By Stephen Pizzo, Mary Fricker 
and Paul Muolo


INTRODUCTION 

Original Sin 

President Ronald Reagan stepped through the tall French doors of the White House Oval Office into the bright sunlight of a lovely fall morning. Whispers and nudges rippled through the crowd, and a hush fell over the Rose Garden. A squad of Secret Service agents melted into the audience as Reagan, smiling broadly, strode across the lawn to the podium. 

The president stood at ease for a moment and looked out over the assembled guests, beaming with pride and satisfaction. He had promised the American people that he would get government off their backs, that he would deregulate the private sector. This day, October 15, 1982, less than two years into his presidency, he had invited 200 people to witness the signing of one of his administration's major pieces of deregulation legislation. 

Reagan told the audience of savings and loan executives, bankers, congress- men, and journalists that they were there to take a major step toward the deregulation of America's financial institutions. He was about to sign, he said, the Garn-St Germain Act of 1982, which would cut savings and loans loose from the tight girdle of old-fashioned, restrictive federal regulations. For 50 years American families had relied on savings and loans to finance their homes, but outmoded regulations left over from the era of the Great Depression, Reagan believed, were preventing thrifts from competing in the complex, sophisticated financial marketplace of the 1980's. The Garn-St Germain bill would fix all that, he promised. 

At the conclusion of his remarks, and following enthusiastic applause, Reagan took his seat at a table surrounded by the bill's proud political parents. He flashed a broad smile for the cameras and launched into the signing process. With each sweep of a souvenir pen, thrift regulations crumbled. It was an exhilarating moment for Ronald Reagan. The bill was "the most important legislation for financial institutions in 50 years," he said. It would mean more housing, more jobs and growth for the economy. 

"All in all"—he beamed—"I think we've hit the jackpot." 

Less than four years later, at the lavish Dunes Hotel and Casino in Las Vegas, Ronald Reagan's words could well have served as the chorus to Ed McBirney's company song. 

Ed McBirney was the fun-loving 33-year-old chairman of Sunbelt Savings and Loan, one of Dallas's largest S&Ls with nearly $3 billion in assets. He was playing host at one of his periodic parties in his plush penthouse suite at the Las Vegas Dunes. One of the guests later described the party: McBirney smiled slyly as he surveyed his guests. Slouched on the floor against a couch, he puffed on a large cigar as Sunbelt executives and customers, whom he had flown from Dallas to Las Vegas on a private 727 jet, mingled and chatted, enjoying pre-dinner cocktails and hors d'oeuvres on Sunbelt's tab. McBirney seemed to enjoy living up to his reputation as an outrageous swinger who conducted business deals between, and during, parties, and entertainment had been secretly arranged tonight that promised to be . . . interesting. 

He glanced toward the door as it opened. Four attractive, well-dressed women entered the room full of men. The buzz of conversation paused as McBirney's guests noticed the new arrivals. They watched expectantly, curiously, as the women smiled seductively and drifted quietly to prominent positions in the room. Suddenly, without explanation, they began to undress. 

The savings and loan guests, well aware of McBirney's reputation, were only momentarily surprised. Then they settled back to enjoy the show. They did assume, however, that once the women were naked, the entertainment would end. They were wrong. When the women finished undressing they moved toward the center of the room and engaged in an enthusiastic lesbian romp. The all- male audience did some embarrassed shuffling, but for the most part they went along for the ride. After the lesbian routine the girls separated and moved among the guests, many of whom were still frozen in amazement. Targeting the older members of the audience, the women began performing oral sex on them while McBirney, sitting on the floor, grinned widely and puffed on his cigar. 

McBirney was skillfully riding a cresting wave of power, and he certainly must have felt like he had hit the jackpot, though it was not quite the one President Reagan had had in mind that morning in the Rose Garden. But just four months after the March 1986 party in Las Vegas, McBirney would be forced to resign from Sunbelt, and he would leave the institution hopelessly insolvent. When the dust finally settled regulators would say Sunbelt's cash drawer was $500 million short. Worse yet, the cost of playing out the thrift's losing hand would be $1.7 billion. Quite a jackpot. 

McBirney, and dozens like him, were a new breed of savings and loan executive that had sprung like weeds out of the rich soil of the October 1982 Rose Garden ceremony. At first no one quite knew what to make of these flamboyant new "entrepreneurs." They were very different from the old traditional thrift officers, but wasn't that precisely the point of deregulating the thrift industry — to attract the best and brightest from America's private sector and give them free rein to work capitalism's magic on an industry clogged with dead wood? Wall Street's wunderkind, arbitrager/financier Ivan F. Boesky, acquired a small upstate New York thrift. Then-Vice President George Bush's son Neil became director of Silverado Savings in Denver. New York Governor Mario Cuomo's son Andrew tried to purchase Financial Security Savings in Delray Beach, Florida. Former Governor of Illinois Dan Walker acquired First American Savings in Oak Brook, Illinois. Surely, people thought, if men of such stature wanted to own savings and loans, the industry must be headed in the right direction.1 

But only 18 months after the Rose Garden signing, Edwin Gray, chairman of the Federal Home Loan Bank Board (FHLBB),2 discovered something had gone very wrong. On March 14, 1984, he received in the morning dispatch a classified report and videotape from the Dallas Federal Home Loan Bank. Gray summoned fellow Bank Board members Mary Grigsby and Donald I. Hovde to a darkened meeting room on the sixth floor of the Bank Board building, just down the block from the White House, to view the tape. Gray, in his late forties, a solid but tired-looking man with graying hair, sat at the head of the conference table. Microphones recorded the moment for history. In the dimly lit room, a videotape began to roll. 

Gray, Grigsby, and Hovde watched in rapt horror. The narrator, a Dallas appraiser, appeared to be in the passenger seat of a car driving along Interstate 30 on the distant outskirts of east Dallas. The camera panned slowly from side to side, catching in sickening detail the carrion of dead savings and loan deals: thousands of condominium units financed by Empire Savings and Loan of Mesquite, Texas. The condominiums stretched as far as the camera could see, in two- and three-floor clusters, maybe 15 units per building. They were separated by stretches of arid, flat land. Many were only half-finished shells. Most were abandoned, left to the ravages of the hot Texas sun. Like a documentary film, the camera zoomed in on building materials stacked rotting in the desert dust. Loose wiring and shreds of insulation swayed in the warm, dead, quiet air. Siding had warped, concrete cracked, windows broken. In many cases only the concrete slab foundations remained—"Martian landing pads," a U.S. attorney would later call them. 

