Inside Jobs

April 7, 2011 (last updated August 8, 2021)

The financial crisis of 2007 and 2008 was not only tragic, and devastating to millions of Americans,  it was ridiculous.

It didn’t have to happen.

In 1989 Stephen Pizzo, Mary Fricker and Paul Muolo investigated the savings and loan crisis and wrote a book about it, “Inside Job, the Looting of America’s Savings and Loans.”[1] 

After three years of crawling through the wreckage of America’s once vibrant thrift industry, we told our readers, and later testified before Congress, that we had learned two important lessons:  Be careful about deregulation and get rid of bank secrecy.

Deregulation, we wrote, was like brain surgery – a little bit goes a long way. Cut away too much oversight and you can do more harm than good. We also warned that outdated rules encouraging bank secrecy, rather than protecting consumers, actually shielded, protected and empowered crooks.

Since then, bankers have deregulated themselves by moving half their business into the shadow banking system,[2] where they are less regulated and more secret than ever.

We are stunned and angered that regulators and politicians have let bankers pull another Inside Job.

We said in “Inside Job”:

“All that are left to salvage from the thrift industry carnage are lessons that we hope were learned. First and foremost is the clear message that there should be a careful reassessment of what can and cannot be deregulated in this country – and that deregulation is one thing while unregulation is something else entirely. Deregulating segments of the financial services industry is not, in itself, a bad idea. … Congress must learn to treat financial service deregulation like brain surgery, realizing that if too much is cut away, the patient will begin acting in bizarre, unpredictable, and often self-destructive ways.

“Deregulation as it was carried out during the Reagan administration benefited not mainstream business, as advertised, but financial rainmakers like Mike Milken, Charles Keating, David Paul, and a host of others who created nothing of lasting value while siphoning off billions of dollars from our national treasury.

“Lesson No. 2: It’s time to bury the depression-era fear of runs on banks. That phobia is one of the underlying justifications for the secrecy that surrounds bank and S&L actions, but, in fact, the best thing that could have happened to the thrifts in this book would have been an early run on deposits to force more timely action by regulators. Secrecy was the single most important factor in allowing losses at thrifts to get so large. It played directly into the hands of anyone who had something to hide. …

“Thrifts and banks must be opened to the light of day. Then, if depositors don’t like what they see and decide to take their money elsewhere, so be it. Examination reports, for example, should immediately be made public. If Vernon Savings’ depositors had discovered the kinds of screwball deals that that thrift was involved in when  its assets were only, say, $300 million, and there’d been an ugly little run on deposits, forcing regulators to pay attention, think how much the FSLIC (the S&L equivalent of the FDIC in those days) would have saved.”[3]

In 1991 Pizzo and Fricker testified before Congress when it was studying ways to deregulate banks and let market discipline take over from regulators. We urged caution. We bring this up now to make this point: If small-time reporters like us understood these dangers, so did Congress, federal regulators and bankers.

Our written testimony began with this summary:

If Congress allows banks to be owned by non-bank companies, to underwrite securities and insurance, and to operate interstate it will unleash on the nation a second financial holocaust which will make the costs of the first one, the S&L crisis, look like chump-change.

As was the case following thrift deregulation, for the first few years banks will appear to prosper beyond everyone’s wildest dreams. But beneath that apparent prosperity will lie the seeds of disaster.

— The number of  Too-Big-To-Fail banks will multiply.

— Bank conglomerates will prefer to lend or invest with associates and affiliates, regardless of their credit worthiness.

— When a substantial portion of the assets of the nation’s banks – perhaps 30 percent – are tied up in self-serving loans and investments made by a dozen  Too-Big-To-Fail banks and a network of renegade community banks, the regulatory system will be faced with the same no-win choices it faced in 1985 when the thrift industry began to melt down.

— After the implosion taxpayers and prudent community banks will have to pick up the bill, which will far exceed the $500 billion S&L loss.

It’s totally predictable.

It happened in the 1930s, when 9,000 banks failed, and it happened again in the 1980s, when 1,000 S&Ls failed, and no amount of smoke blown by the nation’s most powerful – and most unsuccessful – bankers can redirect the winds of history and or repeal human nature. There’s nothing complicated about this scenario, though those same bankers would try to make it seem so. It’s up to Congress to see through the con job and Just Say No.

Among the points we made in our testimony:

“Keeping bank deregulation from becoming a replay of thrift deregulation and the carnage that followed is one of the most dangerous challenges facing Congress. …

“If Congress opens up banking to Wall Street speculation, as it opened up S&Ls and banks to real estate speculation, regulators will quickly lose control over the complex series of events that a pervasive marketplace will immediately set in motion. Insider abuse, self-dealing, and back scratching relationships between institutions will run rampant.

“While speculators play an important role in a free market economy, their instincts and perspectives are exactly the opposite of those we want in our bankers. Wall Street investment bankers are to commercial bankers what fighter pilots are to airline pilots. One takes risks, the other avoids them. …

“Treasury Secretary Nicholas Brady is almost giddy over the prospect of merging banks and Wall Street. It makes sense, he says, because investment banking shares a ‘natural synergy’ with commercial banking.

