‘The Greatest American Shambles’: An Exchange

To the Editors:

In an otherwise excellent survey of the S&L shambles, Michael M. Thomas goes to some lengths to explain why the apparent bill of $150 billion to clean up the mess is really a bill of $500 billion [NYR, January 31, 1991]. He takes this trouble, he explains, because “most nonfinancial types have but a passing sense of the value of money over time.” He then presents an example to show that the “ultimate cost” of a $75,000 loan over 30 years at an interest rate of 10 percent is really $236,944—the sum of the 360 montly payments of $658 (his arithmetic, not mine). If Mr. Thomas really thinks that paying $658 a month for 30 years is in any sense equivalent to $236,944, I would be happy to receive his cheque for the latter sum and to guarantee to pay him $658 a month for 360 months. Hell, I’d even pay him $700 a month for this. The reasoning is simple, even for us nonfinancial types: if I could earn interest of 10 percent a year, I could earn over $23,000 a year on Mr. Thomas’ $236,944, so I’d certainly be willing to pay him a miserable $658/month to do this. The point is, this figure of $500 billion is really of no significance at all unless interest rates are zero. Why does Mr. Thomas think it represents the “true” cost of the cleanup?

One further point: whatever one’s figure for the cost of the cleanup, it should be borne in mind that this is not a cost to the economy in the same sense as, for example, losing $1 billion worth of factories to an earthquake is a cost. If I were to give Mr. Thomas a dollar, even under duress, we would probably not say that America is worse off to the tune of a dollar. I’ve lost but he’s gained; there is some degree of offset there. In the same way, a large chunk of the S&L expenditures are transfers from taxpayers to S&L victims (often ordinary taxpayers themselves) and it’s not clear that each of such transfers should be considered a social loss. Of course, there are real resources used up in saving many of these institutions and the very act of transfer itself is costly, operating as it does through an inefficient bureaucratic medium but, nevertheless, it is misleading to talk, as Mr. Thomas does, of the S&L bailout as somehow rivalling our external debt.

Martin Richardson
Washington, DC

To the Editors:

Although Michael M. Thomas’s article “The Greatest American Shambles” was excellent, his description of the special contribution of deposit insurance to the shambles could be clarified a bit.

While it is true that Congress raised the Federal deposit insurance ceiling to $100,000 in 1980, depositors are not insured per account but rather per depositary institution, with certain exceptions for joint accounts, trust accounts and the like. And while it is true that deposits are insured regardless of whether they consist of principal or accrued interest, they are only insured up to $100,000. If a depositor buys two $100,000 certificates of deposit from the same bank, and each CD accrues $10,000 in interest, the depositor is insured only to $100,000 total, not to $110,000, nor $200,000, nor $220,000.¹

Of course, as Mr. Thomas points out, those fortunate few with more than $100,000 to invest can effectively place their money through a broker in any number of separate, fully insured $100,000 accounts at different depositary institutions around the country. In other words, Wall Street’s invention of the brokered deposit effectively removed the ceiling on Federal deposit insurance.

It should be noted that whatever their failings during the past decade, the FDIC and the FHLBB each attempted to limit insurance on brokered deposits in 1984, only to have their regulations struck down by the United States Federal Court of Appeals. In an opinion written by then Judge, now Justice, Scalia, the DC Circuit held that the FDIC regulations were contrary to the

clear and unequivocal mandate [of Congress] that the FDIC shall insure each depositor’s deposits up to $100,000, determining the amount of those deposits by adding together all accounts maintained for the benefit of the depositor, whether or not in the depositor’s name.²

Congress, on the other hand, has known about and failed to fix the problem for at least seven years.

The banking reform package likely to emerge this year may well eliminate brokered deposits, but it will not eliminate the central problem of Federal deposit insurance. The FDIC’s doctrine of “too big to fail” has also effectively eliminated deposit insurance limits for wealthy individuals and commercial depositors. The “linkage” ably created by The New York Times between the Bank of New England (where uninsured deposits were assumed in full by FDIC-owned bridge banks) and Freedom National [in Harlem] (where uninsured depositors took a 50 percent haircut) only emphasized the problem.

Are we prepared to suffer the general economic consequences of a major bank failure? Neo-conservatives argue that we should let banks fail, just as we let other business organizations fail, and that to do otherwise only encourages greater and greater risk-taking, and all at taxpayer expense. Their solution, and the solution likely to be proposed by the Bush Administration: further deregulate banks by eliminating the Glass–Steagall Act and the Bank Holding Company Act along with “too big to fail.” But this argument turns on the assumption that massive bank runs such as occurred in the 1930s will not occur again—the very sort of arrogant aversion to the lessons of history that allowed Charles Keating & Co. to rob this country blind in the 1980s.

On the other hand, if we are not prepared to have a major bank fail, we must be prepared as taxpayers to insure all deposits, of whatever size and in whatever institution. By itself, such a choice may seem, and in fact is, equally unpalatable. Governmental regulators have again and again failed to effectively monitor risk: the junk bond failures of the S&Ls have only been followed by the oil-patch failures of Texas and the real estate failures of New England. But further steps can be taken. Rather than deregulating and expanding the universe of permissible investments for insured banks, insured banks and savings institutions could be fully insured but could also be required to invest solely in US Treasuries. Individuals and commercial institutions would have an entirely safe place to put their cash; taxpayers would not be underwriting speculation of any kind other than the Federal budget itself; government oversight would simply consist of preventing actual fraud rather than second-guessing investment decisions: and those investors who wanted a higher rate of return could put their money in uninsured banks or in stocks, bonds or mutual funds.

John Coates
New York City

Michael M Thomas replies:

Mr. Richardson reverses the arithmetic, which makes his argument disingenuous, to put it kindly.

To continue my example, Uncle Sam has two options: (a) to borrow $75,000 and repay it with interest over thirty years; (b) to take the $75,000 immediately by raising taxes. The “public choice,” as I believe it is called, is obvious. Borrowing extracts $7,900 in debt service annually from the taxpayers, several present and future generations of them. Pay-as-we-go extracts nearly ten times that sum over one or two years from people who are voting now. Both are paid in real money, but everyone knows that money paid ten years from now by today’s voters’ children seems to belong to a lower order of reality than money paid today by those voters themselves.

As for the “net dollar” argument, which holds that money lost in the S&L mess ended up elsewhere in the economy, this misses the point quite as much as the intermittently popular theory that deficits don’t matter. The hard economic truth about any financial shortfall is to be found in how and at what cost that shortfall is eventually financed, not in the event itself.

Mr. Coates will understand that I felt it important to put across the key conceptual points of the S&L crisis, and therefore perforce left the odd “t” and “i” uncrossed and undotted to avoid overcomplication—as in the matter of defining limits on insured deposits in any one institution. As a practical matter, investors with more than $100,000 to play with spread the money arond. This did not happen, incidentally, with deposits in commercial banks, as certain depositors in Freedom National Bank have discovered to their cost and chagrin.

With regard to the larger issue of deposit insurance, let me say simply taht I am in broad agreement with Mr. Coates. My own preference would be to introduce, over time, a system whereby banks and other institutions would offer depositors a “menu” of insurance choices: (1)federal deposit insurance; (2)private deposit insurance; (3)no deposit insurance. Federally insured accounts would pay no interest. Privately insured and uninsured accounts would pay interest at rates determined by the market. It would be up to each depositor to decide for himself between risk and reward. Such a system would leave room for money funds to continue effective intermediation within the saving process. A certain percentage of federally insured deposits might also be set aside for small-business loans to be made by depositary institutions directly, which would effectively eliminate the inefficient, often corrupt Small Business Administration.