"The Arizona S&L's should have been a great success story. The state's population was growing. Competition was modest, since there were only about a dozen financial institutions in that state. Home building was brisk. But the Arizona S&L's went crazy for growth, office buildings and land, land, land."

"Congressmen, seldom in our experience as accountants have we encountered a more egregious example of the misapplication of generally accepted accounting principles....Lincoln was manufacturing profits by giving its money away."

Kenneth Laventhol, an outside accountant hired by the Federal Government to investigate Lincoln Savings & Loan, quoted in Trust Me: Charles Keating and the Missing Billions, page 369.

As earlier explained, the federal government, in an effort to overcome the S&L problems of the early 1980's, further deregulated the banking field suggesting - in fact urging - more cashed up companies take them over. American Continental Corporation (ACC), a builder of homes with Charles (Call me Charlie) Keating as chairman and largest shareholder, bought Lincoln Savings and Loan of Phoenix, Arizona, paying $51 million for the privilege with junk bonds issued through Michael Milkin's Drexel Burnham. (Debt in other words.)

Normally any S&L simply took in deposits and then lent them out for a home loan. Charlie Keating promised, as part of the buy agreement with regulators, to continue this operation. The next year however, Lincoln made only eleven home loans, 4 of them to ACC employees: new state banking laws were permitting investments in virtually anything else the thrift chose. So like many of the other thrifts, Lincoln commenced buying brokered deposits, $5 billion worth by May of 1988. The incoming deposits were then used to buy junk bonds, raw land (almost a billion dollars worth in Arizona alone), trades in gold and silver and $34 million dollars paid in wages to family members. (Binstein, page 47.) Loans to insiders and political mates also proved a popular activity.

Perhaps though, in one business sense it does not matter what the deposits are used for, provided it generates a profit, for, as noted so well by the authors of Trust Me: "for every deposit acquired by the savings and loan a place must be discovered to plant the money, a place where when harvest time comes the money has grown and is larger than the deposit plus the interest. Or Lincoln goes broke." That is all. In the banking business, it is pretty clear cut.

So began the deal-making to generate those profitable harvests. Binstein reported one thus (page 283):

" There are 2,700 square miles of vacant land west of Phoenix, and Charlie Keating's dream city of Estrella, at twenty-six square miles, is less than 1 percent of this land bank. It is March 31, 1987, and it is time to attend to this dream. Keating has bought the land for about $3,000 an acre, and on the last day of March he sells one thousand acres to West Continental Mortgage Investment Corporation (Wescon) for $14 million, or $14,000 an acre. Lincoln records a profit of $11.5 million on this deal. Wescon puts down $3.5 million cash and takes out a non-recourse note of $10.5 million to cover the rest of the transaction. This is a remarkable feat for Wescon since it has a net worth of $30,000 and total assets of $87,000. But of course, the deal is not as simple as it at first appears. . A few days earlier, on March 25, an independent appraiser had told Lincoln that the thousand acres were worth only $8.5 million, about $5.5 million less than Wescon was happy to pay (the appraiser also noted on his report that he was assessing the land for one Ernest C. Garcia). Also on March 30, Lincoln loaned $30 million to a company owned by Ernie Garcia, and Garcia immediately drew $19.5 million of this sum as cash. That very day Garcia loaned $3.5 million to Wescon, precisely the amount of the down payment on the land in a portion of the Estrella project called Hidden Valley-which at the moment is a remote patch of desert linked to the outside world by a jeep trail. Garcia's loan to Wescon is a non-recourse note, meaning if they don't pay it off, he can collect only by taking over the parcel of land in Hidden Valley. Out of this transaction Lincoln books a substantial profit of $11.1 million, and naturally, 40 percent of this amount must be sent to ACC for the escrow tax fund. Ernie Garcia himself gets the use of millions of dollars for his own ambitions. And so it goes, deal after deal, quarter after quarter."

Accounting profits, but not cash flow.

The deals and investments continued. Lincoln bought almost $12 million Circus Circus junk bonds. The thrift invested $132 million in the stock of takeover target Gulf Broadcasting Corporation. Lincoln also was found to be making regular payments to its owner, ACC, ostensibly to cover federal income taxes despite the fact that ACC did not have a tax liability to the government.

To keep the regulators of his back, Keating hired a squad of lawyers; between $4 million and $9 million a year is spent on them. (Binstein, page 220.) It proved money well spent. When William L. Robertson, the chief examiner at one of the regulating boards sends an 18 page report to his boss asserting that Keating has acquired his S&L through misrepresentation and is investing federally insured funds in risky ventures with very few safeguards, he is demoted and removed from the auditing task.

The lawyers make further suggestions to push his cause by hiring economists to study the thrift industry and write reports on such operations and their merits. Keating hires a promising economist, Alan Greenspan (soon to be appointed Fed Chairman). Greenspan charges Keating $32,000 and reports that Lincoln is a "new, innovative and soundly-run institution that poses no foreseeable risk to the FSLIC". Said The Washington Monthly later (March 1997): "Not long after, all the thrifts on Greenspan's (innovative and soundly-run) list failed but one, and the survivor – although Greenspan didn't seem to know it – was not a thrift."

