4 Who Shaped S&L; Crisis : Government and Industry Officials Sought to Solve Thrifts’ Woes But Ended Up Making Them Worse

By now, it is well known that the crisis in the nation’s savings and loan industry resulted largely from fast-growth lending practices that went bust. Less well known is the role of policy makers and industry leaders who, however well-intentioned, helped create conditions that would later prove disastrous.

As the public looks for people to blame for the S&L; crisis, attention has focused largely on S&L; managers who were either inept or corrupt. But longtime S&L; industry observers also point to others who have escaped scrutiny--government and industry officials who allowed those S&L; managers to run amok.

The thrift industry embarked on a lending binge in 1983 that increased the value of its assets 56% to $1.07 trillion at the end of 1985. Many of those loans turned sour. In so doing, the seeds were planted for a massive number of failures that now are expected to cost at least $90 billion to clean up.

Some lawmakers and regulators encouraged the growth that would later prove troublesome. Others, including some industry officials, remained blind to the enormity of the problem until too late, when it became impossible to ignore.

Following are the stories of four industry and government officials whose public policies, though well-meaning, backfired and contributed to the S&L; problems that will now cost taxpayers heavily.

RICHARD T. PRATT

Now that the thrift industry’s problems have reached catastrophic proportions, Dick Pratt finds that his record as the nation’s top thrift regulator from 1981 to 1983 is being put under a magnifying glass.

The picture is not altogether pretty.

As chairman of the Federal Home Loan Bank Board, Pratt supervised the industry during a period of severe turbulence in which heavy losses and hundreds of failures, brought on by double-digit interest rates, threatened to ruin an entire industry.

Pratt, now 52, took the bank board post after a long career as an economist, consultant and finance professor at the University of Utah. He holds a Ph.D. from Indiana University in finance, real estate and urban economics.

For 24 hectic months, Pratt supervised hundreds of bailouts and helped craft a series of landmark regulations designed to help thrifts operate in a hostile environment. A strong advocate of deregulation and free markets, Pratt pushed successfully for federal legislation designed to expand investment powers for thrifts.

In retrospect, many of Pratt’s actions are being viewed as ill-conceived. In particular, the move by the Pratt bank board to further lower capital requirements and liberalize accounting standards backfired, critics say.

Liberated by looser standards, thrifts swelled in size, lending large sums in areas in which they had little expertise. When many of those loans went into default, lenders were forced to write off much of their value. That in turn wiped out their capital and rendered them insolvent.

“The effect of the Pratt bank board has been extreme in the negative,” said Jonathan Gray, industry analyst for Sanford C. Bernstein & Co. in New York and a harsh critic of Pratt’s policies.

One bank consulting firm, Veribanc in Woburn, Mass., said bank board decisions to let thrifts reduce the required level of capital to 3% from 5% of liabilities from 1980 to 1982 look particularly questionable. That reduction, coupled with other adjustments to capital requirements, gave ailing lenders a grand opportunity to make even more loans and grow even faster.

“We have estimated that the $100-billion cleanup cost could have been reduced by as much as $75 billion if the . . . capital standards had not been relaxed,” Veribanc banking analyst Don Inscoe said in a report prepared for The Times.

Remains Influential

Though Pratt acknowledges that mistakes were made, he points to his positive legacies, such as the new freedoms granted to thrifts to hedge against interest rate risks, including the power to make adjustable-rate mortgages.

Pratt’s subordinates at the bank board also note that many regulatory changes stemmed from a lack of money, which prevented regulators from closing insolvent thrifts and paying off depositors. Further, they say, regulators had grave concerns about possible deposit runs, which led them to soften accounting standards in an effort to shore up public confidence in the industry.

Now head of mortgage capital operations at Merrill Lynch & Co., Pratt remains a familiar and influential industry figure, regularly attending industry meetings and hosting a prestigious housing conference every winter in Park City, Utah.

Any residue of ill feelings about his regulatory actions are usually expressed in private. An imposing man with the bulk of an ex-football player, Pratt is a popular figure who can be candid and caustic in public.

“He has maintained his popularity because he is very direct,” Washington banking consultant Rita Fair said.

