A New S&L Mess

The thrifts' deposit-insurance fund is looking shaky

For most people, the savings and loan debacle of the 1980s, which cost taxpayers $125 billion, is a distant memory. Not, however, for the unfortunate individuals who invested in so-called FICO bonds, $8.2 billion of which were issued by Financing Corp. FICO was established by Congress to pay off depositors of insolvent thrifts. Interest on the bonds is paid from premiums on a chunk of remaining thrift deposits. Over the years, however, thrift deposits have been shrinking rapidly (chart). The result, officials warn, is that the bonds could go into default as soon as next year. That could leave thousands of investors, big and small, holding the bag.

On Apr. 23, House Republican leaders, Treasury officials, and banking regulators decided to move on a deal, backed by S&L executives, to shore up the anemic fund that insures thrift deposits. The deal, however, would have forced commercial banks to pony up an estimated $12 billion over the next 20 years to help in the rescue. Protesting loudly to members of the House Rules Committee, some of whom are recipients of their generous campaign contributions, bankers were able to have the measure yanked at the last minute from a larger government funding deal that went through the next day. While bankers won the Apr. 23 battle, they could lose the war, since any future fund fix could stick them with even more of the bill.

The seeds of the current crisis were planted back in 1987. As the S&L industry's problems became apparent, Congress saw bonds as the only way to deal with the insolvencies. The bulk of the $793 million in annual interest payments on the bonds were to be paid out from thrift deposit premiums. While the bonds aren't explicitly backed by Uncle Sam, the bond market has believed that, if necessary, the government would stand behind them.

DEPOSIT SHIFTING. That annual tab has left the thrift fund in sad shape. The banking industry was able to rebuild its separate fund to a mandated level of $1.25 for every $100 of deposits by the middle of last year. So most banks pay virtually nothing in insurance premiums. But because of the thrift fund's severe undercapitalization, thrifts must continue to pay a hefty 23 cents in premiums for every $100 of deposits each year. The fix that failed last week would have required thrifts to kick $5.5 billion into the fund immediately and then forced bankers to pick up part of the FICO payments. The end result: banks and thrifts would pay the same modest premiums.

What's worse for the S&L fund, thrift executives have been looking for ways to reduce their bill by cutting premium payments. In the final quarter of last year, California-based Golden West Financial Corp. was able to move $2.6 billion in deposits from a thrift fund-insured operation to an affiliate backed by the bank fund. That will lead to a lower insurance bill. But it also lowers the base of premiums that pay interest on the bailout bonds. If that base, currently at about $460 billion, falls below $329 billion, the FICO bonds could be forced into default. "We will have an increasingly unstable situation," warns Ricki Helfer, chairman of the Federal Deposit Insurance Corp., which oversees both funds.

SCARE STORY? While there hasn't been a massive shift by S&L executives into the bank fund, there are signs that Washington's inaction may cause thrifts to accelerate efforts to cut premium expenses. "We're not going to sit here and take" this big premium bill, warns James F. Montgomery, chairman of Great Western Financial Corp., a California thrift.

Bankers contend that the doomsday scenario painted by the regulators is pure fiction. Edward L. Yingling, chief lobbyist for the American Bankers Assn., argues that as a practical matter, thrifts simply can't move deposits very quickly. And he says regulators can slow the process down even further.


However quickly the deposit base of the thrifts shrinks, banks will have trouble trying to avoid a major role in resolving the problem. Banking regulators will continue pressing for passage of the recapitalization plan. Yingling contends that if bankers have to kick in to rebuild the thrift fund, so should players such as secondary-mortgage giants Fannie Mae and Freddie Mac, which buy and securitize some thrift mortgages.

Such efforts have failed before. Treasury Under Secretary John D. Hawke warns that as the thrift industry keeps shrinking, more of the burden to build up the insurance base will inevitably fall to banks. "Banks face a more draconian solution as we get closer to crisis," he asserts. And a lot of nervous FICO bondholders will be keeping their fingers crossed.

Before it's here, it's on the Bloomberg Terminal.