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WRITTEN TESTIMONY OF
STEPHEN P. PIZZO AND MARY FRICKER
CO-Author INSIDE JOB: The Looting of America's Savings and Loans
deregulation and the carnage that followed is one of the most
dangerous challenges facing Congress.
Echoing, almost to a word,
the pleas of thrift industry lobbyists 10 years ago, bankers and
their lobbyists are pushing Congress hard for bank deregulation:
and loans were
because, they said, theY couldn't make a profit making home loans.
They needAd to be able to diversify,
to get into ventures that
offered the promise of a higher return.
Competition from money
market funds, they said, was killing them. (Note: Many healthy S&Ls
opposed that deregulation.).
-- Now, almost exactly a decade later the nation's big banks are
Clamoring for their own deregulation because, they too claim, they
can't make a profit making commercial and consumer loans. They say
they need to diversify, to get into ventures that offer the promise
of higher returns.
Competition from investment banks,
conglomerates and international banks, they say, is killing them.
Commercial Banking vs. Investment Banking:
High on bankers'
list of wants is the dismantling of the Glass
which was passed in 1933 because many of the bank
failures fOllowing the market crash in 1929 were caused by risky
affiliates. The Glass-Steagall Act removed banks from Wall Street
and, to entice a gun shy public back to banks, it created federal
(Bankers today want only one of these Glass
Steagall provisions r.etained .These WOUld-be speCUlators still want
deposit insurance. Free enterprise and level playing fields is one
thing, but removing their federally-backed insurance safety net is
qui te another.)
If Congress again opens up banking to Wall Street speCUlation, as
it opened Up S&Ls and banks to real estate speCUlation, regulators
will quickly lose control over the complex series of events that
a pervasive marketplace will immediately set in motion.
and beck scratching relationships
institutions will run rampant.
While speCUlators play en
role in a free market economy,
their instincts and perspectives are exactly the opposite of those
we want in our bankers.
Wall Street investment bankers are to
commercial bankers what fighter pilots are to airline pilots. One
takes risks, the other avoids them. Investment bankers put their
money at total risk.
On this high wire,
there is no
collateral and no federal insurance net below. An unlUCky investor
can take a plunge - not only to the floor but right through it, in
some cases losing far more than just the money he invested. This
is the world that commercial bankers want to re-enter.
And the Bush administration wants to accommodate this wish, hoping
the repeal of the Glass-steagall Act will attract new money to the
the government won't have to recapitalize
failing banks itself.
Treasury Secretary Nicholas Brady
is almost giddy over the prospect of merging banks and Wall Street.
"natural synergy" with commercial banking.
The same argument was
development business. Developers needed loans - thrifts made loans.
Bingo. Natural synergy. RegUlations prohibiting such joint ventures
and sure enough private capital poured into the
thrift industry as developers bought thrifts and thrifts acquired
their own construction companies.
"My God! This is what I've been waiting for all my life!" gasped
the owner of (now defunct) San Marino Savings and Loan.
Almost immediately the predictable happened. The historical arms
length relationship that had existed between lender and borrower
vanished, and with it went due diligence, common sense and, in too
many cases, ethics. Thanks
facilitating that bit of synergy the
repossessed real estate from failed thrifts. If we sold $1 million
worth of this stuff a day, it would take 800 years to sell it all.
Deregulated banks can look forward to a similar script, with some
of the same bad actors.
Attorney Joe Cage in Shreveport,
Louisiana, told us, "Some of the same people who took down savings
are out in the 'securities business and banking now,
already in place. And they're just waiting for Congress to abolish
the Glass-steagall Act. If that happens I'm afraid they'll take the
banks just like they did the savings and loans."
Bankers want a piece of the insurance business as well. This idea
was also tried by the S&Ls and proved just another way to loot the
system. Many of the old S&L crowd - Gene Phillips, Charles Keating,
Jr., Herman Beebe, Mike Milken - also had their hooks in insurance
companies that have since failed: Pacific Standard Life, Executive
Life, AMI Life, and a daisy chain of Texas insurance companies, to
mention a few. An associate of a major S&L defaulter testified in
court recently ... "Wayne told me that the S&Ls were tapped out and
that we should find a new source for money. He told me we should
consider getting into the insurance business."
