Ask not what your bank can do for you - Real Estate Cycle 1975 - 1991

"Greed is all right by the way - I want you to know that," said Ivan Boesky to an audience of Californian business students in May of 1986. (Just prior to his arrest on charges of insider trading). "I think greed is healthy. You can be greedy and still feel good about yourself."

"We built thick vaults; we have cameras; we have time clocks on the vaults; we have dual control – all these controls were to protect against somebody stealing the cash. Well, you can steal far more money and take it out the back door. The best way to rob a bank is to own one."
A former Commissioner to the California Department of Savings and Loans, to a 1988 Congressional committee. (US Congress, House Committee on Government Operations 1988:34)

"I think that the banking and savings and loan community in this country is probably as solid as one could get in any type of institution."
Alan Greenspan, Nightline program at the time of the Ohio and Maryland S&L shutdown, quoted in The Nation, November 19th, 1990.

After the 1973 / 74 collapse, land values recovered strongly, reaching their 1973 speculative peak within just five years. Here we have a change from all past cycles.

Normally in the past, banks went under, land values halved, and a general re-adjustment took place that eventually put business on a sounder basis from which to launch recovery. And the cycle turned. This time, just about all western governments launched 'rescue operations' to stop the shakier lenders of money from collapsing. This developed from a profound change in the way we view government.

Economists, since the advent of John Maynard Keynes after the terrible depression of the 1930's, had come to espouse that in times of weak business and consumer spending, governments should step in to 'take up the slack' as it were: to better manage the economy. Since the Second World War government spending has become progressively larger, and is now a significant part of the economy. (What the government is doing and in whose interest it operates, has not changed however.)

So after 1974 we saw government action, on a hitherto unprecedented scale, to try and stop economies going into recession. (Actually it becomes an effort to support land price, but is never marketed to us that way.) About the UK market Harrison noted, page 250: "The land market was set to collapse by early 1974 in the way that it had traditionally done after a speculative orgy. But the Bank of England, towing along the main High Street banks, floated a 1.3 billion pound 'lifeboat' operation to support the fringe banks that had helped to fuel the speculation. Twenty-six fringe (or secondary) banks were thrown financial lifelines, and subsequently only eight of them went into liquidation. Had they all gone bust, many more property companies would have sunk with them. The market would have been flooded, and land values would have been depressed to economically realistic levels… The politicians played their part too. Harold Wilson's government spent millions of pounds of taxpayer money on the inner cities, which inflated the expectations of landowners - both private individuals and public corporations - and encouraged the hope that land prices would rapidly recover." Which they proceeded to do.

A similar rescue operation was mounted in the US. Rabinowitz (The Real Estate Gamble, page 207) noted that at the bottom of the market, 1974 - 76, REIT's had lost on average 80% of their stock price with over half of all mortgages in default. The Fed gave support to the REIT's, and encouraged other banks to do the same. This meant that the distressed property of the REIT's did not have to be put on the market in a disorderly fashion, but could instead, because of the additional bank support, be held back to await recovery and higher prices for sale. Writer Dana L Thomas (Lords of the Land, page 289) noted the following about this process: "The business of unloading and buying distressed properties is being conducted in the most discreet way possible. Like a family which refuses to admit that one of its members has died and keeps the corpse embalmed in the living room rouged by a make-up specialist, so the trusts and the banks who are unloading their properties are pretending that nothing out of the way is happening...". In support of the vested interests, in 1976, Congress passed the Tax Reform Act, offering further incentives to the REIT's as tax shelters. Slowly, (but faster than the previous cycle), the real estate market turned.

Stock markets.

In another usual historical repeat, the stock market rebounded in 1975 from the low of December 6th, 1974. Another one of those very good years, remarked Fridson. "The 1975 rebound rally began with a steep drop in interest rates." (It was a very Good Year, page 177.) And the Fed had good reason to ease up on the brakes too, with unemployment rising sharply and the Franklin National Bank - one of the largest banking failures of the time - causing notable angst amongst bankers and the establishment generally. Another loan loss, $30 million, this time at the Beverly Hills Bancorp caused it to fail, and after the Bank of San Diego farce, "hundreds of southern Californians were reportedly so unnerved by these events that they withdrew their savings from local banks and secreted the funds in cookie jars and beneath potted plants." (Fridson, page 178, quoting Business Week.) Confidence in American banks was at its lowest ebb in 40 years.

Taking its cue from the interest rate decline, the Dow climbed 14% in January of 1975 alone, the largest one month rise in 35 years and with it the 1973-75 land price induced recession passed into history. That March, Congress passed a $22.8 billion tax cut (and we know the effect that this will have on land price) and the Dow went on to finish almost 40 percent higher for the year.

Further tax reform followed with tax shelter provisions tightened in an effort to stop a few rorts: "The 1976 tax reform act specifically limited the amount of loss from oil and gas tax shelters, cattle feeding, equipment leasing and film-making and from partnerships other than those in real estate. The 1978 tax revision went further and limited losses in any trade or business other than real estate." (Harrison, The Power in the Land, page 144.) Needless to say, real estate became the hottest buying item for anyone wanting to offset 'losses' against other income.

There was one further item in the 1978 act as well. This was to reduce the tax rate on capital gains from around 50 percent to 28 percent. The effect for the venture capital industry was just about immediate. The great depression had seen the tax treatment of capital gains changed. Prior to that, capital gains or losses were just part of income and taxed as such. After 1931, many wealthy US citizens found themselves, whilst still fortunate enough to be earning something, sitting on some rather large stock losses. It was soon realized that they could sell the shares, create a 'capital' loss, deduct this from their income, pay no taxes for the year and then proceed to buy back the shares immediately after the sale. Laws were changed to stop the practice. By 1977, with capital gains taxes approaching 50 percent, fewer Americans were taking business risks. Especially when any prospective loss could only be offset against a far from certain future gain. In this year, only $39 million was raised by venture capitalists for recognized risky ventures. By 1981, the figure was $1.3 billion. (John Steele Gordon, The Business of America, American Heritage, April 2000.) The development of the Internet owes much to this act. And reveals of course the utter stupidity of taxes on income and profits.