Others note that Pratt’s motives were well-intentioned, even if some decisions don’t look that wise today. “I’d give him an A for effort,” said Theo H. Pitt Jr., a thrift lender in North Carolina, “but for results, I would give him a D.”

WILLIAM B. O’CONNELL

These days, Bill O’Connell works out of an office in Chicago, far from the action in Washington and frustrated by what he sees happening to his beloved thrift industry. The Bush Administration wants to strip the industry of its autonomy by placing its regulatory agencies under control of the Treasury and commercial bank authorities.

“I’m broken-hearted,” said O’Connell, who stepped down last fall as head of the U.S. League of Savings Institutions, the industry’s primary trade group. “I had a great deal to do with building up this industry and the league. The Bush plan is basically going to destroy the business.”

Now 66, O’Connell did not leave his job in a blaze of glory, despite more than 40 years of service with the trade group. After a perfunctory public send-off at the league’s annual convention in Hawaii last fall, O’Connell took a less visible job as head of the group’s profit-making operations.

Critics say that O’Connell made key tactical errors in recent years that have greatly diminished the league’s influence and reputation on Capitol Hill at a time when it needs help the most. It’s now up to Congress to pass judgment on President Bush’s proposals.

‘Members Were Friends’

O’Connell’s association with the trade group goes back to 1948, when he took a public relations job with the Chicago-based organization. He assumed the mantle of chief executive in 1980 at the beginning at what was to be the industry’s worst decade since the Depression.

O’Connell has many supporters, particularly within the industry. They portray him as a superb strategist who worked to avoid confrontation and reach workable public positions that would satisfy his far-flung and often bitterly divided membership.

“He was an astute political strategist and was savvy when it came to seeing what lay ahead for the industry,” said league spokesman Mark Clark.

But critics say O’Connell was shortsighted and far too protective of those thrifts that had gotten into financial trouble.

“The members were his friends,” said Edwin J. Gray, chairman of the Federal Home Loan Bank Board from 1983 to 1987. “He was going to do everything possible to help them. He must have said to me 50 or 100 times: ‘We have to buy more time.’ ”

Gray accused the league under O’Connell’s leadership of trying to sabotage regulations and legislation designed to rein in rogue thrifts that were growing much too fast. But such talk puzzles O’Connell, who claims: “I was (Gray’s) best friend when everyone else was trying to shoot him down.”

Even O’Connell admirers say he had grown weary from the continual industry turmoil and was probably rendered ineffective as league president when the price tag on industry failures soared far beyond anything the trade group had told Congress to expect.

“If there was an overwhelming demand, he would have stayed” as president, said one league staff member who asked not to be identified. “He was never asked.”

PAT NOLAN

To savings and loan traditionalists, the Nolan bill approved by the California Legislature in 1982 was sheer folly.

“The Nolan bill was an unmitigated disaster and a supreme act of foolishness,” said Herbert M. Sandler, who heads World Savings & Loan in Oakland. “It was ill-advised in every respect.”

Authored by an ambitious, industry-friendly assemblyman from Glendale named Pat Nolan, the bill was supposed to provide state-chartered thrifts in California with a limited expansion of their investment powers beyond their traditional role as home mortgage lenders.

Instead, California-chartered thrifts got vastly expanded powers, a move that led to a spree of ill-advised investments--from windmills to “junk bonds”--and helped pave the way for dozens of expensive failures.

The Nolan bill, with modest support from the industry Establishment, passed overwhelmingly with little controversy and no apparent recognition of its potentially disastrous flaws. The only protest came from commercial bankers, who objected to expanded consumer lending powers for thrifts.

Aid to Campaign Funding

“It wasn’t real controversial,” said David K. Milton, a lobbyist for the California League of Savings Institutions. “It was one of those pieces of legislation that was viewed as a turf battle between similar industries.”

The bill was also an attempt to persuade more thrifts to obtain a California charter--as opposed to a federal one--to provide added sources of campaign funding for state politicians. In California, only state-chartered thrifts could legally make contributions to candidates for state office.