What Keating wanted most however, was a monument. Binstein and Bowden (Trust Me, page 187) explained it this way:

"Charlie Keating leaves a trail of deals and various forms of paper. But no monument. And like many men who taste power, he eventually wants to produce something that is physical, that he can show people who do not know a bond from a bidet. He wants to build hotels. There are financial reasons-under the current tax laws governing limited partnerships such investments can be very lucrative shelters. In the current buying frenzy, they can be sold at a great profit. If a hotel is kept occupied, it becomes a cash cow as guests fling money into the till on a daily basis. And cash flow is like blood for anyone who loves to do deals. But the reason of the heart is that Charlie Keating wants a monument. Charlie Keating is going to build the finest hotel on the surface of the earth. Not a Hilton, but a place to rival and exceed the grand hotels of Europe. He is going to build it in Phoenix, Arizona. In order to do this he needs deep pockets that are not anxious about immediate returns on capital. He has, under deregulation, part of the necessary equation in Lincoln Savings and Loan. And now, as Toufic Aboukhater and his sons dine at his table, he has within reach the other piece of the equation, Middle Eastern oil money. He will need it all because before the Phoenician opens its doors on October 1, 1988, over $300 million will have vanished into its six hundred rooms."

Note the timing: the "finest hotel on the surface of the earth", using someone else's money as the cycle approached the 16th or 17th year of the real estate cycle.

The hotel and its opening is worth describing: such openings a reliable guide, historically, to the top of the real estate market:

The opening:

"...Fourth of July, 1988, seventy-two-piece orchestra on the beach, the entire Phoenix Symphony. He got up and made a speech before they started and they had been kind of, you know . . . you haven't contributed anything to the Phoenix Symphony yet. He made some comment about . . . pay them that night. And a shelter over them because we didn't want moisture to get in the instruments and $40,000 of fireworks display put on by the Pyromaniacs out of Washington, D. C., they did the bicentennial celebration in D. C. The same people. It lasted ten minutes. The most spectacular fireworks display I've ever seen. . . . I mean, the place was jammed, people just came to see the Phoenix Symphony and fireworks display, Fourth of July evening. And we were all there selling real estate, we had developers and we had people, all night long parties, beer; wine, whatever you wanted free. . . . And Charlie had his helicopter. . . . He flew in there and it was night time, and he got up there and the band, they were playing these patriotic themes, and it was incredible. He spent forty grand on the fireworks. And then when the whole event ended, Charlie says enjoy yourselves. . .. Charlie's ready to go and he flew out over the lakes real low and they had those lights on the water. . . and everybody was looking, so he goes out, he's got these two pilots, across the lake like that and they go almost straight up, and they turn like this, and then he does a nosedive. Took him just like this down over the lake, coming back this way, and headed east back to Phoenix. And . . . right down over there, and like you were. . . the enemy. Of course, he got everybody's attention, everybody, it was the only thing in the sky after the fireworks display. . . . And the water was blowing like this on the lake, and they had the lights coming down in front of the helicopter; so it was just a spectacular aerial icing on the cake, after the whole thing was done, drinking and eating and fireworks display and the Phoenix Symphony, he gave it an aerial display of absolute crudeness, straight up in the air and then he left, and after that I said, Boy, that's Charlie."

The hotel, as described by one of the contractors (Binstein, page 332):

"The whole thing has a seat-of-the-pants quality. When they started pouring concrete it was for a 400-room hotel, now it's a 600-room hotel. Then Charlie adds on a golf clubhouse, casitas, a health spa, an underground parking garage for 1,200 cars, a tennis complex, a pool island restaurant. The rooms go from white oak to red oak and back to white oak. "We had a very active owner," one contractor confesses. "You know that there's heart and soul in that building, you can look at it, everything in that building is of the utmost quality. "Nothing was off the rack," the contractor continues. "Every item that you look at in the Phoenician you'll notice has no brand names on it, no exposed fasteners with the exception of hinges on the doors. Okay, this room is fine, we'll go to the next one. I think there are fifty-six different varieties of rooms. Holiday Inn has one. Fifteen in a luxury hotel is maybe reasonable, not even that much. They went through consultants like water." Changes keep occurring that Charlie Keating can't control. The state slips through a new water law and slams down a deadline on using drinking water for huge pools and ponds of January 1, 1987. So the pools are thrown together, filled, certified. And then drained. The hotel doesn't exist yet, but the empty pools do. Costs a lot of money to do it that way. The Phoenician sits on the side of a mountain – they blast out 50,000 tons of rock..."

History shows that Keating's thrift failed, and failed miserably; the vaults short at least a billion dollars when it did so. (Eventually $2.5 billion was missing.) On January 6th, 1993, the people delivered their verdict: Keating, never actually listed as an employee of Lincoln on any documentation whatsoever, is found guilty of racketeering and fraud. He serves just 46 months of his sentence however as the conviction is overturned on appeal.

Further reading:

Adams, James Ring. How to Win Friends and Influence Regulators; the Delayed Closing of Lincoln Savings Cost the Taxpayer $1 Billion, National Review, Volume 42, Issue 5, March 19, 1990, page 36.

Binstein, Michael and Charles Bowden. Trust Me: Charles Keating and the Missing Billions, Random House, New York, 1993.

Corn, David. People in Glass S&L's, The Nation, Volume 249, Issue 20, December 11, 1989, page 708.

Davis, L. J. Will Charlie Keating Ride Again ?, Washington Monthly, Volume 29, Issue 3, March 1997, page 28.

Fowler, Jack. The Keating Fizzle, National Review, Volume 3, Issue 2, February 11, 1991.

Museum of American Financial History, financialhistory.org/fh/2002/75-1.htm

Sherrill, Robert. The Looting Decade: S & L's, Big Banks and Other Triumphs of Capitalism (Cover Story), The Nation, Vol 251, Issue 17, November 19, 1990.

Simons, Teresa. Banking on Secrecy: with our Banks about to Go the Way of Our S & L's, It's Time We Made the Freedom of Information Act Cover Financial Institutions Too, Washington Monthly, Vol 22, Issue 11, December 1990, page 31.

Copyright: Phil Anderson, 2004