Treasury wants corporate America to be able to own these banking
securities-insurance conglomerates. But the benefits of corporate
and securities and insurance underwriting,would accrue
primarily to (1) major companies that would like to have a bank
(with its federally insured deposits) in their stables and to (2)
bankers who have proven themselves so inept that they must have a
huge infusion of private capital - from a new corporate owner - or
a chance to "double down" on Wall Street in a desperate attempt to
new breed of banker will use deposits to inflats the
value of stock, extortion to sell insurance and investor's capital
to benefit the bank or the bank's corporate ownership. Forget for
a moment what bankers say they need and instead ask yourself if
their customers, and your voters - taxpayers - need any of
The big "money center" bankers argue that without deregulation
American banks will not be able to compete with European banks
when the European Common Market will combine in a
universal banking system with broad banking and securities powers.
They also complain that they can't compete with the Japanese banks
bank ranks among the world's 10 largest banks.
So what? While European and Japanese banks appear more fragile
every day, American regional and community banks grow stronger.
Could that be why Japanese banks - widely believed to be under
severe stress in spite of their happy-talk annual reports - are
tapping into our regional markets? Why should Congress move in the
direction of weakness instead of strength? If American mega-banks
want to compete without restriction in the international arena,
wish them well,
withdraw their deposit
insurance and let them have at it.
These bankers say they want a level playing field, so give it to
deposits from deposit insurance premiums. It's interesting that,
though bankers are complaining about all the so-called "outdated"
regUlations which are impairing their profitability,
"outdated" regUlation is for a bank like Bankers Trust - recently
approved for securities underwriting by the Fsderal Reserve Board
whiCh has about twice as many foreign as domestic deposits.
Bankers Association of America,
deregulation agenda is
bitterly fighting the
and their reward for sounding the
Interesting. The healthy regional banks are whiners and the nearly
insolvent tumor-like, mega-banks - bearing about them a legion of
past mistakes like the chains around Ebenezzer' s
partner's ghost - are welcomed by Congress with open ears. It's
and if this
another disaster, voters will want to know why.
traditional banking services. American Express, for example, offers
banking, international currency transactions, insurance and data
We favor letting banks become financial service centers in their
communities - selling insurance, stocks, bonds and mutual funds,
offering financial planning services and in general meeting the
financial needs of their customers. But, to do this. banks do not
need the inevitable conflicts of interest inherent in corporate
advantages occur to the American
public by allowing banks into these fields? None.
corporate ownership and securities and insurance underwriting are
moot issues because bankers will agree to impenetrable firewalls
deposi ts -
they claim. Apparently,
through S0me magicai osmosis
that only works one way, Americans are asked to believe that banks
w.ill enjoy the benefits of having securities affiliates without
ever being affected by their problems.
But even as pro-deregulation £orces pay lip service to firewalls,
they attack them. Federal Reserve Board chairman Alan Greenspan,
evidently undaunted by his doomed infatuation back in 1985 with S&L
deregUlation and Charles Keating,
Jr. - cut to the heart of the
firewalls matter when he admitted that firewalls
reason for granting any additional powers to banking organizaticns
in the first place."
And this time Greenspan might just be right. Firewalls proved quite
unreliable during the S&L debacle. In the 1980s, when a thrift's
risky investments started going sour,
regulatory firewalls were
easily breached. For example, thrift executives were forbidden by
business associates or interests - a firewall. To get around this
firewall, thrift management simply found like-minded management at
other thrifts and each made loans to one another. So much for fire
Our expensive S&L lessons should have taught Congress that if banks
are allowed back into the securities business something like this
would almost certainly occur the next time Wall Street crashes:
hundreds of millions of dollars to cover margin calls as programmed
trading plunged the market to new depths.
- The bank's securities affiliate itself would be trying to support
stocks it had underwritten and would need a big cash infusion fast.
So what do we have?
players who own a bank but can't use its cash to bail themselves
out of trouble. In this scenario it wouldn't take these desperate
long to figure out that a
strapped - bank holding company was just a phone call away. They
could quickly arrange millions in loans to each other and to each
other's clients just like thrift officers did. In the flash of a
wire transfer and a
hundreds of millions of
would go right down another federally
insured rat hole. They'd worry about dealing with irate regulators
Though these scenarios are simplified versions of what would no
doubt be almost incomprebensively complex transactions - to hide
them from regulators - ths fundamental point is this: A business
in deep trouble, seeing a chance to make a killing, will use all
the assets at its disposal (particularly those belonging to someone
inadequate when they are needed most -- in times of fire."
Walter Wriston, former chairman of Citicorp, candidly admitted the
futility of firewalls when he said,
"Lawyers can say you have
separation, but the marketplace is persuasive and it would not see
it that way."