The tax cuts had an immediate effect on land price too; it climbed steeply after 1978. (Harrison, page 147.) As a result, most of the (western) world economies ended up with a marked period of stagnation and general worker dis-satisfaction. Rents stayed high, unemployment stayed high, and prices kept rising. Noted Ron Insana about these times: "The banking industry was reeling from soured loans to troubled Latin American nations, and a malaise gripped the nation that was nearly unshakable. Unemployment and inflation rates topped 13 percent. The nation's prime lending rate exceeded 20 percent ! Home and car purchases collapsed under the unusually heavy financing burden. Gold and oil prices soared, drawing money away from financial assets. Indeed, US Treasury bonds were nicknamed 'certificates of confiscation' since their yields failed to keep pace with the soaring inflation rate. Financial instruments were universally loathed, leading Business Week magazine to declare 'the death of equities' in the summer of '82." (Trendwatching, page 139)

The lead in to 1982. (Monetarism, derivatives, and the rise of the trader.)

From a Keynesian perspective, it was not possible to have at the same time a recession and rising unemployment, and rising interest rates and consumer prices. So with unemployment, interest rates and inflation measurements all well into double digit figures the '70's was not a showcase decade for Keynesian economic theory. It was inexplicable. In recognition of the shock this delivered to mainstream economists, an answer for the economic malaise was sought elsewhere.

Fortunately, for the owners of the economy, the required answer was easily found. The economist they turned to was Milton Friedman. Friedman is explained very well by historian Edward Chancellor (Devil Take the Hindmost, page 241): “For two decades, Milton Friedman, an economics professor at the University of Chicago, had been battling against Keynesian orthodoxy. Resurrecting the economic liberalism of the nineteenth century under the new guise of 'monetarism,' he argued that the market was fundamentally a self-correcting mechanism, and that government attempts to interfere with its operation - whether by introducing price controls to curb inflation or by compelling management to influence the level of unemployment - were doomed to failure. In Free to Choose, a popular introduction to free-market ideology that Friedman wrote with his wife Rose, he contended that all government intervention, however well-intentioned, had harmful side effects. For Friedman, markets were the best way to distribute information and provide incentives, regardless of the inequities that might emerge. In a 1973 interview with Playboy magazine, Friedman boldly asserted that all societies were structured on greed: "The problem of social organization," he claimed, "is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of system."”

Friedman's work contributed to a revival of economic liberalism, particularly in the area of financial markets. The Friedman thesis actually defended the role of the speculator, proclaiming that market speculators were essential to the well-being of such markets and to the efficient distribution of the economy's scarce resources. It was the speculator that was uniquely situated to assume the investment risk of the capitalist process.

Building upon the work of Friedman, other economists began to intensively study the operation of the financial markets. Practically overnight a new body of thought, the Efficient Market Hypothesis (EMH) was born. This theory, over the decade of the 1970's, spread quickly throughout US universities and was soon the working gospel of all finance graduates. (Whether or not markets are actually efficient, as this theory propounds, is another story.)

At the same time, another attack upon the prevailing economic paradigm was taking place. Historian Charles Kindleberger (Mania's, Panics and Crashes, page 33) explained it this way: "In the early 1970s Ronald McKinnon led an intellectual attack against what he called 'financial repression,' that is, the segmentation of financial markets in developing countries that favoured (1) loans to government, (2) foreign trade, and (3) large firms at the expense of everyone else. The message appealed particularly to Latin American countries already influenced by Chicago doctrines of liberalism. (Financial) deregulation was adopted in a number of countries..." Astute readers of history would have seen this before of course, with predictable results; explosive bank formation, a huge increase in the creation of credit, inflation, an asset price boom most notably in land price, followed by bank collapse. But we are ahead of ourselves.

On the 6th of October 1979, the newly ensconced Fed chairman, Paul Volcker, in an effort to bring inflation under control, announced that no longer would the country's money supply be permitted to fluctuate. The supply of money to the economy would for the time being remained fixed; instead, interest rates would be permitted to rise. This was a marked shift in Federal Reserve monetary policy. It was now possible that interest rates might swing rapidly. One well placed bond trader of the time, Michael Lewis (Liar's Poker, page 39) described it this way: "Bond prices move inversely, lock step, to rates of interest. Allowing interest rates to swing wildly meant allowing bond prices to swing wildly. Before Volcker's speech bonds had been conservative investments, into which investors put their savings when they didn't fancy a gamble in the stock market. After Volcker's speech, bonds became objects of speculation, a means of creating wealth rather than merely storing it. Overnight the bond market was transformed from a backwater into a casino."

The rise of derivatives.

With the US dollar now fiat (paper money not convertible into gold or silver), the acceptance into mainstream economic thinking of Friedman's economic liberalism (replacing the now discredited Keynesian theory) and the rise of computing power, a financial revolution began. This revolution showed itself in the creation of derivatives markets. A derivative is nothing complicated; it is simply a security created from a contract between two parties. The contract derives its value from the underlying asset, for example a share. When trading a derivative, such as an option contract, a smaller down payment is required than if one was to purchase the real share upon which that option is based. A leveraged position in other words. Such leverage, it had been believed, encouraged more speculation than was good for the economy. Friedman's work put an end to that belief. Noted Chancellor (page 243) about the new doctrine: "If markets were efficient and in constant equilibrium, and if price movements were always random, then the activities of speculators could be neither irrational in motivation nor destabilising in effect." Derivatives markets for gold opened in 1975, for mortgages in 1976, for oil in 1978. Currency futures markets followed in 1982, index futures thereafter.