"I sat in that board meeting," Gray said later, "and I was so shocked and stunned at what I was seeing that it had a profound effect on me. It was like watching a Triple X movie. I was sick after watching it. I could not believe that anything so bad could have happened." 

Empire Savings and Loan had rocketed gleefully into the newly deregulated thrift universe in apparent disregard of the ethical and legal implications of its wild ways, growing seventeen-fold in two years. Later the Federal Savings and Loan Insurance Corporation (FSLIC) would charge that Empire's officers had "sold" land back and forth with associates, to make it look like the land was increasing in value, in order to justify huge loans from Empire Savings for the condominium projects along the 1-30 corridor. They seemed to have completely ignored cautions normally taken by prudent thrifts to ensure the safety and security of money entrusted to them by their depositors. And now the savings and loan was not only broke but deeply in the red. 

The Bank Board closed Empire Savings that very day and about a year later the federal government would file both civil and criminal charges against over 100 companies and individuals involved in Empire's collapse.3 In the end the Empire case alone would cost the FSLIC 4 about $300 million. But Empire, costly as it was, represented just the first small hint of the financial holocaust to come. Deregulation of savings and loans sparked a period of waste and corruption, excess and debauchery the likes of which the nation had not seen since the roaring twenties. The ink wasn't dry on the Garn-St Germain legislation, deregulating the thrift industry, before high-stakes investors, swindlers, and mobsters lined up to loot S&Ls. They immediately seized the opportunity created by careless deregulation of thrifts and gambled, stole, and embezzled away billions in an orgy of greed and excess. 

The result was the biggest financial disaster since the Great Depression and the biggest heist in history. Lens of billions of dollars were siphoned out of federally insured institutions. Following Empire Savings thrift after thrift collapsed, the victims of incompetent management, poor or nonexistent supervision, insider abuse, and, most important, outright fraud.5 By the time the problem was discovered, there was little left for the FSLIC to do but pay back the depositors whose money the thrifts had squandered. In just two short years the FSLIC insurance fund paid out the equivalent of all its income for the past 52 years. 

In early 1987 thrift regulators said it would cost the FSLIC $15 billion to close all insolvent thrifts. (Out of about 3,200 thrifts, at least 500 were insolvent and another 500 were nearly insolvent.) By the end of the year that estimate had jumped to $22.7 billion. In mid-1988 regulators said the cost could go to $35 billion. In October they upped the figure to $50 billion. But at the same time the General Accounting Office 6 was saying the shortfall was more like $60 billion. In late 1988 experts' said costs were increasing by as much as $55 million a day and floated total loss figures of $100 billion or more. When President George Bush announced his S&'L bailout plan in February 1989, analysts put the cost at $1 57 billion to $205 billion for the first ten years and a total of $360 billion over three decades. They were conceding that the cost of bailing out the S&Ls would be more than the entire federal deficit. As everyone in Washington and the thrift industry (except President Reagan, who went eight years without mentioning the problem) haggled over just how many billions might be missing,the late Senator Everett Dirkson's favorite Washington joke came to mind: "A billion dollars here and a billion there and pretty soon we're talking real money." The halls of Congress began to hear the first quiet whispers of a taxpayer bailout. 

The meltdown of the savings and loan industry was a national scandal, a scandal that left virtually no player untouched or unsullied. It was above all a story of failure—failure of politicians, failure of regulators, failure of the Justice Department and failure of the federal courts. But even as the crisis was being unraveled and the alarm sounded, thrift executives and their customers continued to revel in life in the fast lane, surrounded by their women and their mansions, their Lear jets and their Rolls-Royce's. And billions of dollars drifted off into the ozone never to be seen again. Of the missing money, as much as half had been stolen outright. Yet few of the hit-and-run artists who infiltrated the thrift industry went to jail and little of the money was recovered. In short, these inside jobs not only paid but paid very well indeed. And the savings and loan industry as Americans had known it for 50 years teetered on the edge of collapse. 

Coauthors Steve Pizzo and Mary Fricker were jarred to attention by thrift deregulation's fallout when tiny, conservative Centennial Savings and Loan in their rural Northern California hometown of Guerneville began acting strangely in December 1982 (two months after the signing of the Garn-St Germain Act) and announced it was going to pay $ 13 million cash for a construction company. Pizzo was editor of the Guerneville weekly, the Russian River News, and Fricker was news editor. Pizzo wrote a news analysis highly critical of Centennial's plan to spend seven times its net worth' on a construction company, and he began aggressive coverage of a succession of strange happenings at Centennial Savings and Loan. 

Centennial officers suddenly were awash with money. Their names popped up in complex real estate transactions documented at the county recorder's office. Out-of-town visitors from places like Holland, Las Vegas, and Boston mysteriously came and went, taking money with them. Still the thrift's financial state- ments recorded phenomenal growth. And the small-town rumor mill geared up to churn out dozens of explanations for this bizarre behavior. In the Russian River News, Pizzo began asking some fairly obvious questions of the Centennial officers: "Where is all this money coming from? " "Who are you lending it to, and why?" "How can you justify these extravagant salaries, benefits, perks, planes, luxury cars, boats, and trips?" Was this, Pizzo asked, the proper role for a savings and loan, heretofore the most conservative, predictable, and reliable of all American financial institutions? 

Pizzo's journalistic probings infuriated Erv Hansen, the president of Centennial Savings, and he exploded. He dispatched his assistant to complain to the paper's publisher. Periodically he threatened that tellers at Centennial would monitor withdrawals, and if they were substantial, he would sue the News for causing a run on the thrift. Drunk in a local bar one night, Hansen told Pizzo's business partner, Scott Kersnar, "You tell your partner he better stop sticking his nose where it doesn't belong or I'll do to him what I did to that San Diego reporter on that stock manipulation deal." Pizzo had no idea what had happened to the San Diego reporter, but he took the warning seriously because he had already discovered that some of those customers buzzing around Centennial's loan window had organized crime backgrounds. 

For four years Pizzo pursued the Centennial Savings and Loan story, and gradually his Russian River News articles about Centennial Savings found their way outside tiny Guerneville. They circulated quietly at the Federal Home Loan Bank in San Francisco and Washington and at the Justice Department. In late 1985 Centennial collapsed—$165 million was missing. 