An historical look at one bank, Continental Illinois Bank & Trust
CO. of Chicago, says reams about bank deregulation. In 1933 it was
the first major bank in the country to be bailed out by the federal
government as a result of the Great Depression. In 1984 the federal
government bailed it out again, to the tune of S4.5 billion. Both
times, according to FDIC chairman Irvine Sprague, the problems were
purSUit of growth at any cost
go for the fast buck; a bigger
bank means more compensation for its management."
Prior to the
second bailout, Continental had hooked up with the flim-flam crowd
at Penn Square Bank in Oklahoma City,
where wild speculation,
insider abuse and fraud sucked the life from both Penn Squars and
Did those two lessons teach Continental anything about prudence
and risk? Apparently not. In 1967 when the stock market crashed
Continental (still owned primarily by the federal government) was
opportunity to show Americans how firewalls don't work. It made an
emergency $385 million loan to its options trading subsidiary in
transaction. Reportedly, the bank was never censured by regulators
because they agreed the loan was critical to Continental's survival
but they did require that Continental route the money to its
to avoid a direct violation of the regulation
against a bank making a loan to its own securities affiliate.
None of these concerns has deterred the Bush Administration and
many on Capitol Hill from supporting a two-tiered holding company
commercial and industrial companies would own a Diversified Holding
Company that: would own a string of companies
(engaged in real
Diversified Holding COmpany would also own a Financial services
Holding COmpany that would own a bank, a securities affiliate and
. other subsidiaries.
The Financial Services Holding COmpany and its subsidiaries would
be "absolutely prohibited" from lending "upstream" to its parent
Diversified Holding Company and subsidiaries, yet according to one
summary the structure "would permit non-banking firms to invest
industry." Why, one might ask, would they want to do that, if they
can't use the bank f S
money? Maybe as a selfless act of pUblic
How examiners might detect lending within that maze has not been
not a bank examiner in this country who could
couldn't stop the looting at savings and loans -
which are by
comparison a fairly straight forward corporate structure - what
hope is there that bank regulators will be able to monitor a two
structure with multiple
deceptions by an examination system that -
according to George
Champion, retired chairman of Chase Manhattan Bank, and Paul Craig
Roberts, a former assistant secretary of ·the Treasury, writing in
rife with conflict of interest
broken down. The General Accounting Office said in March that in
37 out of the 72 cases it studied, regulators weren't aggressive
enough in dealing with troublesome banks. In candid moments bankers
themselves will tell you that lax accounting guidelines permit
troubled banks to distort the truth and hide their problems until
It is this antiquated and inadequate system Congress that is about
RegUlators will have
complex bank hOlding company structures,
national and international activities,
the dealings of
sophisticated hedges and
straddles and options and swaps, and thousands of daily electronic
transfers among affiliates and SUbsidiaries and brokers.
At the same time the current legislation pays only lip service to
regulatory structure will be beefed up, or where the money will
examiners that will be needed. If specific provisions for funding
this examination force are not included in any bank deregulation
legiSlation, the legiSlation should be dropped like a hot potato.
If Congress tries to enact it later, the same bankers who are now
purring like kittens, to get what they want, will become tigers who
premiums or asks them to contribute to the regulatory kitty.
Bankers pleas for interstate branching should also be ignored. It
isn't needed - banks can already loan everywhere and draw deposits
(and both powers have
maj or source of
problems for banks). Allowing them to have branches everywhere will
only encourage the creation of more mega-banks as the tumor-banks
country to feed their lust for a nationwide branching structure.
The net result of interstate branching will be fewer banks and the
consolidation of the industry into a group of mega-banks, each of
which will then be perceived by regulators as being decidedly Too
Instead ofAS mall percentage of the industry falling
into that questionable category, nearly the entire industry will
fallon the taxpayer's shoulders.
Another unpleasant fallout of interstate banking will be increased
The reason is simple.
Small business supplies and
creates the majority of jobs in America. not the big corporations
Once America's cOJIUnuni ty
banking structure has been absorbed by the big banks. which in turn
have been absorbed by Fortune 500 corporations,
lending patterns which made America the world capital of small
business and entrepreneurship will change course. Banks steeped in
corporate culture will
business and will prefer channeling their loans into more familiar
corporate ventures. Slowly small business will be choked off as
operating loans, inventory loans and start-up capital dry up. In
the end Congress will be
faced with only one
finance - a government program which, we can all rest assured, will
be mismanaged and very expensive.