In 1982 however, the country was still in an officially defined recession from the year before. (What looked suspiciously like the usual mid cycle slowdown.) Volcker's latest Federal Reserve policy maneuver had in fact deliberately attempted to engineer it. Noted Ron Insana (Trendwatching, page 139) about these times: "...just as the entire investing population began to believe that stocks and bonds would go down forever, and gold and oil would soar, a strange phenomenon occurred. Latin American nations, specifically Mexico, threatened to declare a moratorium on the tens of billions of dollars in debt they owed to struggling U.S. Banks... In order to prevent a wholesale financial catastrophe, the Federal Reserve promised to backstop the banks, providing billions of dollars in bailout assistance. The Fed slashed interest rates and turned on the monetary spigot, ballooning the nation's money supply in an effort to 're liquefy' the banking system and stimulate the stagnant economy." The old credit creation trick of the bankers at work again. Continued Insana further: "The trick worked marvelously well... At the same time, the federal government, under President Ronald Reagan's direction, cut tax rates aggressively... Government spending also increased dramatically on defense programs (which created countless jobs) and on a whole host of programs that stimulated state, local, and national economic activity. The trillion-dollar defense buildup, a variety of make-work, pork-barrel projects, along with huge increases in entitlement spending, 'primed the pump,' as economist John Maynard Keynes liked to say. That added gas to an economy that was already being fueled by the Fed's new easy money policies."

There was one more stimulus added, an acceptance by the Group of Five, (now Eight), industrialized nations to weaken what was considered an overvalued U.S. dollar. A 7 percent reduction in the dollar's value, some economists suggest, is like a full percentage point reduction in interest rates. (Insana, page 143) The lower dollar was wanted to boost US growth rates. The monetary spigots once again turned recession into boom times.

The rise of the trader.

The ability of the financial revolution to sustain itself was completed with the coming to power of Margaret Thatcher in England and Ronald Reagan in the US. Both were products of the economic liberalism (free-market ideology) sweeping the world at this time. In 1981, Mitterrand took up the cause in France, followed by Chancellor Kohl in Germany and then Prime Minister Hawke – leading a labor party – in Australia. The ideas even extended to China and Deng Xiaoping. As political adviser to republican presidential candidates Nixon and then Reagan himself, Friedman had a hand in all of this as well. Noted Chancellor once more (page 250): "A powerful alliance had emerged between economic liberals and Reagan Republicans; both agreed that government intervention in economic affairs was undesirable and that the judgement of the market was paramount." The government granted licenses and privileges went on un-hindered of course. Not only that, government has since become larger than ever having been forced re-regulate the entrepreneurial abuses of the licenses and economic privileges so granted.

The pursuit of self-interest was now paramount. Anne Rand was finally to have her time in the sun. Taxes were reduced (described already above) both for individuals and corporations and the entrepreneur's role eulogized. Derivative traders working for large institutions and banks, and private traders with hedge funds using the latest advances in communications were quick to see the potential profits available in exploiting to their advantage the new found leverage available.

The most successful hedge fund, the Quantum Fund founded by George Soros in 1977, produced returns on its leveraged positions in bond and currency markets in excess of 25%. Ivan Boesky developed techniques in risk arbitrage and Michael Milken made himself famous, and the highest paid man on Wall Street ($550 million in one year alone, with his federal and state taxes weighing in at $205.9 million) with the use of junk bonds (debt) to effect leveraged buyouts (LBO's) and takeovers of listed public companies. Suddenly, the trader was hip; an international phenomenon. Everyone wanted to be one.

Notably, it was the boom in LBO's and the credit so easily available that pushed the 1980's bull market to such heights. Said Chancellor about this development (page 262): "The boom in leveraged buyouts became the driving force behind the bull market of the mid-1980s. Conventional measures of value gave way to LBO valuations, known as 'private market value,' which were calculated by examining how much cash (free cash flow) a company generated and how much debt it could support. Professional 'risk arbitrageurs,' on the lookout for the next takeover, became the medium through which private market value was established in the stock market. Acting in unofficial collusion, arbitrageurs searched for vulnerable companies and took large stakes in them, thus putting them 'in play.' Members of the public followed the arbs' operations and imitated them, just as their forebears had followed stock market pools in the 1920s."

The stock market party ended in October of 1987 with a crash on Monday October 19th. It was not however followed by an economic 'crash' or crisis; for that we had to wait for the Savings and Loans debacle, brought to a climax, eventually, by the next land price downturn – 18 years after the last one.

Why rob a bank if you can own one ? The Savings and Loans farce.

Just after the peak of this cycle, in 1989, the US underwent the biggest bailout ever seen of banks and banking institutions generally; the so-called 'savings and loan' (S & L) scandal of the 1980's. The web site at, amongst many others, put it this way: "Thrifts had been established originally to help homeowners obtain mortgages. But in the 1970's inflation undermined the stability of the industry, sticking the thrifts with low interest mortgages arranged years before when inflation was slight. To help the thrifts survive Congress deregulated the industry, lifting restrictions on the kinds of loans they could make. Swindlers immediately took over the industry. As the saying went, 'why rob a bank when you can own one.' By the end of the 1980's the thrifts were in danger of collapsing after approving billions in insider loans for worthless projects. Congress eventually bailed out the industry at taxpayer expense."

Once again, despite the prodigious information available about this banking scandal, most sites miss the causal connection between easy credit, a land price boom, leading eventually, as it must, to bust. And as for the clear historical repetition, this has been missed entirely. Let's take a closer look. A little history is required.

The first S&L association was founded in Frankford, Pa., in 1831 (The Oxford Provident Building Association) when a few locals decided to pool their resources in order that they might be able to buy their own homes, since all the nearby banks had turned down their requests for credit. (Time, Aug 1963) Such an idea had originated in England.

