Earthquake Dangers for S and Ls

1/2Profit squeezes cause some fears of financial chaos

Savings and loan associations are almost as homespun as Jimmy Stewart. In Frank Capra's 1946 movie It's a Wonderful Life, the actor played an embattled S and L officer who eventually triumphs over evildoers when depositors unite to save his business. The nation's 4,600 S and Ls could use a little of the Capra grass-roots rescue treatment right now. Along with their sister "thrifts," the 460 mutual savings S and L banks are caught in a profit squeeze that some analysts fear could lead to their collapse and ultimately to U.S. financial chaos. Says Jonathan Gray of New York's Sanford C. Bernstein & Co.: "Like the San Andreas Fault in California, all the elements for a major quake are there, although no one can tell when it will happen."

The main causes of the problems for the thrift institutions are double-digit inflation and interest rates, which were both unheard of in 1831 when the first S and L in the U.S., the Oxford Provident Building Association, was founded in Philadelphia. The nation's S and Ls and mutual savings banks today hold $650 billion in long-term mortgages, nearly three-fourths of the U.S. total. But about one-third of those were written within the past decade at interest rates of 8 3/4% or less. Moreover, during the past two years the costs to the thrifts of acquiring money to lend has risen dramatically. These two factors have combined to create a terrible squeeze on earnings. In May 1980, S and Ls as a group paid out more in interest rates on deposits than they got back in the form of income from mortgages and other investments. Later in 1980, they began earning money again, but now they are dangerously heading back toward the red. Some analysts predict that S and L losses during the first half of this year could go as high as $2.5 billion.

One key trouble facing the S and Ls is that savers are no longer content with the meager 5 1/2% yields on passbook savings accounts, which have long been the main source of money for lending by the thrifts. Instead, they are putting their resources into money market mutual funds, where 16% interest was common last week, or into the thrifts' own money market certificates, which yielded 15% interest. During the past year, an estimated $28 billion has flowed out of savings accounts into other forms of savings.

The S and Ls face this loss of customers at the same time that they are struggling with new laws governing both banks and savings institutions. Under the Depository Institutions Deregulation and Monetary Control Act of 1980, S and Ls will no longer be bound by federal rules that required them to pay low interest rates on deposits. During the next six years, they will gradually be able to raise the rates that they pay so they can compete for funds with other savings institutions. This will undoubtedly help S and Ls attract new customers, but it will also make their costs even higher.

Alan Greenspan, an adviser to President Reagan, warns that the S and Ls' weakness could force the Federal Government into a massive bailout of the thrifts. One grim scenario: queasy depositors make a run on the S and Ls, withdrawing their savings and cashing in the $40 billion in uninsured certificates of deposit, which the S and Ls would have to make up through sales of assets or more expensive borrowings. Those S and Ls that cannot make ends meet turn to the Federal Savings and Loan Insurance Corp. (FSLIC), under the supervision of the Federal Home Loan Bank Board, which has only $6.5 billion in funds to support them. In desperation, the S and Ls go to the Federal Reserve. The American central bank responds by pumping billions of dollars into the S and L system, greatly expanding the money supply and setting off a round of hyperinflation.

Is there a serious possibility of such a collapse of the S and Ls? No, says John Dalton, chairman of the Federal Home Loan Bank Board: the $32.5 billion in total S and L net worth is more than enough to offset any panic. The notion, though, is not as alarmist as it might seem. Already the stresses are being felt.

As any mortgage seeker knows, S and Ls and savings banks do not now have much money available for new home buyers. Many S and Ls are quickly reinvesting any money deposited with them in high-yielding, short-term certificates of deposit with major banks, an understandable move aimed at getting a greater return than is paid for long-term mortgages. But this has resulted in a decline of the money available for mortgages from $99 billion in 1979 to $71 billion last year.

Many smaller, weaker S and Ls are feverishly merging with larger institutions in an attempt to survive the current turmoil. In 1980 the number of voluntary S and L mergers jumped to 111 from 37 the previous year. Industry sources say that in 1986 there will be 15% to 20% fewer S and Ls, and by 1990 fully 25% fewer. About the only area in the country where S and Ls are doing well is affluent California. More than two dozen new S and Ls were formed there in 1980.

To some in the financial community, the contraction is long overdue, indeed almost welcome. Says John Dwyer, chairman of the Franklin Society Federal Savings and Loan Association in New York: "This is what happens when an industry matures. Larger institutions, which can afford to provide more services to customers, will be better equipped to serve their communities." Adds Frederick S. Hammer, a senior vice president of Chase Manhattan Bank: "Thrifts are simply an anachronism."

To the folks at many S and Ls, though, that seems harsh. They say that their institutions will regroup and recoup, diversifying for the short term into other banking services, then re-emerging as mortgage lenders in a decade or so. Says Thomas Maley, chairman of Chicago Federal Savings and Loan: "Banks are impersonal, while we have loyalty, a solid customer base. Our survival will depend on our ability to adapt to change."A drop in interest rates would also help a great deal.

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