Banks' demands for dramatic changes come at a time when banks are
weaker than they have been since the Great Depression. Almost 1,000
banks have failed in the last four years, more than failed in the
regulations did not cause these problems, as the big banks would
have Congress believe. Instead,
in the last five years American
bankers have discovered about S75 billion in bad loans on their
books. With judgment that faulty,
it's terrifying to think what
they could have done on Wall Street. Never ones to be contrite
about losing other people's money,
the bankers explain
that in essence the devil made them do it. They say that it was
those "old-fashioned federal regUlations" barring banks from other,
potentially greener pastures that forced them into those bad deals.
FDIC chairman until 1986,
most bank failures are caused by one thing - greed. The Comptroller
Currency said bad management
Accounting Office found insider abuse at 64 percent of the bank
failures it studied. The FDIC reported that criminal misconduct by
insiders was a major contributing factor in 45 percent of recent
Swindlers have always been attracted to banks because, as legendary
bank robber Willie Sutton explained, "that's where the money is."
During our eight-year stUdy of savings and loans, the biggest S&L
rogues we identified had cut their teeth by looting banks first.
An FBI agent in Texas told us, "The only difference (between banks
and thrifts in Texas) is that the FDIC still has its head in the
sand on banks. When I looked at the banks that closed between 1984
and 1987, in many of them 1 found people 1 knew, the same S&L crowd
I'm investigating from the failed thrifts there."
High flyers like these make it a point to know where the money is
and to get at it before regulators know its ,gone. And they stand
today straining at the starting gate, with their eyes on Congress
and the banks. A man who arranges mezzanine financing for leveraged
buyouts told us not long ago,
"I think I'll go buy a bank. They
only cost $3 million." When an LBO player thinks a stodgy old bank
is suddenly attractive, should congress begin to worry?
As for bankers who find themselves locked in this fatal attraction,
they should turn for advice to some of their former cousins who
pushed so hard for savings and loan deregulation.
tell bankers to be careful what they ask for
- they might just get it.
What should congress do?
The lesson of the S&L crisis is that deregulation of the financial
services industry should be treated like brain surgery - a little
bit goes a long way. Cut away too much and the patient you were
trying to help will wake up acting in strange and self destructive
Some banks are sick and they need congressional medicine. But not
the narcotics they are begging for. What they need is:
Risk-based deposit premiums.
- Insurance premiums on foreign deposits.
- No insurance coverage for banks that underwrite securities and
insurance or are owned by industrial corporations.
- Increased insurance premiums for banks that involve themselves
in the risky worlds of foreign exchange contracts,
swap contracts and the like.
- Early closure and no forbearance regardless of asset size.
International Settlements in 19BB.
insurance and offer a broad range of financial services.
- Rebuilding the Bank Insurance Fund immediately, so no forbearance
is necessary, even if taxpayers have to kick into the pot.
- Downsizing banks until they all have plenty of capital (Bank of
showed how it's done.)
- Hiring enough examiners to examine every bank once a year.
- Making bank examination reports public. (If $500 billion in bad
news in the S&L industry didn't start a run on deposits, a negative
bank examination sure won't.)
to be more
like the 10Ks required by the Securities and Exchange
- Requiring foreign banks to operate under U.S. bank regulations
and requiring U.S. banks to conduct their foreign operations in
conformance with U.S. regulatory standards (unless of course they
wish to relinquish their deposit insurance coverage.)
Limiting, but not eliminating, the use of brokered deposits.
Federal ReseirVe Board's
deregulation of banks.
But the bottom line is really this: Most banks are healthy. They
know what they're doing. Leave them alone. Don't be spooked into
a big 'operation when some delicate surgery will do.
It would be nice to think that Congress will apply the lessons of
S&L deregulation to bank deregulation, but the record says Congress
doesn't learn from history.-Perdinand Pecora's "Wall street Under
Oath," for example, which is the story of_ congressional hearings
held in 1933 and 1934 on the collapse of Wall Street and the
banking industry, reads as though it were written today. Even the
players are the same: J.P. Morgan and Company, Chase
Company, Lehman Brothers, Kuhn Loeb and Company (Lehman and Kuhn
Loeb are now part of Sherson/Lehman).
More recently, in 1976 the House Banking Committee held hearings
in Texas to investigate bank failures,
and the chairman of the
Fernand St Germain, said at those hearings,
been repeatedly told that most major bank failures have been caused
by criminal conduct."