Following the Great Depression of the 1930's, as noted by the American Journal of Economics and Sociology and indeed the US Congress itself (US Congress: House, 1989a),: "Large commercial banks had abandoned housing lending in favor of more lucrative corporate and state lending, or had charged interest rates that made home mortgages inaccessible to Americans on a moderate income. Congress facilitated the creation of 'thrift' depository institutions (S&L banks and mutual savings banks) to fill this void. The S&L branch of the banking industry was created to supply affordable mortgages to working class families, so that the American Dream of home ownership would not slip beyond their grasp…This regulation of banking created a structure of institutional distinctions within the industry: commercial banks were allowed to invest in a broad variety of instruments (including corporate, governmental, and mortgage lending; stocks and bonds investments; and real estate speculation), to charge market-based interest on loans, and to pay competitive interest rates on deposits. S&L institutions, on the other hand, operated within restrictions not placed on the commercial banks, including a narrow definition of their business activities to home mortgages offered at lower interest rates and for longer maturities than commercial banks; prohibitions against paying out high interest rates on deposits; and restrictions against investing in high-yield but risky investment instruments like real estate speculation and junk bonds."

For these thrifts, the Federal government encouraged them to stick to home mortgages. Thrifts were consequently required - by law - to provide a safe 'deposit' institution for household savings, then invest such savings in thirty-year, fixed-rate mortgages (secured by the property) but only within a fifty-mile radius of the head office. Such deposits, as with other banks, were now also going to be federally insured against loss through possible collapse of the institution. With economic recovery after World War II, the thrifts prospered as the US went from a nation of tenants to a nation of homeowners. Said the US Savings and Loan League's Executive Vice President Norman Strunk in 1954: “We love the guy who walks in with 50 bucks to start a savings account, because we know that in five years he'll probably have several times that in his account – and in the meantime the chances are good that he may have taken out a loan with us.” (Time, Nov 1954.)

By 1963, S&L's were making 46% of all home mortgage loans in the US, three times the number made by the commercial banks. (Time, Aug 30, 1963.) S&L's prospered most where homes went up the fastest. S&L's had a slight edge over banks – government decreed – in that they were permitted to lend up to 90% of the price of a house and land on a 30 year mortgage, whilst the banks had to observe the Fed's mandated 75% lending valuation policy spread over 20 years. So successful was this government policy that by the mid 1960's S&L's were having trouble finding lenders for all the new deposits being lodged. The thrift manager took the motto 3-6-3. Offer savings at 3 percent, lend at 6 percent, hit the golf course by 3.

Ironically however, the prosperous times also contained the seeds of trouble, undermining what seemed like at the time of drafting (the 1930's) pretty safe laws. The laws put in place ensured that the thrifts were in fact borrowing short, (paying interest on deposits) and lending long, receiving interest on long term mortgages. Normally, the long interest rate stays above the short rate, presenting little problem to the thrifts. In addition, houses are often sold prior to the end of a thirty-year mortgage, reducing further any risk to the thrift. But in the late 1960's and early 70's, things were anything but normal. Interest rates went up, and up. So did inflation.

A squeeze developed within the S&L industry as depositors, in a high inflation environment, took their money out of the thrifts and sought higher rates at other institutions not hindered by the laws and regulations - money market accounts and mutual funds for example. (Remember that thrifts had been prohibited from paying out high interest rates on deposits – to protect them from high funding costs apparently ! And they could not adjust the rate on those 30-year mortgages once issued to borrowers, as bank customers in Australia would be familiar with. The mortgage rate was fixed for the life of the loan.) Even worse was to come as interest rates continued to rise into the late 1970's, meaning that the thrifts were now paying more to depositors than they were earning on the mortgage loans, not really an effective business model. In part, this trouble arose from deliberate Federal Reserve policy. Michael Lewis (Liar's Poker, page 117) explains: "Paul Volcker had made his historic speech on 6 October 1979. Short-term interest rates had skyrocketed. For a thrift manager to make a thirty year home loan, he had to accept a rate of interest of 10 percent. Meanwhile, to get the money, he was paying 12 percent. He ceased, therefore, to make new loans, which suited the purpose of the Federal Reserve which was trying to slow the economy." (Housing starts collapsed as a result, dropping to record post-war lows.) Prior to the Fed's move, only seven percent of thrifts were losing money. After Volcker's actions, 85 percent of the thrifts were in trouble and losing money. (Washington Monthly, May 1995.) The monetarist influences of Friedman, as put into practice by Chairman Paul Volcker at the Fed, were packing quite a punch.

In response the Carter administration, with an eye to re-election, (subsequently defeated) made some changes that took affect in March of 1980; voting in the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) aimed at, in the words of the Federal Deposit Insurance Corporation (FDIC): "eliminating many of the distinctions among different types of depository institutions and ultimately removing (the) interest rate ceiling on deposit accounts. Authority for federal S&Ls to make ADC (acquisition, development and construction) loans (was) expanded." ( Oddly though, at the very last moment and without debate, the deposit insurance limit was raised from $40,000 to $100,000, a crucial development. More on that shortly.

The new Reagan led administration (Reagan took office in 1980) under the now direct influence of Friedman's economic liberalism went further with deregulation of the industry, permitting the Federal Home Loan Bank Board (FHLBB) to allow any thrift in difficulty to issue 'Income Capital Certificates'. These could be purchased by the Federal Savings and Loans Insurance Corporation (FSLIC) and therefore included as capital by the issuing thrift. Rather than showing that an S&L institution was insolvent, this accounting sleight of hand helped the troubled thrifts present accounts that gave an immediate impression that the industry was returning to better health.

