A home is everyone’s dream and financial institutions literally encash on this. But during the late 70s, the Savings & Loans and Thrifts associations were losing more money than they could make, thanks to increased wages, heavy competition from its peers, excessive regulation, accessibility of the Money Market to the commoners and vestiges of recession. To save them, the Reagan administration had signed the Garn-St. Germain Depository Institutions Act on 15/10/1982, after which he proclaimed,
“All in all, I think we hit the jackpot.’’
Perhaps the greatest benefactor of this act was Empire Savings & Loans. Empire, a Texan thrift (which started as Town East Savings & Loans in 1973) witnessed tremendous growth after the arrival of Spencer Blain Jr, along with the help of Danny Faulkner and James L. Toler. The rags-to-riches-and-back-to-rags story highlights how deregulation (and subsequent exploitation) of laws could bring a whole economy to its knees. Let us briefly see how the scam unfolds.
ABOUT THE SCAM
The aforementioned act came with multiple perks that saved the industry: relaxation on the amount of reserves to be kept (which means that more amount could be lent), S&Ls could invest in whatever they liked and the amount of Federal Savings and Loan Insurance Corporation (FSLIC) backed deposit insurance jumped from $40000 to $100000.
But some geniuses had indeed hit the jackpot by using the acts to their own benefits. Blain (through the Mesquite branch) pushed for aggressive lending by undertaking risky loan proposals and Faulkner & Co. used these relaxations to construct buildings that eventually mushroomed across the Interstate-30 road. They made use of land flips, that too at a high frequency. They bought the dry Texan land for cheap and inflated the value by changing the deed from one person to another (usually starting with Faulkner), each happening in the gap of days or even hours, with the appraisals and regulations going for a toss. As if to not raise any suspicions, they usually sold the lands as small tracts at inflated prices (in one case, it was 800% the actual appraised value), to developers who would be financed by the Empire loans. The appraisers and intermediaries (usually young professionals and doctors who are lured by quick money without investing much) would be rewarded by hefty bonuses.
To finance these heavy loans (“110% loans” as they were called), Empire used money from Money Brokers and ordinary depositors, by showing inflated financial statements and promising extremely lucrative interest rates on Certificates Of Deposits (both insured and uninsured) and also relying on Fannie and Freddie Mae. The profits from the scam would be shared by the conspirators and invested in various assets or in off-shore tax havens. Soon enough, the Empire became the poster boy of thrifts. Assets grew to $308.9 million by January 1984, with more than 85 percent of the deposits coming from deposit brokers. But the house of cards was destined to fall back to earth.
The excessive lending led to the “Condo Glut” — an increase in the supply of land without a commensurate increase in demand. As the properties gathered dust, the developers defaulted on loan payments due to lack of rent. Even the lack of diversification to any land other than those on either side of I-30 led to its downfall. Any pyramid scheme has a lifetime only till there is a steady flow of income. The deposits dried up when the authorities got the whiff of dubious transactions and when the Empire was struggling to repay the high interest promised. FHLB, though late, ordered the company to close down and started unraveling the messy puzzle spread over two years.
The aftermath was scary. There were a lot of half-built buildings lined the sides of Interstate 30 and many more laid vacant. The depositors who invested in Empire felt the burn as the company was hemorrhaging money. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion and then went bust and was replaced by The Savings Association Insurance Fund. Blain, Faulkner and Toler had to face trial. At least $135 million in federally insured deposits at five savings & loan institutions in Texas and Arkansas was wiped out. This also casted a shadow on the very trust in these institutions. Other thrifts, who had emulated this scheme, too had fallen like a domino.
The above case shows why deregulation could be a double-edged sword: on one hand, it helped to revive the S & L industry which was experiencing a downward slump; but on the other end, it ended up benefiting the wrong people, the banks and middlemen, instead of the target market (middle-class families). The Empire financed the construction of condos and high-rise office spaces rather than homes for common folks which would have driven up the real economic output. The scam led the government to take up the reins of the industry again and to protect the hard money, at the cost of dwindling treasury funds. This helped to reduce the so-called White-collar crimes, though it still looms around other industries. Also, it was the recurrence of the housing boom that had caused the 2008 recession.
India, with scams like Adarsh Housing Societies Scam and Life Mission, etc., must take lessons from this fiasco and should not turn a blind eye towards the problems. Or else, it might aggravate into a nightmare and lead the economy down in a spiral at a break-neck speed.
- https://www.nytimes.com/1989/04/23/magazine/fast-money-and-fraud.html (20/10/2020)
- Niall Ferguson, The Ascent Of Money (pg. 256–260)
- https://repositories.lib.utexas.edu/bitstream/handle/2152/65569/DavidLawrenceMason.pdf?sequence=2&isAllowed=y (21/10/2020)