Another Time Bomb Goes Off

By Stephen Koepp.

When a savings and loan crisis hit Maryland last week, depositors knew all too well what to do. They gathered up their lawn chairs, thermos bottles and portable radios and lined up outside the banks as if they were embarking on a familiar American outing. In a sense, they were. Only two months ago, depositors across the U.S. witnessed scenes right out of the Great Depression during a panic that temporarily shut down Ohio's 69 privately insured thrifts. At the time, Governor Richard Celeste warned several other states that they should prepare for similar events. "You're sitting on a time bomb," he told Maryland Governor Harry Hughes.

The panic indeed exploded in Maryland last week, prompting Hughes to seize emergency control of his state's 102 privately insured thrifts. The events demonstrated the shaky state of consumer confidence in banking and sparked demands that all deposit-taking institutions be federally insured. Most of all, Maryland's crisis raised doubts about the overall health of the savings and loan industry, which is attempting to recover from a six-year slump. Said Willard Butcher, chairman of Chase Manhattan Bank: "We have the potential for a very serious thrift crisis in this country."

A whiff of trouble was all it took to ignite the fears of Maryland's depositors. Press reports about management improprieties at Baltimore's Old Court Savings & Loan sent customers scurrying to withdraw deposits. The panic spread to other thrifts because many of the state's institutions, as those in Ohio once did, rely for deposit protection on a private insurance fund rather than federal agencies. Maryland depositors feared that their $286 million fund, the Maryland Savings-Share Insurance Corp., would be exhausted by a major run on the $7.2 billion in deposits that it guarantees.

Even though Maryland's government has no obligation to support the private insurance fund, many customers might have got a false sense of security from the thrifts' prominently displayed decal symbol, which was designed to look very much like the official state seal. "The thing that's scaring me is that everyone else is scared," said Jeff Shank, an auto mechanic who took a four-hour lunch break to withdraw $14,000 in savings from an Old Court branch.

By week's end Hughes managed to restore calm and slow down the cash drain by ordering the 102 thrifts to limit withdrawals to no more than $1,000 a month. Federal regulators moved quickly to help. The Federal Savings and Loan Insurance Corporation, a U.S. agency that guarantees deposits up to $100,000, sent an army of auditors to Maryland to rush the process of bringing many of the thrifts under its coverage.

Customers at Maryland's privately insured S and Ls have been jittery since the Ohio crisis, withdrawing about $630 million in two months. But like Ohio's episode, which was touched off by the failure of Cincinnati's Home State Savings, Maryland's full-blown panic started with trouble at just one institution. The run began when press reports revealed that Old Court's president and part owner, Jeffrey Levitt, had stepped down under pressure from the insurance fund, which was worried about the thrift's sloppy management and overly rapid growth. In three years, Levitt had pushed the thrift from $140 million in assets to $873 million. Old Court made that leap with risky real estate deals and flashy Government securities trades, but faltered when some of those ventures fell through.

That was not all. Maryland authorities contended that Old Court's top officers had engaged in such improprieties as giving themselves lavish consulting fees and writing at least $5.8 million in overdraft checks. Maryland's attorney general is conducting a probe of Old Court's management that could produce criminal charges.

The panic spread to Baltimore's Merritt Commercial Savings (assets: $339 million) following news reports that state regulators had asked the thrift to bolster its cash position by selling a 39-story downtown skyscraper it is constructing. Maryland authorities tried to restore confidence by placing both institutions under the wing of state conservators, but that failed to stop the runs from spreading to other privately insured thrifts.

Hughes, cutting short a trip to the Middle East, jetted back to the state and imposed controls on withdrawals. By keeping the thrifts open, he managed to bring the blood pressure of depositors down a few points. Even so, the $1,000 limit sparked bitter complaints from small companies that needed to meet payrolls and from customers who need money for large purchases. A few thrifts affronted consumers with the final insult by offering to lend them money instead, at rates of about 11%.

