A Regulatory Reign of Terror
Jude Wanniski
February 21, 1990


When the Office of Thrift Supervision seized Franklin Savings of Ottawa, Kansas, last Friday, a few days after Drexel Burnham threw in the towel, it became painfully clear that we are well into a regulatory reign of terror that is ever-so-slowly strangling the credit markets. Franklin, with $11.4 billion in assets, now the biggest S&L in government hands, is basically a sound thrift. It has been sunk by a regulatory apparatus that has every incentive to act quickly, whatever damage it causes, to avoid criticism for not acting with dispatch. The Lincoln S&L fiasco in California, courtesy of Charles Keating, Senator Cranston et al., has stripped away the political buffer that has always provided a check on regulatory excess. Now, members of Congress cannot afford to lift a finger on behalf of their S&Ls for fear of being swept up in another billion-dollar scandal.

In an editorial that ran last week in a trade paper, National Thrift and Mortgage News, headlined "Reign of Terror," we got a whiff of what followed at Franklin: "Regulators appear to be clamping down on some of the better companies in the industry. At the heart of the problem is what appears to be an effort by the Office of Thrift Supervision examiners and supervisory agents throughout the country to make their own accounting rules. Putting thrift financial reporting under generally accepted accounting principles (GAAP) makes good sense...But the OTS is disputing outside auditors and making clear to thrifts that it believes it has the authority and ability to define the GAAP."

Franklin's chairman Ernest Fleischer a decade ago took the thrift from a negative net worth of $44 million to the giant it is today. He did it with an imaginative hedging strategy partly designed by Fed Governor Wayne Angell who a decade ago was a professor of economics at Ottawa (KS) University. The dispute with OTS is over GAAP accounting used to record losses in this hedging process, with Fleischer sure the regulators don't understand what he's done. Under the no-due-process provisions of the RTC enabling act, the regulators did not even need a court order to snatch Franklin. This is all no doubt unconstitutional, but by the time this is resolved the thrift will be in bits and pieces. In yesterday's Wall Street Journal, we find Fleischer on his hands and knees in "Chairman of Thrift in Kansas Praises Seizure by U.S," pleading with the munchkins to let him have his S&L back once they break a few bond covenants that are worrying them. The Lilliputians are in control and it's best to speak to them as if they were brilliant.

Drexel, Burnham is part of this Swiftian nightmare. Five thousand employes out on the street, courtesy of Uncle Sam, "Rico" Giuliani and the Lilliputians. Granted, Drexel's management minus Milken helped dig its own grave, copping a plea and paying a $650 million fine (that Drexel's creditors should sue the government to recover). But the frenzy whipped up around junk bonds and the S&Ls finished the job. If the government had not forced the S&Ls to disgorge their junk portfolios, and if the Fed had not forced the banks to mark to market their depressed junk holdings, the junk market would not have been decimated and Drexel would not have had to fold. Why is it any surprise to anyone that the junk market has been battered during this government reign of terror? High-yield securities went from the best assets in the thrift portfolios to near the bottom. The cost to the taxpayers of this KGB government stomping around Wall Street continues to climb!

If you haven't noticed, the cost of the S&L bailout is nearing the moon, with little evidence that the munchkins running the Resolution Trust Committee are going to be able to dispose of any of the "assets" piling up as the regulatory terrorists close down Franklin Savings, et al. On The Wall Street Journal's weekend radio report last Saturday the commentator advised his national audience to stay away from the RTC's sale!!! - as there are no bargains there!!! He advised that the properties cannot sell for less than 95% of appraised value and that a purchaser must make a 25% down payment. He further advised that the red tape is incredible, with long lines and unbelievable paperwork. A savvy real estate developer tells me he spent two days in Washington looking over the RTC scene, thinking he'd spot a bargain, but gave up in disgust: "Congress has arranged it so that nobody can make any money on the thrift properties. There are not that many people with the vision and the energy to take something that's broke and give it value, and they're not going to do it if there is no incentive. I'd rather develop something that isn't broke." He figures the cost to the taxpayers will exceed $200 billion. Meanwhile, all that dead real estate hangs over the market.

When will this end? Clearly the corporate elites are happy with developments over the past few weeks, the pendulum swinging in their direction. Next, let's all watch the insurance companies get beat up, and then let's get the banks to call their loans to cover their junk losses marked to market! But eventually a reign of terror has a way of turning on the spectators. When enough of them have their blood spilled, we might be able to get a coalition strong enough to fight back. Meanwhile, it is not a pleasant sight.