BULIMIA AT THE BANKS

Nicholas von Hoffman on the

spreading disease of American banking

New York ON WALL Street they live and die by the quarterlies. Every three months people in the American financial world hold their breath and brace themselves for bad news. It is when the quarterly earnings reports must be issued that a bank will announce that X or Y million dollars is being shifted into their loan loss reserves, for it is then that they are obliged to reclassify what they coyly call 'non performing assets' as bad loans. They don't always live up to their obligations, but it's when they do that the stock holders get the bad news.

As the first quarter of 1985 ended, the auditors for Financial Corporation of America, a large chain of California sav- ings and loan associations, said that with losses of almost $600 million last year they doubted the company could survive; Texas Commerce Bank shares, the 21st largest banking holding company, after 16 years of happy quarterly tidings, said it would have to add $45 million to its bad loan conting- ency fund; after that First City Bank Corp, also of Houston, faced up to losses almost as large as Texas Commerce, but the most publicised chain of events began when ESM Governntent Securities Inc. of Fort Lauderdale, Florida, went into receiver- ship. In short order the Home State Sav- ings Association of Cincinnati, Ohio. was forced to close its doors, thereby forcing the state's governor temporarily to shut down 71 other saving and loans associa- tions. The repercussions from that one drove gold up and the dollar down in the world's money markets. But it's May now, the next quarterlies are not due till the end of June and we have some time to reflect on America's recur- ring banking problems. Reflection is all that will get done. For although the trou- bles are plain enough, the political will to tidy them up does not exist. Even the sinking of the multi-billion-dollar Con- tinental Illinois last year was not enough of a jolt to get repairs started on the distres- sed banking system. Part of the problem has to do with ethics, not mechanics and structure. Fraud, embezzlement, favouritism and bribery have played a not inconsiderable part in some of our bigger banking disasters. The failure of Oklahoma's Penn Square Bank which brought on the death of Seafirst, the largest bank in the state of Washington, and the current dismemberment of Con- tinental Illinois can be laid at the door of flagrantly illegal activity. Frequently this takes the form of making enormously large loans to bank officers, members of the board of directors or front nominees for them. Federal officials are saying that illegal insider loans may be the problem at Texas Bankshares on whose board Lyndon Johnson's widow, Ladybird sits. The fail- ure of a major bank chain in Tennessee several years ago has led to criminal prosecution of its board chairman, Jake Butcher, who has pleaded guilty to stealing millions.

In the last few weeks, Paul Thayer, former deputy secretary of defence, former chairman of the board of the LTV Cor- poration, and former president of the Boy Scouts of America, has been sentenced to four years' jail for cheating on the stock market. The E. F. Hutton Company, one of the nations largest stockbrokers with over 300 branch offices, has pleaded guilty to 2,000 (yes, that's right) counts of fraud in a scheme to bilk over 400 banks out of interest money.

Unfortunately government only seems to get on the case after the money is stolen. This is not always for lack of knowing: often it is for lack of doing. The record shows that government bank examiners knew that many of Penn Square's loans were worthless and that this was a bank in deep trouble for years before the end came. It took perfunctory, ineffectual mea- sures to correct the situation, which is more than can be said of the regulatory inaction in connection with the collapse of Continental Illinois, the largest American bank failure in the modern era. The government knew Continental was in trou- ble, the stock market knew, the big money manager depositors knew, which was why they were getting higher interest rates at Continental, the Federal Reserve Board knew and yet nothing was done. The reasons? Timidity, inertia, the old boy network. A long history of eschewing preventive action and the traditional fear of jostling any stick in the structure lest depositors lose confidence and lenders begin calling in loans. The American system, if you can dignify such anarchy with the word system, makes any effective oversight a matter of wonder- ment. There are no fewer than five federal agencies, of which the internationally known Federal Reserve Board is but one, charged with one kind of regulatory re- sponsibility or another over depository institutions. There are 50 state bank ex- aminers with primary jurisdiction over non-federally chartered banking institu- tions and there are literally thousands of these. But who gets to supervise whom depends not only whether a bank is operat- ing with a federal or state charter but how you run your business.

It's crazy but, if you are a federally chartered bank, taking deposits and mak- ing loans to other businesses, you will be supervised by the Federal Reserve Board and the comptroller of the currency: if you take deposits but you do not make loans to businesses you don't need a charter from anybody to operate and you will be super- vised, in a half-baked sort of way, by the Securities and Exchange Commission.

In such a hodge-podge the permutations and possibilities for dangerous and dishon- est gamesmanship are endless, the more so since it is no secret in Washington that Federal Reserve Board chairman Paul Volcker does not get along with the heads of the other agencies involved in banking supervision and regulation. In Europe Volcker is considered the United State's central banker. Moreover there are lacu- nae unsupervised by any official agency, yet investors from around the world look on American banking as safe, stable and sane.

In the Ohio situation the weaknesses combined, as they have done so often in the last couple of years (98 failures in '84 and '85 and that's not counting banks like Continental Illinois which were actual but not official statistical failures) to bring on a panic. It started when Home State in Cincinnati began buying government securities from ESM in Fort Lauderdale.

