The Dukes of Moral Hazard

The Big Fix: How an Unholy Alliance of Politics and Money Destroyed America's Banking System, by James Ring Adams, New York: John Wiley and Sons, 308 pages, $19.95

It has often been said that the real scandal in Washington isn't what's illegal, but what is legal. Jim Wright resigned last year over a trivial junk book, while the House Ethics Committee overruled its outside counsel and cleared him of improperly intervening in the $400-billion S&L mess.

A lot of people are trying to keep taxpayers from discovering who was largely responsible for the S&L crisis. (That crisis, it is now estimated, will cost the average American family at least $4,000.) "The point isn't whose responsibility it is," says M. Danny Wall, former staff director of the Senate Banking Committee and chairman of the Office of Thrift Supervision until he resigned under pressure last November. "That's all history."

There is more than enough blame to go around, and James Ring Adams has uncovered most of the villains in The Big Fix: How an Unholy Alliance of Politics and Money Destroyed America's Banking System. Adams, a former reporter for the Wall Street Journal and Forbes, spent three years looking under the carcasses of brain-dead thrifts to learn the reasons for the biggest financial scandal in U.S. history. He discovered that the thrift supervisors who were supposed to keep tabs on the federally insured S&L industry were woefully underpaid and often discouraged from aggressively challenging an institution's books.

Freed from regulatory requirements by a cooperative Congress but retaining the protection of taxpayer-provided deposit insurance, the industry began building risky asset portfolios that ranged from junk bonds to foreign-currency holdings and windmill farms. Treasury Secretary Don Regan had been cozy with the S&L owners for years and actually tried to fire Ed Gray, the top federal thrift regulator, when Gray began questioning the industry's soundness.

Adams fingers Congress, which chose both to ignore the mounting crisis and to follow the wishes of the thrift industry in deliberately delaying any solution, as the ultimate villain in the S&L mess. It may become the biggest stain on Congress's record since the Credit Mobilier railroad scandal of 1873 led to the defeat of a third of House incumbents.

Adams, the author of a previous book on the history of the tax revolt, traces the roots of the S&L crisis back to a single day: the early morning of March 5, 1980, when exhausted House and Senate conferees ended three days of negotiations on a key banking deregulation bill. The U.S. League of Savings Institutions wanted to raise the level of taxpayer-guaranteed federal deposit insurance. The Senate had voted to raise it to $50,000 an account from $40,000. The House hadn't acted, so at the last minute House Banking Committee Chairman Fernand St Germain, the recipient of lavish gifts from the league, pushed through a "compromise" of $100,000. "I'm told the conferees would have done anything to get out of that room," former Rep. Ron Paul (R–Tex.) has said.

The St Germain "compromise" allowed money brokers to bundle large deposits together in lots of $100,000 and chase the high interest rates offered by insolvent thrifts that were trying to stay open by expanding. Later, in 1982, St Germain and his Senate counterpart, Jake Garn of Utah, allowed thrifts to attempt to recoup the high interest rates they were paying by investing in such risky ventures as office buildings and sperm banks. With deposit insurance covering the questionable investments, the only loser would be the taxpayer.

California and Texas extended liberal investment standards to state-chartered thrifts, and soon a new breed of highflying entrepreneurs had remodeled their S&Ls into veritable casinos in which risk-fraught loans and investments were made with the care of a dice throw. Small wonder that Franklin D. Roosevelt had opposed deposit insurance in 1933 because he feared it would eventually subsidize bad institutions.

Former Senate Banking Committee Chairman William Proxmire admitted in March that there is "no defense" for Congress's failure to curb the investments of the state-chartered thrifts that account for 80 percent of insolvent California and Texas S&Ls. Clearly, some members of Congress stalled not out of ignorance, but to protect local S&L interests.

The best-known congressional members of this S&L Appreciation Society are the notorious Keating Five. The Senate Ethics Committee is investigating their role in protecting Lincoln Savings & Loan, a financial black hole whose owner, Charles Keating, rang up losses that will cost the taxpayers some $2.5 billion.

The senators all say their actions were merely part of their "constituent service." Arizona Sen. John McCain, a Republican, has likened his intervention in an enforcement action by the federal regulators examining Lincoln to "helping the little lady who didn't get her Social Security." But Charles Keating was asking for a lot more than a lost check, and he was willing to pay. The evidence: the $1.3 million he funneled to the five senators in contributions to their campaigns or causes.

The Big Fix points out that congressional interference on behalf of privileged interests goes far beyond the single case of Lincoln Savings. Rep. Jim Leach of Iowa, a Banking Committee member, says business-as-usual congressional pressure to withdraw or alter the regulations of independent agencies under the cover of "constituent service" has become an "absolute scandal."

Such outcomes are inevitable given the government's growing power to affect economic outcomes through subsidies, loans, trade protection, and entitlements. With a government as big as the one in Washington, the line between constituent service and influence peddling cannot help but be blurred. The S&L highflyers just happened to have the sharpest elbows, the largest campaign goody baskets, and a presence in every congressional district in the nation.

Many Americans have long known that much of what is entirely legal in today's Washington would be properly viewed as unethical by the vast majority of people beyond the Beltway. Until now they have largely accepted such behavior as part of the price of government. But because of deposit insurance this politics as usual will cost each and every American at least $1,000.

There's a chance voters may now start asking questions about what their elected representatives are actually doing in Washington. That's why columnist George Will has said the issues raised by the S&L scandal—the moral hazard of deposit insurance and the question of where "constituent service" ends and influence peddling begins—are "a fuse that has been lit that could blow this town sky high."

In providing a readable history of the S&L mess—history that Danny Wall and the Congress would like taxpayers to forget—Adams has made a real contribution to the American public's political education. The manipulation of government for private gain is an old story. But the breathtaking size and scope of the S&L rip-off makes it impossible to dismiss. If the public fails to act now in response to the danger signs posted throughout this book, it will only be asking for a repeat of the disaster.

John Fund is an editorial writer for the Wall Street Journal.