We left off with the building boom and the coincident lending that went with it last time in the Southwest and the sharp drop in oil prices that did affect the economic health of that region. Two banks had already collapsed. One deservedly so and another merely as a wiping boy in my opinion. That second bank in Abilene had its holding company file for chapter 11. I handled it. All the creditors got paid and the shareholders even got a return of a portion of their capital investment. The depositors at the bank did not lose any money either because the Feds made it “sell” those banks to another banking company. I always wondered what would have happened if my guys had refused to sign the transfer documents that were required by the Feds. But that was water under the bridge and happened before I was engaged. Maybe they would have been waterboarded until they signed.
About the same time a real promoter type in Dallas went under. He had led a very ostentatious life and flaunted his money like hillbilly come to the big city. He was no doubt living on the edge and turns out there was indeed criminal activity regarding the loans and appraisals to fund his deals. He had developed many apartment projects and they all went into foreclosure and the lending instituion he used went under. So the perfect storm was almost complete. The elements were an overheated building boom, but manageable by itself; a drop in oil prices that did indeed cause a loss of steam in the southwestern economy, but again nothing that wouldn’t have corrected itself in a few years; the failure of a couple of banks, one justified and one not; and then a high profile developer going under and taking an S and L with him, combined with actually criminal wrong doing; then add to that mix the media and its insatiable desire to “expose” and titilate with juicy stories and dire warnings that more was to come. Then came the politicians, the very ones who had promoted all this activity in the first place and had laws in place to encourage it. No economic storm occurs without politicians behind it, that is a truism. You can take it to the bank. The politicians don’t ever, ever like to accept blame for anything (read the headlines of the last few weeks and compare them to the facts about Fannie/Fredie, etc.) and when the media up east gets excited they start calling hearings for oversight and putting extreme pressure on the regulators to correct things. The regulators depend on Congress for their funding and their prestige and power so they will always respond to the wishes of Congress.
Almost overnight in late 1985 and into early 1986 the FDIC, FSLIC and the Comptroller of the Currency were descending on the southwest in groves and so was the FBI to investigate the “corruption” in the lending business for oil and real estate in the southwest. They set up special tasks forces. That always means they are going to find something for sure. You usually find what you are looking for when you know the conclusion you want to reach. The politicians acted shocked that people had gotten loans without a personal guarantee and only mortaged the land for collateral on multi-million dollar loans. They were as shocked as the French cop in Casablanca to learn that gambling went on in Rick’s. As is always the case, when the Feds really want to find a crime involving paperwork, a so called white collar crime, they almost do so everytime. They pour over ever document you have ever produced or signed. If any of those documents have any error then you can be in real trouble if the document ended up even indirectly in the hands of a Federally insured bank or S and L. I mean routine loan applications and balance sheets showing values or net worth or appraisals. The courts ruled that you were cheating the Federal government with any of these errors because the banks were insured by the Feds and thus an “agency” of the US! I had one client who was investigated by the FBI for three years looking for some crime involving his multi-million dollar loans for real estate deals. He was convicted for a personal balance sheet that listed his wife’s car at a vaule they said was wrong by a few thousand dollars. I mean really! His wife’s car. What value would you have put on your wife’s car? And what if later the Feds got several experts to say your value was wrong by at least several thousand dollars–out of a balance sheet listing millions in both assets and liabilities. I am not making this up.
With all that pressure to examine everything under the sun, of course when the bank examiners started going through the banks’ books they would question everything. The examiners required new proof that values were genuine on the banks books and often required new appraisals. This should sound familar with today’s headlines about “mark to market” requirements. Appraisers can read the papers. These events were not happening in a vacuum. The press was breathlessly reporting each little tidbit of rumor or inuendo. Naturally all the new appraisals came in at lower vaules. The banks pressed their borrowers to make more payments or starting calling loans due. The deal almost everytime had been that the banks would renegotiate the short term loans and rework them. It had been going on that way for several years. But now with the pressure from Washington and reporters crawling all over the place they demanded immediate payment. You should also know, which most of you won’t and there is no reason you should, that in many cases the banks were really “partners” with the developers on the deal.
Naturally things got much worse and the whole real estate market collapsed. The lower appraisals made the loans in default and woe to the bank that tried to work out something sensible with a developer. The market for real estate evaporated overnight. The banks weren’t making any more of those loans. The pressure was too intense. The more the pressure was applied by the Feds and the banks the worse things got. It spread throughout all of Texas and Colorado and other parts of the country.
The banks often structured the loans such that they got a piece of the action on the sale or development of the land. I handled many such cases. Some were documented exactly that way. I won’t go into the legal niceties but the courts later ruled that even though the banks had signed such deals that they were not partners because the board of the bank had not approved that arrangement in the board minutes, only a loan and the word “partner” was never used. But if it looks like a duck, walks like a duck and quacks like one. A real technicality that overlooked the facts and reality but once again let the Feds look like the innocent lamb that had been hoodwinked by the corrupt developers in the southwest and was costing the tax payers money due to failed banks.
Many people went to jail. A handful did deserved that. There was some lax lending practices here and there but those were business decisions of the banks and borrowers. There in fact was very little fraud. Probably a half dozen out of all the people put under the microscope had committed crimes. The others were thrown under the train by politicians wanting to blame anyone but themselves and a media that likes to denigrate the blood and gore watching crowds in the colleseum but love to report about each drop of blood in excruciating detail; and the prosecutors lusting for those trophies on the wall regardless of the correctness of the action.
In many, many of these cases the original developer could and did offer to renegotiate the loan, get new terms such as a lower interest rate or even some reduction in principle but keep the project moving and maintain it and bear all the costs of managing the properties. After all the developers were much better at managing these properties than the banks or later the RTC. This would have reduced the size of the losses to the Government by literally billions. The universal response from the banks/FSLIC/RTC was no. They took them and ran them terribly and made the losses much worse than they would have been.
Guess I really should stop about here. This is a much bigger topic than I realized and can’t be condensed very much. I won’t go into the role of the RTC. Suffice it to say that it was a boondoggle. Don’t believe a word you hear now that it was a success and therefore we should be comfortable that any new agency the Government creates to deal with the current subprime bad loans will be able to come out whole or even make a profit. What all those anaylysts overlook is that the RTC got the properties it took at a very steep and artificially Government-created discount. The values were low on its books. Yes, it technically came out fine on its books, but the losses had already been absorbed by the banks and the ordinary Joes here in the southwest. The overall Government effort was the cause of huge losses and the real estate market took about 7 or 8 years to fully recover.
The Government as usual made things worse and the law of unitended consequences proved itself once again. What would have been a few banks failing, a handfull of miscreants sent to jail and a significant but manageable slowdown in the southwestern economy became a real disaster due to those people saying “we are from the Government and here to help you”. Many details in this story have been left out. Which I could go into all of them but that would I fear test the patience of the reader. Please check into this yourself and certainly use some of these thoughts as you evaluate the current bailout proposals being bandied about by the same folks who brought it to you. Yeah, I know about the greed on Wall Street, but the heart and soul is always in Washington.