In January of 1982, the FHLBB reduced the net worth requirement for insured thrifts from 4 to 3 percent of total deposits. "Additionally", noted the FDIC further on its website about the history of the scandal, "S&Ls (were) allowed to meet the low net worth standard not in terms of generally accepted accounting principles (GAAP), but with the even more liberal regulatory accounting principles (RAP)." Incredibly, this meant for example, that if one thrift took over another, whose assets were say $4 billion, but whose liabilities were $5 billion, the difference, a billion dollars, could be counted as goodwill and the goodwill then accounted for as capital in the accounts of the buying thrift. Noted Bert Ely, a respected author of the S&L crisis, about this process: "Therefore, just as (thrifts), encouraged by deregulation, took on more risk, they had a smaller capital cushion to fall back on." (

Then, in April of 1982, the FHLBB eliminated the restrictions on the minimum number of shareholders that a thrift had to maintain. Up to this time, any thrift had to have at least 400 shareholders, of which at least 125 were required to be local citizens. One person could not own more than a tenth of the shares and no single group control more than a quarter. Now there could be a single owner. And the new purchaser could, if he wished, put up real estate as collateral for the purchase, making the purchase of a thrift much easier.

Whilst all this was going on, the Tax Reform Act of 1981 came into force, providing, in the words of the FDIC: "powerful tax incentives for real estate investment by individuals." Readers of history would have no trouble forecasting the result; an increase in land value and over-building. Said Steven Wilmsen about the Act, when writing his story about Silverado S&L in Denver (Silverado: Neil Bush and the S&L Scandal, page 75): "Nobody could lose because property values went through the roof as speculators nearly went hysterical bidding for prairie acreage-cum-office parks."

The tax act of 1981 also included a further tax break for thrifts, again well explained by Michael Lewis (Liar's Poker, page 121), who saw the effect this had from the inside: "The tax break allowed thrifts to sell all their mortgage loans and put their cash to work for higher returns - often by purchasing the cheap loans disgorged by other thrifts…The huge losses on the sale (they were selling loans for sixty-five cents on the dollar they had originally made at par, or a hundred cents on the dollar) could now be hidden. A new accounting standard allowed thrifts to amortize the losses over the life of the loans…But what was even better is that the loss could be offset against any taxes the thrift had paid over the previous ten years. Shown losses, the Internal Revenue Service returned old tax dollars to the thrifts."

For the thrifts, the idea was now to generate losses - any losses. The vast surge in trading business brought a massive windfall to Wall Street bond trading corporations like Salomon Brothers. "The most irresponsible period in the history of capital markets," said one partner of the Wall Street firm the Blackstone Group. (Liar's Poker, page 124.)

To complete the government designed re-flating of the thrift industry, the Reagan Administration passed the Garn-St Germain Depository Institutions Act in December of 1982. This Act, noted the FDIC, was designed to: "complete the process of giving expanded powers to federally chartered S&Ls and enable them to diversify their activities with the view of increasing profits. Major provisions include(d): elimination of deposit interest rate ceilings; elimination of the previous statutory limit on loan to value ratio; and expansion of the asset powers of federal S&Ls by permitting up to 40% of assets in commercial mortgages, up to 30% of assets in consumer loans, up to 10% of assets in commercial loans, and up to 10% of assets in commercial leases."

"All in all", said President Reagan as he signed the St Germain bill into law in front of over 200 S&L executives, bankers and Congressmen, "I think we've hit a home run."

Indeed. Now, thrifts were no longer required to lend only within their own communities – that fifty mile radius; 100 percent financing became a reality and a thrift could now be owned by just about anybody who could, and did lend money to themselves... The story goes that Mafia lawyers and accountants spent a good deal of time following the passage of the Garn-St Germain bill through Congress, waiting (perhaps not so) patiently for the law to pass, or so it was rumored.

To politicians inside the Reagan Administration, the response to the crisis in the thrift industry may have appeared quite logical at the time. Government legislation got the thrifts into a mess in the first place; give the thrifts more freedom – less government oversight – to help them trade out of it. Writer Catherine England at the Cato Institute put this succinctly: "Imagine a fifty-year-old owner/manager of an S&L opened by his father. It is 1980, and he has helplessly watched his institution's capital erode. The housing market has slowed to a virtual standstill, and his customers have moved their savings to money market mutual funds. He is unhappy with general economic conditions and the regulatory constraints that have caused his problems, and he wants his congressman and senators to know about it. In addition, he expresses the strongly held conviction that it would be wrong to close hundreds of S&Ls with financial problems not of their making. Then Congress acts, granting him permission to make loans and investments other than mortgages. In addition, the phase out of interest rate ceilings is begun."

Noted writer Michael Lewis further, (page 97, Liar's Poker): "The Savings and Loan industry made the majority of home loans to average Americans and received layers of government support and protection. The breaks given to Savings and Loans, such as deposit insurance and tax loopholes, indirectly lowered the interest cost on mortgages, by lowering the cost of funds to the Savings and Loans. The Savings and Loans lobby in Washington invoked democracy, the flag, and apple pie when shepherding one of these breaks through Congress. They stood for homeownership, they'd say, and homeownership was the American way. To stand up in Congress and speak against homeownership would have been as politically astute as to campaign against motherhood. Nudged by a friendly public policy, Savings and Loans grew, and the volume of outstanding mortgage loans swelled from 55 billion dollars in 1950 to 700 billion dollars in 1976. In January 1980 that figure became 1.2 trillion dollars, and the mortgage market surpassed the combined United States stock markets as the largest capital market in the world."

Two further changes fed the S&L developments. As already noted above, part of the early 1980's legislative response to the thrifts difficulties was to lift the level of deposit insurance to $100 000; this despite the fact that up to that time the average thrift deposit rarely amounted to much more than $10 000. Since deposits were now insured, depositors did not have to exercise judgement as to whether the thrift that held their deposit was sound, nor how it was managed. Because the thrift knew the deposit was insured, it learnt it could 'afford' to offer rates marginally, and continually, above market to attract funds. Got more than $100k to invest ? Just spread it to more than one thrift. Here then, the government had, with one quick stroke of the pen, undercut the market maxim that high yield equaled high risk. So much for deregulation.