A few months later Pizzo ran a full-page story entitled "Bust-Out," which explained the decades-old mob scam of gaining control of legitimate businesses and then looting, gutting, and abandoning them. Pointing to characters he had discovered in association with Hansen at Centennial, Pizzo raised the possibility that Centennial might have been a victim of such an operation. After the article appeared FBI agents quietly working on the Centennial case took Pizzo aside and behind closed doors told him they personally believed his premise was correct. 

Three thousand miles away, in New York City, Stan Strachan, editor of a trade publication called the National Thrift News, described by USA Today as "the Bible of the thrift industry," heard of Pizzo's pursuit of Centennial. He called associate editor Paul Muolo into his office and told him to go to California to find out if there was a story in all that alleged skullduggery. Two days later Muolo sat in Pizzo's small, cluttered Cuerneville office and wondered if Pizzo was actually onto a story or was just a nut—his bust-out theory left little room for neutral ground. Was it even remotely possible that deregulation had allowed organized crime and their legions a foothold in the thrift industry? Muolo had to admit that thrift failures suddenly were multiplying exponentially around the country. The National Thrift News was reporting on the collapses every week. Something frightening, and not at all understood, was going on, and Pizzo's profile of Centennial's collapse was practically a template that could be laid over several others Muolo was writing about for the National Thrift News. Pizza complained that he had tried to alert regulators about Centennial in one way or another for months, but they had ignored him. The implications of Pizzo's suspicions were enormous. Muolo went back to New York to sort out what he had heard. 

A week later Mary Fricker called Pizzo. She had left the News and now worked for a daily newspaper nearby, but she had followed Pizzo's Centennial stories and had for a year been working on a related investigation of her own. Slie wanted to sit down and go through his files. Fizzo's Centennial "file" was a big, disorderly cardboard box stuffed with documents and notes. For a day she dug through the box and weighed the evidence that more had been going on at Centennial than met the eye. 

In December 1986 the three of us agreed that whatever was going on at thrifts was too big a story for any one writer to get his or her arms around alone. We decided to cooperate in a thorough investigation of savings and loan failures. We were still running on hunches at that point, but we had enough information to sense that we were on the threshold of what could be the story of a lifetime. And so we began sorting through Humpty Dumpty's eggshells scattered coast to coast. While industry professionals told us time and again that the growing number of thrift failures were simply the result of natural selection following deregulation, we steadily amassed evidence that suggested otherwise—Humpty Dumpty- had been pushed. 

By the end of 1988, Centennial Savings and 581 other thrift institutions were dead and another 800 were in regulatory intensive care and might not survive. Some of the people who had run those institutions were also dead — garroted, shot, or victims of suspicious accidents. And still the looting continued. In fact, it threatened to get worse as, incredibly. Congress made plans to deregulate banks. The multi billion-dollar problem created by the insolvency of over 500 of the 3,200 federally insured S&Ls, and the near insolvency of over 500 more, mind-boggling as it was, would be peanuts compared to an equivalent problem among the 14,000 federally insured banks. 

We were driven in our investigation by evidence that much of the looting in progress at many of the savings and loans around the nation was in fact not the work of isolated individuals but instead was the result of some kind of network that was sucking millions of dollars from thrifts through a purposeful and coordinated system of fraud. We saw evidence that classic "bust-outs" were in progress at thrifts everywhere we looked. At each step of our investigation our suspicions grew because, of the dozens of savings and loans we investigated, we never once examined a thrift—no matter how random the choice without finding someone there whom we already knew from another failed S&L. Yet there was no coordinated national investigation into the causes of the savings and loan crisis. Individual reporters and individual FBI agents around the country were peeking away at their own local thrift failures, but no one seemed to be pursuing the common links between geographically disparate thrift failures. Pizzo's suspicions since 1984 that there was a connection behind much of the looting had met with scoffs of disbelief at the highest levels of the Justice Department and the Federal Home Loan Bank Board in Washington. If some group or groups had successfully orchestrated the theft of tens of billions of dollars from financial institutions, in broad daylight, without firing a shot, and had gotten away with it without raising the Justice Department's suspicions, the implications for the country were grim. 

We believed we were in a race to identify the players in this massive looting operation. In the process we uncovered mobsters, arms dealers, drug money launderers, and the most amazing and unlikely cast of wheeler-dealers that ever prowled the halls of financial institutions. The damage they did to this country's thrift industry will be with us well into the next century. It will significantly add to our national debt and will cost every taxpayer in the country another $2,000 in taxes over the next ten years. The 150-year-old thrift industry itself may not survive.

CHAPTER ONE 

A Short History Lesson 

The deregulation of savings and loans in the early 1980's was prompted by a series of new problems that suddenly beset an industry that had been a stable member of the American financial community for 150 years. The first savings and loan in the United States—then called a "building and loan" and tailored after building and loan societies in England—was the Oxford Provident Building Association, formed in 1831 in Frankford, Pennsylvania (now part of Philadelphia). Savings and loans filled a vacuum created by banks, which were primarily interested in making consumer and commercial loans, not home loans. 

There were 12,000 savings and loans in operation by the 1920's but they were not part of an integrated industry. Each state regulated—or failed to regulate—its own S&Ls, and regulations differed widely from state to state. At the same time competition between thrifts and banks was creating friction be- tween the two kinds of financial institutions. Congress had created the Federal Reserve System for banks in 1913, thereby giving banks an aura of federal control and safety that S&Ls did not enjoy.  

In this environment a movement began to initiate federal regulation of thrifts, but before Congress could take concrete action the stock market crashed in 1929 and the Great Depression followed.- Over 1,700 thrifts failed and depositors lost $200 million in savings. Thrifts were desperate for help, and their lobby, the U.S. League of Local Building and Loan Associations (later to become the U.S. League of Savings Associations, the nation's largest and most powerful thrift trade association), urged the federal government to come to the industry's aid. 

By then thrifts had become a critical element in the national economic machinery and their troubles could not be easily ignored. President Herbert Hoover responded to industry pressure and signed the Federal Home Loan Bank Act in 1932, creating a federal S&L pyramid with the Federal Home Loan Bank Board (FHLBB) in Washington at the top, 12 semi-independent regional federal home loan banks (FHLBs) beneath it, and individual savings and loans at the base of the pyramid Thrifts were given the option of being state or federally chartered, but those who chose a federal charter had to operate under strict federal regulations and examiners were sent to make sure they did. 