In a 13-hour emergency session on Friday, the state assembly passed seven bills that give the Governor more power to regulate the state's thrifts and replace the old private insurance system. The new laws will require all Maryland S and Ls to obtain federal coverage within four years or close their doors. In case they need state help in the meantime, the legislators authorized a $100 million bond issue. To reduce Maryland's potential loss in rehabilitating the Old Court and Merritt thrifts, the state began negotiating their sale to such institutions as New York's Citicorp and Chase Manhattan.

Following the Ohio episode, Maryland's crisis may have dealt a fatal blow to private insurance in the rest of the country. While 83% of U.S. thrifts are federally insured, 30 states allow at least some of their banks, thrifts or credit unions to rely on private coverage. Many institutions that are small or in a hurry to grow prefer local insurance funds because they tend to be less strict than federal regulators. Old Court, for example, was able to boast money-market accounts with interest rates of up to 11%, compared with about 8.5% offered by federally insured thrifts.

Despite those lucrative rates, customers have begun to shy away from privately insured institutions. "Because of the problems in Ohio, people are pretty aware of insurance," says Thomas Brown, marketing director for Old Stone Savings (assets: $288 million) in High Point, N.C. "They call us to ask how we are insured. We in North Carolina think that the state insurance is just as good as federal. Unfortunately, because of the bad press, the customers don't always see it that way." Consumer anxiety has prompted many $ privately insured thrifts in North Carolina and Massachusetts, among other states, to apply voluntarily to the FSLIC. Editorialists and legislators have called for a law to make this step mandatory for all deposit-taking institutions.

Since 1980, the thrift industry has been struggling to pull out of a slump caused by an interest-rate spiral that peaked with a prime rate of 20.5% in 1981. Competitive pressure forced the thrifts to pay 10% or more to bring in deposits, but their income remained far below that level because it was largely dependent on old, fixed-rate loans paying interest rates as low as 6%.

Thrifts have been gradually replacing those loans with adjustable-rate mortgages, or ARMs, which protect the institutions from unexpected rate increases. In addition, the steady decline of interest rates has given thrifts a breather by reducing their cost of attracting deposits. The welcome trend continued last week. The Federal Reserve Board cut the rate it charges its member banks from 8% to 7.5%. Several major banks dropped their bench-mark prime rate by half a percentage point to 10%, the lowest since 1978. The easing of rates has helped most thrifts make profits again. While about 85% of thrifts were losing money in 1981 and 25% were still in the red early last year, only about 10% are now. The industry is expected to earn as much as $5 billion this year, in contrast with 1981's loss of $4.6 billion.

The improving picture, however, is pockmarked by a potentially serious new problem: management missteps. Deregulation has enabled thrifts to plunge into new, riskier ventures in areas with which many of them are unfamiliar. While thrifts once concentrated on inherently stable home loans, they now lend money for everything from casino construction to consumer vacation trips. In most cases the thrifts simply want to earn enough to account for the competitive rates they are paying to savers. But in a few other cases managers have been overtaken by lofty growth goals and carelessness. Example: federal regulators last month bailed out Beverly Hills Savings, a go-go California institution that toppled after tripling its size in two years, to $2.9 billion.

With so much attention directed at the FSLIC as the rescuer of last resort, many experts have begun wondering whether that fund is adequate. The increasing number of federal rescue missions has shrunk the FSLIC's reserve pool from a longtime average of 1.2% of all deposits to just .76%, or about $6 billion. As a result, the FSLIC has asked Congress for permission to begin charging higher insurance premiums to thrifts that get into risky investments. That would create a larger reserve pool and provide an incentive for sound management.

Regulators are also tightening up rules. The Federal Home Loan Bank Board this year required many thrifts to boost their net worth, and started curbing both the growth rate and the investment choices of thrifts. With such rules in place, FHLBB Chairman Edwin Gray thinks a safe future is nearly assured. "We have been going through a transition of truly historic dimensions," says Gray. "It is clear that there has been a significant turn for the better." Millions of depositors want to believe that that is a fact, not just an opinion.

With reporting by Thomas McCarroll/New York and Christopher Redman/Washington