The other change was the computerization of the industry. Any depositor could now access markets nationwide, thanks to the explosive growth of information and its storage. Intermediaries – deposit brokers - began the process of gathering deposits from individual savers, then funneling the totals, en masse but broken down into 100k bundles, to thrifts (amongst other institutions) that offered the highest rates. More deposits, more lending, creates more deposits. Thus, with restrictions virtually eliminated, a liberally inclined government installed, and ever decreasing supervision of the industry, the only control left in the industry was the thrifts own management integrity and risk management practices. And like anything else, this was effective in some and deliberately ignored in others. Ironically, a more favourable interest rate climate through 1983 / 85 saw the condition of most thrifts ease considerably.

In response to a rash of state chartered thrifts defecting to the federal system permitting them far more potentially lucrative opportunities, various states including California, Texas and Florida passed further liberal laws allowing their thrifts to invest 100% of their deposits in activities of any nature. (State thrifts converting to a federal charter also meant the loss of a rather lucrative source of campaign funding for state politicians.) Notably, after all the regulatory changes, thrifts began heavy lending to real estate developers, builders and construction companies. And there was no shortage of willing investors as people queued up to take full advantage of the 1981 federal tax law changes that were now so generously rewarding investment in construction.

The Federal Government had acted. Promptly, the thrifts began to lend themselves out of trouble and into potentially more profitable areas, or so the government thought...

Easy credit. In actuality, more than a few sophisticated, financially savvy Savings and Loans managers proceeded rather quickly to rip the 'thrift' out of the thrifts. No longer dependent upon funds from local borrowers and instead permitted to borrow funds 'wholesale' from virtually anywhere, officially encouraged to 'diversify' their loan portfolio away from once solid 30-year mortgages and into other property areas, with laws changed to allow lending on almost any speculative venture that could be found, with loans allowed up to 100% of appraised value, and accounting changes made to help make it all look good, this proved rather easy to do.

Former house builder and real estate developer David Paul bought into Dade Savings and Loan (regulators were happy at the time that someone wanted to take over the faltering thrift, having been caught like many others in the interest rate squeeze of the early 1980's) renamed it Centrust Savings Bank of Miami, then used the deposits he brought into the bank through loan brokers to buy $1.4 billion worth of Micheal Milkin's so called junk bonds and other related Milkin issues. Paul "paid himself $16 million, took an apartment at the Carlyle Hotel in Manhattan, and spent $1.4 million a year on a corporate jet, $13 million on a painting by Rubens and $8 million on a yacht." (Devil Take the Hindmost, page 274.) With gold-leaf ceilings and a Jacuzzi in the master bedroom, the thrift's yacht Le Grand Cru added to the bank's balance sheet and made quite an impression on visiting dignitaries and politicians. The losses on the junk bonds went unreported however.

Thomas Spiegel, himself a former Milkin associate and bond salesman, bought into Columbia Savings and Loan, with Milkin taking part of the business too. Using the almost unending supply of deposits now available to the thrifts, (whenever they wanted more, they had only to lift the interest rate on offer a small percentage point or two) Spiegel soon managed to move the bank balance sheet totals up to $13 billion by 1987, from just $400 million five years earlier. One third of the deposits entering Columbia found their way into Milkin's junk bonds. For all the hard work, Spiegel paid himself around $9 million a year, travelling in the bank's recently bought corporate jets for the all the deal making.

A number of thrifts were soon expanding at the rate of 1200% a year and more, simply by taking in deposits from the growing legion of deposit brokers who would, for a fee, match thrifts with savers like pension funds and other institutions wanting to put their money to work at the highest interest rate available. The thrift would then put these deposits to work by loaning out the funds, "mostly on speculative property deals". (Devil Take the Hindmost, page 274.) Under the new accounting rules, the thrift could then report a profit from the fees charged. More deposits, more loans, more profits (at least on paper) and pretty soon the young thrift was reporting solid growth. Or so it appeared.

Nor did the hard work and deal making prevent the thrift owners and managers from enjoying the finer things in life. "...Don Ray Dixon of Vernon Savings took his wife by private jet and Rolls-Royce on a 'market study' of French Michelin three-star restaurants... He also bought half a dozen jets, a vintage car dealership, and the sister ship to President Roosevelt's yacht. Edwin 'fast Eddy' McBirny of Sunbelt Savings, fed his guests at his north Dallas home on lion meat and antelope, while presiding over the festivities dressed as Henry VIII with dry ice billowing around him. At another party at his penthouse suite in Las Vegas, McBirney allegedly diverted his bank's clients with an 'enthusiastic lesbian romp'...". (Devil Take the Hindmost, page 274.) But as this writing is meant for a wider audience than just adult entertainment, we might leave the rest of the McBirney party details for another time. Thomas Spiegel and his family made at least four trips to Europe, an uncountable number of domestic trips, bought guns, ammunition and accessories totalling $91,000 bought resort villas and other real estate, spent $1900 for silverware, $8,600 for towels, $11,840 for music concerts, and much more, all paid for by federally insured (Columbia) thrift deposits. (Calavita, page 59) Said Tom Gaubert, former Texas real estate developer and new owner of Independent Savings Association: "I'm tired of playing Monopoly with my money. This way, (through owning a deregulated thrift) we can use the depositor's money." (Calavita, page 103)

As word spread and conferences organised about what a Pandora's box of opportunity the government had opened up, the thrift rorting took on epidemic proportions. Any reader of Business Week knew what to do: "Start an S&L. Offer a premium interest rate and watch the deposits roll in. Your depositors are insured by Uncle Sam, so they don't care what you do with their money. And in states like California, you can do almost anything you want with it. Add enormous leverage – you can pile $100 of assets on every $3 of capital – and you've built a speculators dream machine." (Business Week, Casino Society, 1985.)