Many Americans had lost their life savings during the "bank holidays" of the Depression and they were slow to put their money back into banks and thrifts. To encourage them to fund their neighborhood savings and loans with their meager savings. Congress decided the industry needed to insure its depositors' money against loss. In 1934 Congress established the Federal Savings and Loan Insurance Corporation (FSLIC), which insured deposits up to $5,000 — big money in those days. The FSLIC (pronounced Fizz-Lick by industry insiders) insurance system was funded not by the government but by assessments made on its member thrifts. 

In this new and improved federal thrift system, local insured deposits were loaned out to local home buyers, who then became solid members of the community, and new depositors—a business cycle that worked beautifully for 50 years. Savings and loans occupied a special place in America, making home ownership affordable for the emerging middle class primarily through 30-year, fixed-rate mortgages. Thrifts provided the fuel for the home-building engine that for almost half a century acted as the fountainhead of America's dynamic domestic economy. Headlines reading "Housing Starts Decline" always predated recessions, and "Spurt in Housing Starts" always announced the recovery. The American life-style centered around the single-family home funded largely by the little neighborhood savings and loan, a system immortalized in the classic Frank Capra film It's a Wonderful Life. In the film, Jimmy Stewart played George Bailey, the head of a sleepy little hometown thrift that lent money to residents of the mythical Bedford Falls. Insiders called those days the 3-6-3 days, when savings and loan executives borrowed (from depositors) at ? percent, loaned (to home buyers) at 6 percent, and were in a golf cart by 3 p.m. 

The first real trouble for this comfortable savings and loan world appeared during a mildly inflationary period in the 1960's when Congress worried over the increasing cost of homes. Since the Second World War affordable housing had become an American birthright. Congress' solution to rising home prices was to put a cap on the interest rate that thrifts could pay on deposits placed with them. Congress' reasoning was that if S&'Ls didn't have to pay too much for deposits, they wouldn't have to charge too much to the homeowners who borrowed from them. It was here that Congress' tinkering with the thrift system began going terribly wrong. The interest rate cap, designed to help the housing sector, became a serious handicap for thrifts in the 1970's. The wildfire of inflation that then swept the economy put savings and loans in a bind because by 1979 inflation was running at 13.3 percent but thrifts were limited to paying only 5 percent on deposits, and depositors were not willing to invest their money at such low rates. To compound the thrifts' problems, in the 1970's wily entrepreneurs introduced an entirely new product, the money market fund, which paid higher interest rates. Other companies—like Sears, American Express, and Merrill Lynch — saw the possibilities and also developed investments to attract savers' deposits. This increased competition was aided by new technologies. A twenty-first-century rail of satellite dishes and fiber optics enabled depositors to place their savings nationwide, even worldwide. They were no longer confined to their community bank or thrift in their search for a better return on their savings. Thrifts hemorrhaged from a steady outflow of deposits. By 1982, for example, there was over $200 billion in money market funds. 

The outflow from thrifts quickly reached crisis proportions. In 1972 the nation's savings and loans had a combined worth of $16.7 billion. By 1980 that figure had plummeted to a negative net worth of $17.5 billion, and 85 percent of savings and loans were losing money. Regulators began to warn that if nothing were done, all thrifts would collapse by the end of 1986. 

Throughout the years, when savings and loans experienced financial difficulties, federal regulators had traditionally added more layers of regulation. But they could not regulate away the effects of inflation, so in the mid-1970's they decided the opposite approach might work—deregulation. In 1980 Congress finally passed its first thrift deregulation bill, the Depository Institutions Deregulation and Monetary Control Act, designed to phase out interest rate controls on deposits placed with banks and S&Ls. At the same time Congress increased the FSLIC insurance coverage on deposits from $40,000 per account to $100,000. Regulators later said this may have been the most costly mistake made in deregulating the thrift industry. Suddenly thrifts could attract $100,000 blocks of (insured) money with which they could wheel and deal at no risk to the depositor or to the thrift officers. Ironically, this increase in FSLIC coverage was made with little debate and no congressional hearings. While legislators were hammering out the details of the Depository Institutions Deregulation and Monetary Control Act in a late-night session on Capitol Hill, Glen Troop, chief Washington lobbyist for the powerful U.S. League of Savings Institutions, and an associate convinced congressmen to make the increase.' 

"It was almost an afterthought," a House staffer later told a reporter. 

Deregulation of interest rates by the Depository Institutions Deregulation and Monetary Control Act was a mixed blessing for thrifts. It did increase their deposits but it created a deadly profit squeeze in the process. As the cost of deposits increased, the spread between the price thrifts paid for the short-term deposits and the rate thrifts had charged for the long-term loans they held (some of which they might have made 30 years earlier) increased. Thrifts were paying significantly more interest on deposits than they were receiving on old loans. In the first half of 1982 S&Ls lost a record $3.3 billion. Thrifts from around the country found their balance sheets bleeding a sea of red ink, and lobbyists from the U.S. League of Savings institutions and other trade organizations begged Congress to throw them another life preserver. The result this time was the most significant thrift legislation in 50 years, the Garn-St. Germain Depository Institutions Act of 1982, which Ronald Reagan signed in the Rose Garden ceremony in October 1982. Garn-St Germain went beyond simple tinkering. It was a complex piece of legislation that changed the face of an entire industry with a pen stroke. Two key elements were: 

S&Ls would be allowed to offer money market funds, free from withdrawal penalties or interest rate regulation. 

Thrifts could invest up to 40 percent of their assets in nonresidential real estate lending. Commercial lending was much riskier than home lending, but the potential returns were higher. This provision made thrifts vulnerable to enormous losses. 

Also in 1982, in a move designed to reassure worried depositors who heard about the thrift industry's problems, Congress passed a Joint Current Resolution that placed the full faith and credit of the U.S. government behind the FSLIC.  Thrift regulators also got the deregulation fever: 

To combat the dying off of S&Ls, a regulation requiring a thrift to have 400 stockholders with no one owning more than 25 percent of the stock was changed in April 1982 to allow a single shareholder to own a thrift. This did result in the start-up of many new savings and loans, but it completely changed the character of the industry. Approval for a new thrift charter had traditionally been based on a clear community need and widespread local support for the thrift. Now the thrust was to attract innovative, visionary entrepreneurs to be the saviors of the thrift industry. What the industry got was a rush of brash, new owners with no other stockholders to buffer the S&L's well-being from the controlling owner's ambition, bad judgment, or greed. 

