All Commentary
Thursday, November 1, 1990

The Great Banking Scandal

Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania. He is the author of the 57-page booklet The Savings and Loan Bailout: Valiant Rescue or Hysterical Reaction? available from The Foundation for Economic Education at $4.45.

Federal Reserve Chairman Alan Green-span recently shocked the financial world when he estimated the eventual cost of the savings and loan bailout at half a trillion dollars. And Treasury Secretary Nicholas Brady added a jolt by admitting that taxpayers must bear most of the burden.

It is a scandal, all agree, the greatest ever in U.S. financial history. It is greater by far than the bail-outs of Chrysler, Lockheed, and New York City, even greater than the costs of the default of Third-World debtor countries. In ages past, it would have been ignored as a malicious story that was absurd and impossible. Yet, it is as real as the S&L losses and bankruptcies.

It is even more scandalous that most of the perpetrators are escaping unscathed. The legislators and regulators who created the system during the 1930s have left the stage of life and can no longer be held accountable. But there are many who helped to fashion the S&L structure, who drafted and enacted the Depository Institutions Deregulation and Monetary Control Act of 1980 that stoked the fires of inflation, and the Garn-St. Germain Act of 1982 that invited crooked appraisals and dubious accounting. They are making their escape.

A few politicians actually paid a nominal price for the damage they inflicted. Representative Fernand St. Germain of Rhode Island, co-author of the law that made matters worse, was defeated for re-election. Speaker Jim Wright, who badgered Federal regulators for his favorite S&L bankers, resigned in disgrace. Five Senators are at risk because they intervened with regulators on behalf of big campaign donors. Yet, no Representative or Senator is expected to lose a penny from the debacle. In fact, they voted themselves several boosts in salaries and pensions and are about to raise them again.

The politicians who created and nurtured the system are quick to point at the bankers who saw an opportunity to splurge and steal. Some 50 thrift officials and accountants already have been convicted, and more are likely to face indictments as inquiries proceed. But even if a few hundred incompetent and corrupt owners and managers should be found out, their numbers are puny when compared with some 50,000 employees laboring in the industry, it is unlikely that the number of industry perpetrators will ever reach 1 percent of employees, but it is obvious that more than one-half of legislators created and fashioned the system and that regulators guided it every step of the way.

The greatest outrage, however, is the lack of Congressional interest in the causes of the disaster. There are no hearings, no investigations, no special prosecutors, not even committee debates on the real causes of the scandal. Congress is visibly skirting the real issue.

The reasons for such conspicuous silence may be as numerous as the voices against the hearings and investigations. Some legislators undoubtedly are convinced that they have the answer: the irresponsibility and greediness of bankers. Many newspapers and broadcast media share this opinion, which implicitly exculpates the legislators.

The conspicuous silence may also hide an awareness of guilt. Many legislators not only cast their votes for the system but also have used it, and continue to use it, for their own ends. Savings and loan associations and other government-sponsored and regulated institutions are among the most generous contributors to the re- election campaign funds of the politicians who legislate and regulate the conditions of S&L existence. The con tributions amount to many millions of dollars, bolstering the political and financial fortunes of incumbents. Surely, any Congressional investigation would soon discover the connection, which would be rather embarrassing to the legislators.

Public opinion, which offers a ready answer to all things, usually points at a lax Reagan Administration and a reckless industry. It neither theorizes nor analyzes, nor argues on grounds of inexorable principle. In vague and eclectic fashion, public opinion clings to simple notions of good and evil, command and obedience. It places the blame on evil bankers and lazy regulators who neglected their police function.

Actually, the bankers’ greed and the regulators’ negligence merely are visible symptoms of much greater evil. The real cause of the disaster is the very financial structure that was fashioned by legislators and guided by regulators; they together created a cartel that, like all other monopolistic concoctions, is playing mischief with its victims.

The structure was erected on the foundation of government force rather than voluntary cooperation. Held together by numerous laws and regulations, it weakened from the inflation fever of the 1970s and growing institutional competition during the 1980s. It suffered severely during the Nixon, Ford, and Carter Administrations which lifted interest rates high above the rates S&Ls were permitted to pay and charge. As depositors withdrew their deposits and turned to higher-yielding money market funds, S&Ls were caught in the vise of inflation and regulation. Moreover, rising interest rates caused S&L instruments consisting primarily of long-term mortgages to plummet in price. All S&Ls suffered staggering losses. It is surprising that some actually managed to survive.

In desperation about their sinking ship, the legislators finally consented to “deregulate,” that is, they relaxed some rules while they tightened others. They passed the Depository Institutions Deregulation and Monetary Control Act which reduced aggregate reserve requirements for Federal Reserve member institutions by about 43 percent and tightened Federal Reserve control over financial institutions.

To lower reserve requirements is to pour more fuel on the fires of inflation. The 43 percent reduction that member banks experienced was unprecedented in scope and magnitude; it flooded the markets with new credits, caused interest rates to skyrocket to a 20 percent prime rate, and precipitated an inflation rate that reached a staggering level of 18 percent. To control the price inflation, the Carter Administration then invoked the Credit Control Act of 1969 and placed controls not only on banks and thrift institutions but also on all consumer lenders, such as retailers and auto dealers.

The Depository Institutions Deregulation and Monetary Control Act extended Federal Reserve credit controls by imposing reserve requirements on all transaction accounts. At the same time, credit unions, savings banks, savings and loan institutions, and nonmember banks were required to keep their reserves with the Fed. In short, the extension of Federal Reserve controls and the expansion of Federal Reserve funds greatly tightened the vise that was to crush more than 3,000 thrift institutions.

The S&L industry is a component part of the American financial cartel that builds on legislation and regulation. Federal deposit insurance was added in 1933 to prevent a repeat of the sad banking picture of the Great Depression. Unfortunately, government insurance is self-defeating. The greater the protection government provides, the greater the risks the insured are willing to take. Depositors who are fully insured have no incentive to select a solid bank over a poorly managed bank. Federal deposit insurance contributed to the debacle of the S&L industry.

As with so many government programs gone awry, the S&L system was born of good intentions and economic ignorance. Unfortunately, the economic ignorance of politicians and officials is always visited on the people. It is visited anew on the American people who are facing a bailout bill of some $500 billion.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.