Often a bank buys the securities with an agreement that they will be repurchased in so many hours or days or weeks at a stipulated sum. These repro agreements are one of a bewildering variety of invest- ment instruments invented in the last decade. Their number and complexity compounds the difficulties in keeping track of who is and who isn't solvent.

Government securities houses like ESM are unregulated by anybody and, of late, some of them have been very naughty.

Four have crashed in the last few years and the splash from one of them, Drysdale, cost Chase Manhattan $134 million. It is a wild market that allows speculators to buy at one to three per cent down, so that the trading can be fast and devastating even when it's honest, and the government is charging that ESM was but a nest of confidence men.

In any event Home State appears to have lent ESM about $150 million with the government securities as collateral, the only hitch being that ESM evidently bor- rowed elsewhere, using the same securities as collateral twice. At the same time it turned out that while Home State was throwing its depositors' money around in this way, a government investigator has charged that the owner of the bank had a different and much better risk-free deal with ESM and why didn't any of this come out before? It is being charged in one of the myriad law suits already filed that the ESM's auditors were bribed.

But dishonesties aside, Home State had done something which violates good bank- ing practice and regulation. It had put too high a percentage of its funds in one place. This happens again and again when Amer- ican banks go bad. They lend too much money to one borrower instead of spread- ing it around. They also lend too much money to one industry, so that by being overcommitted in one place they are vulnerable when things take a dip as they finally do.

Seafirst, the big Seattle, Washington bank, and Continental Illinois were both done in by loading up on bad oil loans they bought from Penn Square, and some of the Seafirst people went bonkers trying to get them. When the Penn Square guys hit town one of the Seafirst people dressed up in cowboy duds (to impress the Yahoos from Oklahoma) and everybody went out night- clubbing. In the process of conducting their nocturnal business conferences, these up- and-at-'em bankers are supposed to have filled their cowboy boots with champagne and toasted each other. When you read about what these self-same guys were. doing every- day at the office you can believe it.

Making loans in areas they don't under- stand has been an abiding failing of Amer- ican bankers for the past 15 years. While some of the loans to countries like Brazil, Mexico, Chile and Argentina probably were done at the behest of the American Government, as bankers maintain, for the most part the blame for making tens of billions in bad loans is their own. They simply lent staggering amounts on no collateral or security to people who put the dough in their pockets or zipped it to Zurich as soon as the cheque cleared.

They tell a story on Wall Street about the official from the Mexican Ministry of Finance visiting his counterpart in Chile, but it could just as well be a Brazilian visiting an Argentine. Taken out to visit the Chilean finca the Mexican was amazed

at his host's wealth. 'I had no idea you were so rich,' he said. By way of reply the host pointed to a dam in the distance and then pointed back at himself as he spoke the words: `Ten per cent.'

Shortly thereafter the Chilean was visit- ing the Mexican's Latifundia and he was yet more astonished at his host's greater

wealth. 'You sly fellow, you never told me you were so rich,' he said. By way of reply the Mexican pointed his finger towards a river and a valley in the distance where no dam was to be seen. Then he pointed to himself and said. `One hundred per cent.'

American bankers had gone profit crazy. They lent money to anybody who promised high interest charges regardless of the ability to carry such loans. As these loans have soured, not only have they taken a beating, but the suspicion is about that the only reason a number of them still open their doors every morning is thanks to large, quiet infusions from the Federal Reserve. Somebody has had to pay for the `restructuring' or the `rescheduling' (they have fertile minds when it comes to euphemism) of this gigantic mass of foreign borrowing.

For much of it there is no hope that it can be repaid. However, as long as the interest payments are met, a loan does not have to be categorised as 'non-performing' and therefore does not need to muck up the quarterly reports. The money for the interest payments in many instances comes from yet more borrowing, So that, by the canons of conservative bank examination, many of our most renowned institutions are at least technically bankrupt. In the last year government regulators have been forcing banks to come up with more stockholder money and loss reserves to cover the bad loan situation, but the amount of worthless paper in the vaults probably can only be covered by more quiet propping up from the Federal Re- serve.

You might say American bankers suffer from a financial form of bulimia, the binge-purge eating syndrome. In the last ten years they have gone through loan orgies in oil, in real estate, farm land and South America, followed each time by pain and penance. More recently they have been doing the same thing with what are called `leveraged buyouts', another euphemism for lending somebody who is investing virtually no money of his own the wherewithal to buy a large going concern. Often the newly purchased company's pro- fits are less than the interest on the loan to buy it: ergo more restructuring.

In the early 1930s as depositors lined up to pull their money out and lenders every-

where called in their loans, the Federal Reserve Board out of confusion and a shortage of decisiveness failed to pump enough money into the banking system. Thousands of banks closed their doors.

That lesson has not been lost on the present generation of regulators in

Washington. Nothing of that sort is going to be allowed to happen again, as the handling of Continental Illinois and the Ohio Bank crisis shows. There will be no bank panic, no general collapse regardless of who defaults on his payments. The Fed will print enough money to keep the banks open but whether that will also be enough money to cause a major worldwide infla- tion is open to speculation.