To make it even easier for an entrepreneur to purchase a thrift, regulators allowed buyers to start (capitalize) their thrift with land or other "non-cash" assets rather than money. (This provision was a boon to land developers who had extra land lying around that they had not been able to develop.) 

To encourage more loan business for savings and loans, regulators said thrifts could stop requiring traditional down payments from borrowers. Instead, thrifts could provide 100 percent financing, with the borrower not having a dime of his own money in the deal. 

Thrifts were permitted to make real estate loans anywhere. They had until now been required to loan on property located in their own market area, with an emphasis on community home building and ownership. But with this new regulation (which was intended to encourage a freer flow of funds from cash-rich to cash-poor areas and to increase loan opportunities for thrifts), thrifts were allowed to loan on property too far from home to monitor properly. 

On top of these revolutionary changes, owners of troubled thrifts began stretching already liberal accounting rules—with regulators' blessings—in order to squeeze their balance sheets into compliance. (Traditional accountants termed the liberalized thrift accounting methods "voodoo accounting.") For example, "goodwill"—defined as customer loyalty, market share, and other intangible "warm fuzzies" accounted for over 40 percent of the thrift industry's net worth by 1986. 

In all these ways—Congress passing legislation and regulators easing regulations and accounting standards—the federal thrift industry was systematically deregulated between 1980 and 1983. And for a while it looked like deregulation was working. In 1983 and 1984 the thrift industry appeared to grow by $300 billion. Empire Savings, for example, had assets of only $20.7 million in 1982, but by 1984 it recorded assets of $320 million. George Bailey's little sleepy building and loan became a powerful money lending/development conglomerate that could make loans on, or even own, hotels, shopping malls, mushroom and windmill farms, tanning beds, Arabian horses, Wendy restaurants, and hot-tub spas—or invest in junk bonds and the futures markets. The sky was the limit and it could all be done with federally insured deposits. 

Unfortunately, many of the "entrepreneurs" attracted by these changes were actually con men intent upon draining as much money from the system as they could and then moving on. Simply put. Congress and Bank Board officials failed to add into the deregulation equation almost everything mankind has learned about human nature since the dawn of recorded history. Greed, avarice, ambition, and ego dictate that some things in the social order just can't be left on the honor system, and at the top of that list is the care and feeding of other people's money. 

One former swindler, speaking to us from Fort Leavenworth federal penitentiary, where he was serving time for loan fraud, said his compatriots knew immediately what deregulation could mean to them. Imagine how they felt, he recalled, when "they realized they could have access to all the money they ever wanted." 

It's not hard to understand why savings and loans in the 1980's became known as "money machines." As one regulator remarked years later, "They didn't deregulate the industry, they unregulated it." 

Perhaps conditions could still have been kept under control, in spite of deregulation, if the examiners responsible for watching over savings and loans had done their job. So where was that diligent cadre of solemn bank examiners who had once traveled the country making certain that bankers stayed honest? Well, first of all, there were a lot fewer of them. The philosophy of the Reagan administration was that deregulation meant fewer regulators and examiners, so their number was cut. States, too, cut their supervision staffs. Turnover by 1984 was running at 16 percent. Those examiners who were left were simply outgunned, overworked, under trained, underpaid," and ill-equipped to face down the new breed of banker attracted by deregulation. Each FSLIC employee was responsible for watching $18.7 million in assets, about four times the $4.7 million in assets watched by each employee of the FDIC, which insured banks. As the industry deregulated, inspectors accustomed to examining nearly identical sets of books at each thrift, books based on simple 30-year home mortgages, suddenly were expected to be able to follow the intricate machinations of highly speculative finance. Examining a $20,000 loan on a home was a far cry from trying to judge the quality or prudence of a $20 million loan on a shopping center or a multi tiered master limited partnership. 

It wasn't long before thrift failures rippled across the nation like one of those elaborate displays of dominoes that are erected and then destroyed for the Guinness Book of World Records. But the destruction didn't all happen in a day or a week or a month. It was four years in the making, and as we followed it we often asked ourselves the same question that Charles Bazarian, one of the borrowers convicted of fraud, demanded of us: 

This all didn't happen just yesterday. This happened over a long period of time. So where were the regulators, huh? They like to run around now, acting like they just discovered all this. Where were they when it was going on? Where were the goddamn regulators then?

Where. indeed, were the regulators-' while thrifts were being looted? During our investigation we got very little in the way of answers to that question. Spokesmen at the FHLBB either flatly refused to discuss thrift failures or they lied about them. In 1983 they told us there was no problem. Then later, when the trouble burst into the open, they lied to us about the size of the problem. Then they lied to us about the causes of the problem. There was no fraud, no organized crime involvement—it was the economy's fault, they said. Then they threw a blanket of secrecy over the solutions they said they had in mind. 

In the thrift industry itself, trade groups like the powerful U.S. League of Savings Institutions worked overtime during the years following deregulation to make sure the industry's dirty little secret never got out. They feared that if the public learned that some people were using deregulation to loot thrifts, they would demand re-regulation. 

It was only after we were well along in our investigation, and had cultivated solid sources within the Justice Department and the law firms working for the FSLIC, that we began to learn just why everyone was so afraid to talk. If what we saw at crooked thrifts had concerned us, nothing had prepared us for the abuses of power we found in Washington. But we also found courage, and we found the story of a lonely and painful passage for a most unlikely man—Edwin Gray. U.S. League members had talked Gray into becoming chairman of the FHLBB. When he took office, in May of 1983, he assumed control of a regulatory apparatus completely unequipped to handle the coming thrift explosion.

CHAPTER TWO 

Shades of Gray 

On a Monday in November 1982, stocky, congenial Edwin Gray was in New Orleans to attend the annual convention of the U.S. League of Savings Institutions. Gray represented Great American First Savings Bank of San Diego, California; he was their PR man. His old friend from California, Ronald Reagan, was to be the keynote speaker at the convention. Gray and Reagan went way back together—Gray had been Reagan's press secretary during his years as governor of California. Gray, 47, was a mainstream Reaganite. He believed in Reagan and his free market philosophy. When Ronald Reagan was elected president. Gray had briefly taken a job with the administration as assistant to the president and director of the White House office of policy and development. But Gray's wife, Monique, had disliked Washington and its humid climate and wanted to return to their home in sunny San Diego, so Gray left the administration and went back to his post at Great American First Savings Bank. 