The list of thrifts rorted was practically endless, as were the deposits available from the deposit brokers with which to finance it. Some examples:

Banks robbed 1991 style - PDF

In 1988, the comptroller of the currency, having surveyed all the recent banking and thrift failures, reported that less than ten percent of such failures had been caused solely by economic factors; indeed, most were attributable to faulty lending practices or just outright fraud. (The FHLBB had by this time referred more than 11 000 S&L cases to the justice Department for possible criminal prosecution.) At this time, the FSLIC reported it would have $20 billion available for bailing out any other thrift in the industry in similar difficulty, an amount it had deemed "adequate for the bank provided there is no economic downturn." (Time, June 20, 1988.)

It was not just the thrifts, but all the banks in general that went on an acquisition and real estate lending spree during the 1980's. One such bank, the Boston based Bank of New England (BNE) had by the mid 1980's become quite a large regional bank after several buys or friendly mergers with Connecticut Bank and Trust, Maine National Bank, and other smaller local institutions. BNE then went aggressively into real estate lending, so that by the late 1980's, over 30 percent of its loan portfolio was in commercial real estate. (BIS, page 63.) This was to shortly prove disastrous.

Into the peak

In the spring of 1989, one of San Fernando Valley's hottest real estate moguls, Mike Glickman, made a bold prediction that Southern California real estate values would never fall. Reported Ron Insana (Trendwatching, page 136) about this real estate spruiker: "Glickman, who at age 15 delivered real estate tear sheets for a local broker, became one of the most successful real estate agents by the time he was in his early twenties. By age 30, he owned the fastest-growing real estate brokerage in the region. He was frequently billed as one of the best young entrepreneurs in Los Angeles. He paid above-average commissions, gave generous perks and bonuses, and expanded his operations with a speed unheard of in the real estate business."

Glickman's prediction marked the top of the cycle. In several landmark real estate transactions that set new records as Glickman was delivering his forecast, Minoru Isutani, a Japanese real estate developer paid $841 million – or rather his banks did - for the hallowed greens of Pebble Beach golf course, further stoking fears that the country was set to take over America. (The Japanese had already bought New York's Rockefeller Centre.) A consortium of American golfing enthusiasts including Clint eastwood bought it back some years later for less.

The quality of the Savings and Loan industry's (indeed all bank's) credit risk had become dependent, of course, on the quality of its lending and the value of the security supporting it. These 'risk-factors' for credit providers are always the same; property values, rental income and occupancy rates. Everything looks good as property prices (land value in reality) rise, but should prices ever start to fall... And of course if some of the loans in the first place were never designed to be repaid, or the loan simply stolen, then there will be major trouble ahead

After 1987, land values stopped rising. Remember those 1981 tax law changes that promoted real estate over-building? The laws were tightened in 1986, affecting the value of much that had just been built. The falling prices began to seriously undermine thrift assets all over the US. Although thrifts had been failing right throughout the decade of the '80's, (due to local conditions or outright fraud) the failure rate hit fever pitch in 1989 just as President Bush took office. Predictably perhaps though, the massive S&L problems – and they were massive – did not form any part of the 1988 election battle: the Democratic contender's running mate (Lloyd Benson) owned a thrift or two and so also did the Republican candidate's son, Neil.

Given the growing size and dollar amounts of the failing thrifts, Congress in 1989 began adopting legislation for taxpayers to foot the bill and bail out the industry, whilst at the same time moving ahead with plans to deregulate the 14,000 federally insured banks. But not before a number of scams and crimes on a hitherto unimagined scale came to light. Falling land values meant that the banking scandal could no longer be hidden from public view by authorities, since now, a lot more real estate loans were worth less than the real estate upon which the loans had been made, and a lot more banking institutions and thrifts were in trouble.

The scams.

The larger thrift frauds that had America enthralled and angry are detailed here:

It wasn't just the thrifts that had gone on a real estate lending spree either. The bankers too had turned to real estate, observed James Grant (The Trouble with Prosperity, page 171-172): "expanding those credits by threefold in the 1980s, to $750 billion from $248 billion." In fact, between 1984 and the middle of 1990, some 72 percent of all loan growth at commercial banks was provided by real estate. "By late 1990," continued Grant, "the concentration of real estate assets on the balance sheets of banks of all sizes had reached alarming proportions."

For the Bank of New England (BNE), the collapse of real estate values brought difficulties in the form of non-performing loans, which by the end of 1989 were running at approximately 2.2 percent of total loans (BIS, page 63.) As the real estate situation grew worse however, so too did their loan portfolio. A mere one year later, BNE's non-performing loans on real estate stood at 20 percent of all loans. In early January of 1991, the bank announced to investors a probable fourth quarter loss that would technically render the bank insolvent. Nervous depositors withdrew over a billion dollars from the bank, a good deal of it over the weekend from the new automated teller machines. (No more need to wait until Monday for the doors to open.) The taxpayer funded bailout would ultimately cost $2.3 billion after the FDIC and Reserve Bank decided the bank was simply 'too big to fail'.

Credit created out of nothing, on the back of a government granted license in land value that inflates such land value, will at some point lead to a bust. In the capitalist / government granted license style economy that operates today – a system being taken up by more and more countries around the world it might be noted – such a bust is inevitable.

In England, the publishing empire of Robert Maxwell, Maxwell Communications, collapsed after it had become obvious Maxwell had paid inflated prices for all the media assets he had bought, on credit, financed by friendly banks. It was soon discovered that Maxwell had also along the way looted $1.4 billion from the company, including some $800 million from the employee pension scheme.

The BCCI (Bank for Commerce and Credit International) scandal came to light after the downturn, in 1991, when it was revealed the bank was being used both to launder drug money and as a haven for the ill-gotton gains of various dictators throughout the world, President Ferdinand Marcos of the Philippines included. Marcos used the bank to launder his gains to his family's Swiss account. BCCI (since named the Bank for Crooks and Criminals Inc.) was a Pakistani-managed, Middle-Eastern financed bank with branches in more than sixty countries. It was, and remains, the largest banking (and land) heist in history. In July of 1991, $20 billion was found to have been stolen, lost or swindled.