Committee member Henry Gonzalez said,
"Inadequate regUlation is
what has made possible the kind of outlandish sordid conduct we
later St Germain
sponsored the Garn-St
hearings in Texas had never taken place. (Gonzalez voted against
it.) Thus unleashed, S&Ls during the unregulated 19BOs united with
securi ties firms
and insurance companies,
and the resul ts were
thoroughly predictable. Drexel Burnham Lambert, Lehman Brothers,
Lincoln Savings, Columbia ::;avings, San Jacinto Savings, Pacific
Standard Life Insurance, Executive Life Insurance, AMI Insurance,
deregulated relationship. Now they no longer exist.
Is that what Americans want for their banks?
In addition to the attached material, we refer readers of this
congressional record to two important books:
"Bailout" by Irvine
Sprague (FDIC chairman until 1986), pUblished by Basic Books, Inc.,
in 1986, and "Wall Street Under Oath" by Ferdinand Pecora (Counsel
to the United states Senate Committee on Banking and Currency,
1933-1934), published by Augustus M. Kelley in 1939 and reprinted
in 1968. Because both books are out of print and may be difficult
to acquire, we are attaching important passages:
From Irvine Sprague in "Bailout:"
"The list of super banks is sure to grow as interstate banking, an
inevitable fact of the future,
will just as inevitably produce
combinations that will dwarf the present giants of the industry ...
Major banks will continue to be treated differently than small
ones. I cannot believe that any future FDIC board would allow the
cOllapse of one of the giants of American banking."
"The major banks of the nation today range virtually unchecked
abandon, and piling up off-book liabilities - some risky and few
"The record of repeat behavior points to the greed factor that
remains the major - often the only - reason for a bank's failure.
Banks fail in the vast majority of cases because their managements
seek growth at all cost, reach for profits without due regard to
give privileged treatment to insiders,
management that loots the bank."
remember, in 1939):
"Under the surface of the governmental regulation of the securities
that produced the
excesses of the 'wild bull market' of 1929 still give evidences of
their eXistence and influence. Though repressed for the present,
it cannot be doubted that, given a suitable opportunity, they would
spring back into pernicious activity.
"Frequently we are told that this regulation has been throttling
the country's prosperity."
its memory of the
unhappy m?rket collapse of 1929 becomes blurred, it may lend at
pleading for a return to the 'good old times.' Forgotten, perhaps,
by some are the shattering revelations of the Senate Committee's
investigation; forgotten the practices and ethics that The Street
followed and defenqed when its own sway was undisputed in those
good old days.
"After five short years, we may now need to be reminded what Wall
Street was like before Uncle Sam stationed a
policeman at its
corner, lest, in time to come, some attempt be made to abolish that
"National City Bank grew to be not merely a bank in the old
fashioned sense, but essentially a factory for the manufacture of
stocks and bonds, a wholesaler
retailer for their sale, and a
stock speCUlator and gambler participating in some of the most
notorious pools of the 'wild bull market' of 1929.
"But how was this possible? For surely, the layman will protest,
the law does not permit a bank to engage in such activities. A
sacrosanct, its power strictlY limited by Act of Congress, and its
activities carefully and regularly examined by skilled examiners.
"The layman is right. But he has reckoned without the ingenuity of
authorities toward powerful financial and business groups during
the lamented pre-New Deal era. With their superior advantages, a
method was worked out whereby a bank could assume a veritable dual
personality. In one aspect - the aspect which it presented to the
as to which it was
subj ect to governmental
control - it observed strictly all the proprieties of a properly
In the other aspect,
it knew no regUlation and no
limitations: it COUld, and did, engage in the most diverse, risky
and unbanklike operations.
"The technical instrument which enabled the bank to carry on in
deducting heavy losses of .about
$4 million for the depression
years, 1931 and 1932, Albert Wiggin, the head of Chase National
and his family corporations still showed a net income for
the whole period of over $8.6 million. Not many Americans could
look back, in 1933, upon so satisfactory a balance sheet.
"How were these millions made? ... Mr. Wiggin was able to make an
income many times in excess of his ($175,000) salary, in large part
by using his unique opportunities as the trusted and all-powerful
head of a great bank, for his personal advantage.
"To assist him in his private operations, Mr. Wiggins formed no
less than six corporations,
all of them owned and controlled by
himself or members of his immediate family.
Three of these were
Canadian corporations organized in the hope that they might prove
useful in reducing income taxes . . . •
"Mr. \'1i.ggin' s private operations in Chase Bank stock for his own
wer.e intimately intertwined and'synchronized
undertaken by the bank's own affiliates. The full story of these
involved relationships is an incredible one."
legislation now being considered.