President Ronald Reagan was coming to New Orleans to tell members of the U.S. League of Savings Institutions that their industry was well on its way back to its halcyon days. With the signing of the Garn-St Germain bill less than a month earlier, Reagan believed he had personally unfettered a mighty industry which could now rise to towering heights. Gray believed the same, and in fact he had spent a good deal of time in Washington lobbying for the bill before its passage. Once, when he submitted a $2,000 expense voucher, his superiors at Great American Savings quipped, "Since you're spending so much time working for the U.S. League, lobbying for Garn-St Germain, maybe they can pick up part of this." One of the items on the tab was $600 for a dinner Gray had hosted for another old California friend, Ed Meese. 

Ed Gray was enjoying being a gadfly at the New Orleans convention when suddenly Leonard Shane, the 1983 chairman of the U.S. League, pulled him aside. The position of chairman of the Federal Home Loan Bank Board (the Washington, D.C. , agency that regulated the nation's federally chartered savings and loans) was coming up for grabs, Shane told Gray. Its current chairman, Richard Pratt, a Mormon and a burly former educator from Utah, was returning to private business. Traditionally the U.S. League had a major say in picking the FHLBB chairman. 

"Ed, we want you to be the next chairman," Shane told Gray. 

Gray was flattered. Bill O'Connell, president of the U.S. League, also asked him if he'd consider being chairman. Gray told them only that he'd think about it, but the word had already gone out among the membership that Gray had been given the League's benediction. Delegate after delegate came up to him and asked him to take the job. It became a little embarrassing, but the refrain was like music to Gray's ears. A thrift executive becoming chairman of the Federal Home Loan Bank Board was like a priest being elected Pope. How could he say no? Ed Gray's chimney soon issued forth the white smoke of acceptance. 

On May 1, 1983, Ed Gray was sworn in as the seventeenth chairman of the Federal Home Loan Bank Board (FHLBB or the Bank Board), a three-member board that consisted of the chairman and two directors who were referred to as "members." Under law, one board member had to be a Republican and the other a Democrat. 

With his wife at his side, Gray raised his right hand and took the oath of office, administered by his friend attorney general Ed Meese. Then Gray took off his horn-rimmed glasses and smiled. Those who were there that day remembered that he already looked tired. But being chairman of the FHLBB wasn't a hard job, and he'd promised Monique he'd stay only two years. Gray would have to make a lot of upbeat speeches about how well the industry was doing, and he was expected to support legislation the industry wanted—or that's what the job had been like for his predecessors. Had Gray known what really lay ahead, and that his term would turn out to be one of the longest and most tumultuous in FHLBB history, he might have put his right hand back in his coat pocket and taken Monique home to San Diego. 

In the coming four years, until the end of his term in June 1987, Gray would be investigated by the FBI and the Government Ethics Committee and badgered by congressmen and senators, including the powerful speaker of the House, on behalf of their constituents. His own administration, and his longtime friend Ronald Reagan, would turn their backs on him, turning him down when he asked for more money and more regulators to help deal with the massive abuses and insolvencies besetting the S&L industry. And that very same thrift industry that had begged him to take the job would vilify him for his efforts to save it. Ed Gray would become a pariah. 

Gray didn't know it then, but he had just been sworn in as the central character in an epic drama. And how unlikely a protagonist he was. Ed Gray was in no way prepared for the task that was about to be handed him. Some would say he wasn't qualified for it either. He was a public relations flack by trade. He gave warm smiles, firm handshakes and great back slaps, and he told a good story. He was an old-fashioned gentleman with thinning, graying hair who called his women acquaintances "dear." A nice guy, an honest guy . . . but he did not have the national stature of a Paul Volcker. 

But then Gray had not been selected on the basis of his qualifications. He was supposed to be a cheerleader for the thrift industry and a tool of the administration. That point was driven home his first day on the job when he received a phone call from Treasury Secretary Don Regan. 

"You're going to be a team player. I take it?" Regan asked him. 

"Sure," Gray said, leaning back in his swivel chair. "Sure." 

Regan hung up with Gray still holding the receiver. What was that all about? Gray wondered. 

He threw himself into the job of chairman. He loved the idea of being a public official, and he took the responsibility to heart. He was a Mr. Smith Goes to Washington kind of guy. Ed was no monetary genius, but what he lacked in experience he tried to make up for by putting in long hours. He wanted to know what was going on in the industry and, conversely, he felt it would be helpful for thrift executives to know what was on his mind. So Gray had his staff mail copies of all his speeches to the directors and chief executives of the nation's major thrifts. "The Thoughts of Ed Gray" became a regular part of industry mail call. Stodgy industry leaders viewed all this with amusement, and the joke started to circulate that if you suddenly realized you'd been dropped from Ed's mailing list, it probably meant the Bank Board was getting ready to close your thrift.

Gray was a very different kind of regulator than his predecessors. Like the president, who had appointed him, he held strong, sometimes simplistic views of what he considered to be right and wrong. And when he had to make decisions on technical matters, he let those instincts mold his course. 

Gray's first few months in office passed in relative quiet. The only problem on his plate at the time was untangling the mess left by the collapse of Manning Savings and Loan in Chicago. The Bank Board had closed Manning Savings just before Gray was made chairman. The $117 million thrift had failed after growing rapidly, not by attracting local deposits but by using deposits from deposit brokers to invest in questionable real estate ventures. 

Deposit brokers handled billions of dollars for institutional investors like pension funds, insurance companies, even Arab nations looking for a profitable place to park their oil revenues. They scoured the nation each morning for the highest interest rates being paid that day on certificates of deposit (C.D's), and then purchased $100,000 insured C.D's with their investors' money. Such brokered funds became known to regulators as "hot money" because they were temporary. When the certificates matured the money would again flow to whomever was paying the best rate that day. The fickleness of these deposits forced thrifts to offer higher and higher interest rates to attract them. 