At the height of the crisis, The Nation (July 9, 1990) gave pause to suggest a study of the 'catastrophe' that overtook the thrift and banking industries might offer a unique study of institutional corruption and decay. The Justice department, it said, had run out of staff to investigate and prosecute the officers of the thrifts who had run off with the money, the FBI reported too few agents for the task, the Treasury department lifted daily its estimate of the eventual Taxpayer-funded bailout cost and Congress refused to investigate, let alone discipline any of its members for acceptance of campaign contributions and honoraria (read bribes).

Symbols of the era, and right at the top of the real estate market, David Paul finished his 48 storey Centrust tower and Charlie Keating put the finishing touches to his Phoenician Hotel.

In describing the bust, Ron Insana (Trendwatching, page 136) had this to say: "In March of 1989, when (Glickman) made his bold assertion that the market would never go down, he was riding the wave of a 15-year bull market in real estate. The bubble had been inflating with great vigor for at least the preceding five years. ... When interest rates started to go up in 1989, leveraged transactions in the stock market and the real estate market were hit hard. Within a year, Glickman's operations were severely constrained. He eventually went personally and professionally bankrupt, the victim of over expansion and the undying belief that prices only go in one direction. . . up. Real estate prices in Southern California crashed. Those who bought at the top watched the value of their homes plunge by 25 percent or more. The bear market in real estate would last close to eight years. It would be a decade before prices returned to their pre crash levels. The entire real estate bubble, while driven by the changing demographics of the region and a huge population influx, was financed by very easy money. The implosion of that bubble, along with a huge bear market in commercial real estate, would saddle the nation's biggest banks with uncollectable debt. The subsequent banking crisis in 1990 and 1991 led the Federal Reserve to embark on another dramatic lowering of interest rates. That repetitive cycle led to the new bull market in stocks and, ultimately, a new bubble in financial assets."

Which leads us into the next real estate cycle.

Further reading:

Chancellor, Edward, Devil Take the Hindmost: A History of Financial Speculation. Papermac edition, 2000.

Grant, James. The Trouble with Prosperity: A Contrarian's Tale of Boom, Bust and Speculation. Random House, 1996.

Lachman, Leann. Demographics: The Key to Successful Real Estate Projects in the 1990's, Real Estate Finance Journal, 6: pages 16-21, 1990.

Lewis, Michael, Liar's Poker, Coronet Books, 1989.

Stroud, Hubert B., William S. Spikowski, Planning in the Wake of Florida Land scams, 1998, Association of Collegiate Schools of Planning, Journal of Planning Education and Research, and available online at

Stroud, Hubert B., The Promise of Paradise: Recreational and Retirement Communities in the United States since 1950, John Hopkins University Press, 1995. – wall street history section

S & L Crisis.
Bank for International Settlements, (BIS), Bank Failures in Mature Economies, available on-line at

Calavita K., Henry Pontell and Robert Tillman, Big Money Crime: Fraud and Politics in the Savings and Loan Crisis, University of California Press, 1997.

England, Catherine. Lessons from the Savings and Loan Debacle; the Case for Further Financial Deregulation, in Regulation, The Cato Review of Business and Government, Cato Institute.

Ely, Bert. Savings and Loan Crisis, The Library of Economics and Liberty, available on-line at

Georges, Christopher. Egads ! The S&L Scandal Lives ! Washington Monthly, Jan-Feb 1992.

Lowy, Martin. High Rollers: Inside the Savings and Loan Debacle, Praeger, 1991.

Pizzo, Stephen. Inside Job: The Looting of America's Savings and Loans, McGraw Hill Publishing Company, 1989.

Simons, Teresa. Banking on Secrecy, Washington Monthly, Vol. 22, Issue 11, Dec 1990.

Wilmsen, Steven. Silverado: Neil Bush and the Savings and Loan Scandal, National Press Books, 1991.

The Dialectics of White-Collar Crime: the Anatomy of the Savings and Loan Crisis and the Case of Silverado Banking, Savings and Loan Association - Special Invited Issue: Money, Trust, Speculation and Social Justice - Part 1: Trust, Confidence, and Crime. Davita Silfen Glasberg. American Journal of Economics and Sociology, October 1998

US Congress: House. 1989a. The Other Side of the Savings and Loan Industry. Committee on Banking, Finance, and Urban Affairs, Subcommittee on Financial Institutions Supervision, Regulation and Insurance. 101st Congress, 1st session. Washington, DC: Government Printing Office.

US Congress: House Committee on Government Operations. 1988. Combating Fraud, Abuse and Misconduct on the Nation's Financial Institutions: Current Federal Efforts are Inadequate. H. R. 100-1088.

Time Magazine archive
- Savings and Loan Men Teach Bankers a Lesson, Nov 29, 1954
- The Twelve-fold Increase, Aug 30, 1963
- A Program for a Banking Free-for-all, Aug 13, 1973
- Earthquake Dangers for S&L's, Mar 2, 1981
- Another Time Bomb Goes off, Stephen Koepp, May 27, 1985
- Troubled Temples of Thrift, George Russell, May 18, 1987
- Too far Gone to Bring Back, June 20, 1988
- How to Rob Banks without a Gun, Gordon Bock, Aug 15, 1988
- Gold Among the Ruins, Christine Gorman, Sep 19, 1988
- Who Will Pick up the Check, Nov 7, 1988
- Dad Would Make a Deal with the Devil, Richard Woodbury, Feb 20, 1989
- Help Your Country and Help Yourself, S.C. Gwynne, Feb 20, 1989
- His Personal Piggy Bank, Mar 12, 1990
- Good Ole Bad Boy, John E. Gallagher, Jun 25, 1990
- Spooky S&L Stories, Richard Zoglin, Dec 3 1990

Copyright: Phil Anderson, 2004

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