Those who wrote the bill thought they were writing rules for a conservative industry that would use the expanded investment powers prudently. But events unfolded differently, in part because a provision in the bill empowered thrifts to invest their money in subsidiaries that in turn had unlimited investment powers.

Meanwhile, in Washington, the Federal Home Loan Bank Board under Chairman Pratt eliminated a rule that required thrifts to have a minimum of 400 shareholders. The regulation was a throwback to simpler days when savings and loans were broad-based local organizations whose owners were supposed to represent the community at large.

Eager to attract more capital into the industry, thrift regulators decided that thrifts needed no more than one shareholder. As a result, small groups of investors rushed to buy savings and loans, though they had little interest in making home loans. Many wanted to be investors and real estate developers and saw thrift ownership as the vehicle.

The combination of the shareholder rule change and the Nolan bill “made for quite an explosion,” said Regan E. Kelly, a regulator for the California Department of Savings and Loan in the mid-1980s under Commissioner Lawrence W. Taggart.

“The intended effect was to get more capital into the industry,” said one former federal regulator, alluding to the bank board’s action. “It was a well-intended act that went awry.”

Much has happened to Nolan since his bill passed. Once considered a rising star in the Republican Party and a possible candidate for governor, he has since stumbled and is now a target of a federal probe involving possible campaign contribution irregularities.

Nolan makes no apologies for his legislation, which he says was passed with the goal of helping an extremely troubled industry. He blames subsequent problems on regulators who did not adequately do their job as supervisors and on industry traditionalists looking for someone to blame.

“My bill became a scapegoat for the dinosaurs of the industry who feared competition,” the 38-year-old lawmaker said.

LAWRENCE W. TAGGART

When Larry Taggart was the state’s chief thrift regulator in 1983 and 1984, he was a folksy and friendly supervisor who did his best to promote the industry in which he had grown up and worked for most of his adult life.

As a loyal Republican and faithful follower of the Reagan doctrines of more growth and less government, Taggart encouraged new capital to come into the business and urged thrifts to take full advantage of the expanded investment powers provided by the Nolan bill.

Time has not been kind to Taggart’s regulatory philosophy. Today, the California industry is paying heavily for the fast-growth lending polices of thrifts doing business while Taggart was commissioner of the California Department of Savings and Loan.

Lawmakers and government officials now say the industry was riddled with fraud and abuse during the time Taggart was at the helm. According to congressional testimony, state-chartered thrifts accounted for most of the failures that have haunted the California thrift industry since 1984.

Taggart could not be reached for comment on this article.

“We’ve had commissioners who have done a lot better job than Mr. Taggart,” said Dean Cannon, head of the California League of Savings Institutions.

In recent years, Taggart worked as a consultant and later took a job as a mortgage lender for a firm owned by Charles W. Knapp, former chairman of the now-bankrupt Financial Corp. of America. It was during Taggart’s tenure as state commissioner that federal thrift regulators forced Knapp resign from FCA during a massive deposit run.

Now 46, Taggart surfaced in San Francisco several weeks ago to testify before a congressional committee that was probing the thrift industry’s problems.

Committee members were particularly interested in a letter that Taggart had written to then-White House Chief of Staff Donald T. Regan on Aug. 4, 1986. At the time, Taggart was a consultant working with a number of troubled but politically influential thrifts in Texas.

Letter Was a Red Flag

In that letter, Taggart complained bitterly about Gray, then chairman of the Federal Home Loan Bank Board. His actions were causing “irreparable harm” to the thrift industry and would likely have “a very adverse impact on the ability of our party to raise needed campaign funds in the upcoming elections,” Taggart warned.

The letter was a red flag for some congressmen, who indicated they felt it was unseemly for a former regulator to be trying to exert that kind of political influence on Regan, whose dislike for Gray was well known. Taggart denied that he had done anything improper.

One of his former assistants, Regan Kelly, remembers that the real problem during the Taggart era was that the commissioner’s office had nowhere near enough supervisory resources to do its job properly.

“I remember one budget analyst looked at me and said: ‘Deregulation means less supervision, not more,’ ” Kelly said. “It showed a complete lack of understanding of the problem.”