Brokered deposits, in small doses, could help a thrift stabilize its deposit base and give it a quick, though expensive, source of funds when the thrift was a little short. But Manning Savings had overdosed on brokered deposits. An old adage came to Gray's mind: The only thing that separated a medicine from a poison was the quantity in which it was used. Gray remembered another time, back in the 1960's, when thrifts had turned to brokered deposits in a big way. The result was a wave of cut-throat thrift competition for deposits that drove up the interest rate the S&L's had to pay to attract those deposits. Thrifts willing to pay the highest price then grew too fast. The FHLBB in Washington had ended the practice in July 1963 by limiting the amount of brokered deposits a thrift could hold to 5 percent of its total deposits. 

But that was old-fashioned regulation. In 1980, when thrifts were having a hard time attracting deposits, regulators had repealed the 5 percent limit, and brokered deposits once again became all the rage. But unlimited brokered deposits combined with Garn-St Germain, which deregulated what thrifts could do with those deposits, created a volatile chemistry. Thrifts could get their hands on all the money they wanted and could invest that money in almost any scheme they thought might turn a profit.'

Gray saw immediately the risk inherent in the combination of ambitious entrepreneurial thrift owners, with their quest for high-yield investments, and the easily available brokered deposits to fund those investments. He knew that the Federal Deposit Insurance Corporation (FDIC) under chairman William M. Isaac was struggling with a similar problem, following the 1982 collapse of Penn Square Bank, a small shopping-center bank in Oklahoma City. Brokered deposits had fueled Penn Square Bank's wild speculation in oil industry investments and had contributed to an unhealthy atmosphere of management fraud. (In 1988 a bank official would plead guilty to criminal charges in a scheme that regulators said involved risky loans and kickbacks.) But few people in Washington other than Isaac, and almost no one out in the 50 states, shared Gray's assessment. 

Since the creation of the federal S&L industry in 1932, state and federal savings and loans had coexisted peacefully. State thrifts could receive FSLIC insurance if they chose to pay the premiums, but they were regulated by state agencies and state regulations instead of the FHLBB and federal regulations (except that they did have to adhere to FSLIC standards). On the whole the differences between state and federal regulations were slight (though state regulations tended to be more liberal than federal regulations) until federal deregulation in the early 1980's changed the rules of the game. Then, many say, real deregulation happened on the state level. Notable among the states with more liberal thrift regulations were Arizona, Florida. Illinois, Louisiana. Michigan, Mississippi, Missouri, New York, North Carolina, Ohio, Virginia, and Washington. But Texas and California outdid them all, grabbing the lead in deregulation one-upmanship (Texas won first place, but California ran a close second). 

Actually, deregulation was not new to Texans. They had significantly liberalized regulations for state-chartered thrifts in 1972 and again in 1981. In addition, banking had for years been done differently in Texas. Typical features of the state thrift business included risk-taking, wheeling and dealing, and domination by a good-old-boy network that had close ties to the most powerful Texas politicians. When oil prices went from $7.64 per barrel in 1975 to $34.50 per barrel in 1981, the Texas economy boomed, building permits quadrupled, and Texans thought they were invincible. All the thrift industry needed then to rocket into the stratosphere was for the feds to approve brokered deposits and for the FSLIC to decide to insure S&L deposits up to $100,000 each, all of which happened in 1980. In the early 1980's Texas thrifts attracted huge deposits by promising to pay a higher interest rate than anyone else in the country, and they invested those deposits in commercial real estate ventures. Texas thrifts grew at roughly three times the national average. So many new owners were attracted to thrift ownership in Texas—because Texas thrifts seemed to be able to get their hands on endless supplies of money and the Texas real estate market was booming—that by 1987, when Texas thrifts finally were failing in large numbers,  50 percent were run by managers who had entered the business after 1979 (over 80 percent were former real estate developers). 

Typical of the new thrift owner in Texas was Harvey D. McLean, a Dallas developer and chairman of Paris Savings and Loan. Reports in Business Week that he had attended a costume party wearing punk regalia and blue hair and joked that he was dressed that way to visit his banker surprised no one in the out-of-control Texas thrift environment. Durward Curlec, a Texas thrift lobbyist who had been executive director of the powerful Texas Savings and Loan League, was referring to Texas thrift owners' penchant for fleets of airplanes when he remarked to a Business Week reporter, "That's not criminal. That's Texas." 

Out in California state-chartered savings and loans had been struggling to survive since 1975 under a state administration that employed hard-nosed regulators. When the federal government eased up on regulations between 1980 and 1982, over half of the state's S&L's, including most large California thrifts, switched to federal charters. The result was a precipitous drop in S&L contributions to state politicians and also in income (from fees charged to member thrifts) for the California Department of Savings and Loan, which regulated state S&Ls. The department lost more than half its income and had to lay off more than 60 state examiners. Under those dire circumstances Governor Edmund Brown, Jr. decided to treat S&Ls more kindly. 

Former State Assembly Minority Whip Paul Priolo told us later that the California League of Saving's Associations (the Cal League), the thrift industry's statewide lobbying group, lobbied the state legislature every year with the same theme: "They told us every year that we had to pass legislation to match any federal legislation that might cause thrifts to switch to federal charters. The buzzword was 'parity.' They constantly lobbied for parity, or better, with federal legislation. And they almost always got what they asked for. " Priolo said legislators knew little about the thrift industry and relied on the Cal League for guidance in drafting new state regulations. A former federal regulator said state politicians were also concerned they would lose contributions if state-chartered thrifts switched to federal charters. 

In response to the political and financial pressure. Republican state assemblyman Pat Nolan, who was an associate of a number of S&L executives, sponsored the Nolan Bill, which became law January 1, 1983. Under the terms of the new California law, virtually anyone could own an S&L, attract as many deposits as he could pay for, and invest all those deposits in anything. And it could all be insured by the PSLIC and backed by the full faith and credit of the U.S. government. California's deregulation made Garn-St Germain look conservative by comparison, and in retrospect it was a terrible mistake. But only one lawmaker voted against it, and traditionalists in the thrift industry who worried about it kept their concerns to themselves. (Five years later, however, they would claim that the thrift industry's problems were not their fault.) 

Later Ed Gray would remark, "Can you imagine? Any business, any entrepreneur [in California] could get a charter and could run whatever operation he wanted on the credit of the U.S. government? Imagine that! It didn't matter. You could choose any business you wanted to be in. . . . Just incredible." 

