Criminal activities in the manipulation of Lincoln Savings and Loan were found to be symptomatic of deeper problems in the thrift industry.
Charles Keating, a champion swimmer, antipornography crusader, and attorney who built a financial empire through takeovers and stock sales, acquired control of a Southern California savings and loan (S&L), Lincoln Savings and Loan, in 1983. In April, 1989, the holding company for that S&L, American Continental Corporation,
Keating had worked as an attorney in Cincinnati, building relationships with important clients, such as Carl Lindner, Jr., who acquired and sold other companies as a feared “takeover” artist. Through Lindner, Keating acquired part ownership in American Financial Corporation, which had a network of businesses. One of the businesses that attracted Keating was a home-building firm in Phoenix, Arizona, named Continental Homes. Keating acquired Continental Homes directly from Lindner in 1976 after a federal suit against Keating’s and Lindner’s companies resulted in a consent decree.
Charles Keating looks to his family as he is convicted of securities fraud in April, 1992.
At first, Keating had planned to liquidate Continental Homes,
Keating, physically and managerially removed from American Financial Corporation, concentrated on Continental Homes. He concluded that although home construction provided good returns, financing of home construction could be even more lucrative. Keating found the perfect vehicle for such financial operations in a Lindner-owned California-based S&L, Lincoln Savings and Loan. He purchased the S&L in 1983, at a time when Continental Homes was building three thousand to five thousand homes per year, and assumed possession of Lincoln S&L in 1984. Lincoln S&L had assets of $1.2 billion, and after a year under Keating’s management, it boasted assets of $2.5 billion. It failed, however, along with its holding company, in 1989, and Keating was investigated under a full range of charges.
Like other S&Ls—often referred to as thrift associations or simply thrifts—Lincoln suffered from long-term problems that had started to beset the industry in the 1970’s. Most of those problems had originated in the New Deal regulations that established and governed the thrift industry. During the Great Depression,
By the late 1970’s, the thrift industry faced deep losses, and it lobbied Congress for relief from the restrictions on lending. Congress enacted several laws, such as the Garn-St. Germain Depository Institutions Act of 1982,
Suddenly freed to lend on consumer items, commercial properties, and even low-grade bonds (usually referred to as junk bonds), the S&Ls had to make up substantial losses in a short time or collapse. S&L owners and managers, therefore, sought the riskiest investments, as such investments often have the potential for the highest return. In the early 1980’s, those investments included junk bonds and, more frequently, speculations in land. Prior to the New Deal, S&L owners and managers had been restrained by the fact that they knew their depositors’ funds were at risk in such speculative ventures; if an S&L failed, the depositors lost their money. During the New Deal, however, the federal government created deposit insurance for banks through the Federal Deposit Insurance Corporation
Owners correctly deduced that if they continued on their present course, their institutions would go out of business, but if they guessed wrong on their investments, their institutions would go out of business. In either case, the depositors would get their money. Only if the owners invested in high-risk ventures that succeeded could the S&Ls and the depositors all win. Deposit insurance therefore had the effect of motivating the owners to seek the riskiest investments.
With the majority of deposits insured, S&L owners and managers, facing certain collapse without a dramatic turnaround, invested in the riskiest land speculations and, to a much lesser degree, in junk bonds.
In 1979, there were 5,147 S&Ls or thrift associations in business. By 1989, the number had fallen to 3,347 institutions covered by FSLIC (or its successor fund, SAIF) or the Bank Insurance Fund (BIF). No direct evidence exists to show that the 1,800 thrifts that failed did so because of criminal activity by operators such as Keating, but an assessment of significant investments in junk bonds—usually blamed as the primary culprit for S&L problems—has revealed that investments in junk bonds and commercial holdings grew at a slower rate than either land loans or consumer loans by S&Ls. Nontraditional holdings as a percentage of total S&L assets rose by 10 percent from 1982 to 1985 alone. Consumer loans doubled and land loans tripled, suggesting that land and consumer loans were most responsible for the falling asset value of the S&Ls.
Criminal activity was present in numerous S&L cases, however, particularly in Texas, where Democratic Speaker of the House of Representatives Jim Wright
Charles Keating was indicted in California on racketeering charges, tried, and convicted. In April, 1992, a state court sentenced him to ten years in prison; in 1993, a federal court also convicted him, and he received a sentence of twelve and a half years. He actually served only four and one-half years in prison, however, because eventually both sentences were overturned. After the state conviction was thrown out owing to technicalities concerning jury instructions, the state declined to try the case again. In 1999, rather than face retrial on federal charges (after the initial conviction was overturned because of the possibility jurors had been influenced by their knowledge of the state trial), Keating entered into a plea agreement in which he admitted to committing bankruptcy fraud and his federal sentence was reduced to the time he had already served. Only those who had invested directly in American Continental Corporation or Lincoln lost significant amounts of money in the long run: Deposit insurance protected most of the average depositors.
The Keating affair broadened amid revelations that in 1984, Keating had met with five U.S. senators—Democrats John Glenn
In broader terms, the S&L crisis did not produce the dreadful results many predicted for the American economic system. As land values returned to previous levels, the government was able to sell many of the S&Ls it held in receivership for more than analysts originally had expected. S&Ls that had not failed gradually returned to health in the deregulated atmosphere.
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Adams, James Ring. The Big Fix: Inside the S&L Scandal. New York: John Wiley & Sons, 1990. Emphasizes internal corruption, political ties, and fraud as the causes for S&L difficulties. Relates Texas scandals with apparent violations of the regulatory/examination process. Fails to take into account the effects of deposit insurance, the original interest rate mismatch, and simple fluctuations in land prices. -
Binstein, Michael, and Charles Bowden. Trust Me: Charles Keating and the Missing Millions. New York: Random House, 1993. Rambling and disjointed, but contains numerous quotations from Keating and has as much biographical information as exists in a single source. Posits that deregulation and criminal elements caused the industry’s woes. -
Black, William K. The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry. Austin: University of Texas Press, 2005. Account by the director of litigation for the Federal Home Loan Bank Board in the 1980’s describes how Keating and others used a weak regulatory environment to perpetrate accounting fraud. Links the S&L crisis to business failures of the early twenty-first century. -
Brumbaugh, R. Dan, Jr. Thrifts Under Siege: Restoring Order to American Banking. Cambridge, Mass.: Ballinger, 1988. Comprehensive study of the problems of thrifts and the role of deposit insurance and regulation was published before the restoration of land values undercut some of the effect of calls for immediate action to forestall further disaster. -
Glasberg, Davita, and Dan Skidmore. Corporate Welfare Policy and the Welfare State: Bank Deregulation and the Savings and Loan Bailout. New York: Aldine, 1997. Examines the topic of the American welfare state by using the S&L crisis as a case study in corporate welfare. Argues that the federal bailout that followed the crisis was an extension of a larger pattern of economic intervention. -
Pilzer, Paul Zane, with Robert Deitz. Other People’s Money: The Inside Story of the S&L Mess. New York: Simon & Schuster, 1989. Blames poor judgment by S&L managers and bad luck, in addition to corruption, for industry troubles. Attempts to analyze the effects of regulation on the industry. -
White, Lawrence J. The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. New York: Oxford University Press, 1991. Excellent scholarly study of S&L problems analyzes the portfolio changes in the industry, showing that commercial, consumer, and land loans, not junk bonds, caused the asset value to fall, while regulatory problems allowed the S&Ls to weaken.
U.S. Congress Deregulates Banks and Savings and Loans
Insider Trading Scandals Mar the Emerging Junk Bond Market