Ed Forde, who owned San Marino Savings and Loan in Southern California (which failed in 1984 soon after Empire Savings collapsed), told us years later how he felt when he learned of the new California regulations at a seminar sponsored by state regulators. " 'My god,' I said to myself, 'this is what I've been waiting for all my life!' " Clever consultants and law firms began canvassing the state offering seminars on owning one's own savings and loan. Jeffer, Mangels and Butler, for example, was a Los Angeles law firm that gave seminars called "Why Does It Seem Everyone Is Buying or Starting a California S&L?" 

The strategy failed to attract back most of the thrifts that had recently switched to federal charter, but it did attract hundreds of entrepreneurs interested in starting new S&Ls. What politicians and regulators later claimed they could not foresee (the loopholes and opportunities created by deregulation) were instantly recognized by those who wasted no time flooding the state with applications—235 between April 1982 and the fall of 1984. Unfortunately, the rush of applications far exceeded the state savings and loan commissioner's ability to investigate the applicants. 

When the job of state commissioner became available in March of 1983 (with the new Republican administration of George Deukmejian), Ed Gray recommended his friend Lawrence W. Taggart for the post. But Taggart, it turned out, had a very different regulatory philosophy from Gray. Gray was deeply troubled by the brokered deposits that by 1983 were fueling fearful growth in California, but Taggart saw no problems. When many of the new California thrifts ballooned their assets from the minimum start-up capital of $2 million to tens and then hundreds of millions of dollars, using brokered deposits, and when growth rates at some California thrifts exceeded 1,000 percent a year, Taggart wasn't worried. On the contrary he took a real shine to the new breed of thrift owners, accommodated them in every possible way, and approved their thrift applications as soon as the paperwork could be completed (he approved 60 charters in his first six months in office). 

And look who showed up as California savings and loan owners: 

Dr. Duayne Christensen, a Southern California dentist-turned-real-estate speculator, got tired of begging for loans from straitlaced thrift officers and in January 1983 he opened North American Savings and Loan in Santa Ana, California. A married man with teenage children, Christensen had undergone a midlife crisis of some sort and had taken up with a flashy real estate lady from Oak Grove, California, Janet F. McKenzie. Both apparently shared a burning desire to be rich. 

In short order, according to an FSLIC lawsuit, the two began to wheel and deal with North American's deposits, investing them in grossly over appraised real estate projects in which they held a secret interest. One project alone (a 20- unit condominium project in Lake Tahoe, Nevada), which they acquired for less than $4 million, they sold back and forth to artificially increase its value to $40 million, regulators said. Reno mortgage broker John Masegian helped put together loans for the condominium deal. The next month, February 1983, while he was attending a savings and loan convention in Miami, he was garroted in the stairwell of the Fountainebleau Hilton. The murderers had tried to stuff his body down the trash disposal chute but it wouldn't fit. No one was charged with his murder. A security guard claimed that a few months later Christensen tried to hire him to kill a business partner who lived in Arkansas, but later Christensen changed his mind. 

North American collapsed in June 1988 and cost the FSLIC $209 million. The day before North American was seized by federal regulators, Christensen was killed in a mysterious single-car accident when his Jaguar slammed head- on into a freeway abutment at six o'clock in the morning, leaving a $10 million life insurance policy that named McKenzie as sole beneficiary and a will Christensen had signed three days earlier that named McKenzie as his sole heir. The coroner ruled out foul play in Christensen's death and the $40 million that regulators said Christensen and his associates spirited out of North American Savings remained missing. In April 1989 McKenzie and four others were indicted and charged with racketeering. The case was pending as of this writing. 

A few miles away, in Ramona, California, former rug salesman John L. Molinaro and his partner Donald P. Mangano, who owned a construction company, were granted a charter and opened Ramona Savings and Loan in April 1984. in short order the thrift made loans to condominium construction projects being built by Mangano & Sons Construction Company, condominiums whose floors were later covered by carpets from Molinaro's carpet store. Regulators and the Justice Department later charged that the two men became more and more bold in devising ways to part Ramona Savings from its deposit money as time passed. Two years after opening its doors Ramona Savings collapsed into insolvency. FSLIC officials said Ramona Savings would cost them $70 million. 

Ten months after Ramona Savings' collapse, a San Francisco passport clerk caught Molinaro trying to get to the Cayman islands on a dead man's passport. When the FBI arrested him and searched his Mercedes, they found false ID's and materials on how to establish a false identity and launder money. They also found, and filed in court, his list of things to remember, which included . . . "consider storing gold in Cayman deposit box . . . write out a plan for depositing Cayman cash and bringing some back thru (sic) Canada" . . . etc. When FBI agents checked inside the Cayman safe-deposit boxes, they found what the FSLIC believed was some of Ramona's money. Molinaro told FBI agents he had deposited $3 million at First Cayman Bank, and in safe-deposit boxes he had stashed $278,000 in cash and $100,000 in gold and diamonds ... all accessible by secret code. 

The list of colorful characters who showed up at thrifts in California following deregulation was a long one, and they arrived at a time when the state regulatory commission was crippled by the recent loss of 60 examiners (caused by the budget crunch when state thrifts defected to federal charter from 1980 through 1982). Not until Taggart was succeeded by William Crawford as state savings and loan commissioner in 1985 would the examining staff begin to be rebuilt. 

During those under supervised years high fliers and swindlers looted the thrift industry of billions of dollars, right under the overworked examiners' noses. They even developed shoptalk to describe their crooked deals: "dead cows for dead horses," "cash for trash," "kissing the paper," "land flips," "daisy chains," and "white knights." Each was a sleight of hand that rogue thrifts employed around the country to confuse regulators and hide the frauds that underlay their operations. 

The profligacy of thrifts around the country, especially in Texas and California (and secondly Florida and Arizona), didn't begin to catch Ed Gray's eye in Washington until the Empire Savings failure in 1984. By that time the horse was definitely out of the barn. Most of the problems were developing at state-chartered thrifts rather than federally chartered institutions (because the states adopted regulations even more lenient than were enacted on the federal level), but Gray was affected in a very important way by what happened on the state level because the FSLIC, which he and his fellow board members at the FHLBB administered, insured most of those state thrifts and would have to bail them out should they fail. Ironically, it was precisely the FSLIC coverage that made the looting of thrifts so lucrative and relatively risk free—for everyone except the FSLIC and, ultimately, the taxpayer. Thanks to the FSLIC insurance, depositors didn't have to worry about their money, and the people who were spending it certainly didn't.

Next
Centennial Gears Up for Deregulation

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