“Sound familiar? The same argument was used a decade ago when savings and loans wanted to get into the construction and development business. Developers need loans – thrifts made loans. Bingo. Natural synergy. Regulations prohibiting such joint ventures were abolished, and sure enough private capital poured into the thrift industry as developers bought thrifts and thrifts acquired their own construction companies.

“‘My God! This is what I’ve been waiting for all my life!’ gasped the owner of (now defunct) San Marino Savings and Loan.

“Almost immediately the predictable happened. The historical arms-length relationship that had existed between lender and borrower vanished, and with it went due diligence, common sense and, in too many cases, ethics. Thanks to facilitating that bit of synergy the taxpayer is stuck with $300 billion worth of repossessed real estate from failed thrifts. If we sold $1 million worth of this stuff a day, it would take 800 years to sell it all. …

“The big ‘money center’ bankers argue that without deregulation American banks will not be able to compete with European banks after 1992, when the European Common Market will combine in a universal banking system with broad banking and securities powers. They also complain that they can’t compete with the Japanese banks that are flooding U.S. markets. They pointedly note that no American bank ranks among the word’s 10 largest banks.

“So what?[4] …

“Bankers assure their critics that the potential dangers of corporate ownership and securities and insurance underwriting are moot issues because bankers will agree to impenetrable firewalls between their corporate, banking, securities and insurance affiliates.  If the securities company gets into trouble, for example, firewalls will protect the bank’s federally insured deposits, they claim. Apparently, through some magical osmosis that only works one way, American are asked to believe that banks will enjoy the benefits of having securities affiliates without ever being affected by their problems. …

“There’s not a bank examiner in this country who could control such a corporate banking octopus. If S&L regulators couldn’t stop the looting at savings and loans – which are by comparison a fairly straight forward corporate structure – what hope is there that bank regulators will be able to monitor a two-tiered holding company structure with multiple affiliates and subsidiaries? …

“It is this antiquated and inadequate system Congress is about to ask to monitor banks involved in securities and insurance underwriting. Regulators will have to unravel the dealings of complex bank holding company structures, foreign transactions, national and international activities, sophisticated hedges and straddles and options and swaps and thousands of daily electronic transfers among affiliates and subsidiaries and brokers. …

“Bankers’ pleas for interstate branching should also be ignored. …

“The net result of interstate branching will be fewer banks and the consolidation of the industry into a group of mega-banks, each of which will then be perceived by regulators as being decidedly Too Big To Fail. …

“Banks’ demands for dramatic changes come at a time when banks are weaker than they have been since the Great Depression. Almost 1,000 banks have failed in the last four years, more than failed in the first 30 years after Glass-Steagall was passed. Restrictive regulations did not cause these problems, as the big banks would have Congress believe. Instead, in the last five years American bankers have discovered about $75 billion in bad loans on their books. With judgment that faulty, it’s terrifying to think what they could have done on Wall Street. Never ones to be contrite about losing other people’s money however, the  bankers explain that in essence the devil made them do it. They say that it was those ‘old-fashioned federal regulations’ barring banks from other, potentially greener pastures that forced them into those bad deals.

“Others disagree. Irvine Sprague, FDIC chairman until 1986, said most bank failures are caused by one thing – greed. The Comptroller of the Currency said bad management is to blame. The General Accounting Office found insider abuse at 64 percent of the bank failures it studied. The FDIC reported that criminal misconduct by insiders was a major contributing factor in 45 percent of recent bank failures.

“Swindlers have always been attracted to banks because, as legendary bank robber Willie Sutton explained, ‘that’s where the money is.’ …

“A man who arranges mezzanine financing for leveraged buyouts told us not long ago, ‘I think I’ll go buy a bank. They only cost $3 million’ When an LBO player thinks a stodgy old bank is suddenly attractive, should Congress begin to worry?

“As for bankers who find themselves locked in this fatal attraction, they should turn for advice to some of their former cousins who pushed so hard for savings and loan deregulation. These former thrift operators might tell bankers to be careful what they ask for – they might just get it.

After our 15 minutes of fame, we went home to cover the 1990s, which turned out to be an unsettling time, thanks to debt, derivatives, deregulation and dot.coms.

In 1994, Proctor & Gamble, Gibson Greeting, Atlantic Richfield, Dell Computers, Orange County and more than 100 others announced multi-million-dollar losses on investment strategies based on derivatives and repurchase agreements. The Mexican crisis in 1995, the Asian meltdown in 1997, the failure of the Long Term Capital Management hedge fund in 1998, the and telecom bubbles at the end of the decade, the conflicts of interest the bubbles exposed at investment banks and credit rating agencies, Enron’s collapse in 2001 and WorldCom’s failure in 2002 – all were warnings that financial markets were living on the edge. After the housing bubble appeared in 2003, we covered it for five years. In our respective roles – Pizzo was blogging and freelancing about politics, Fricker was a daily business reporter at a mid-sized newspaper, and Muolo was an editor of a national trade journal for the mortgage industry — we wrote about them all.

For a couple of years in the early 1990s, it seemed as if Congress had really listened to us and others, as they enacted several tough laws to fight fraud, shut down financial institutions promptly before they became insolvent, limit brokered deposits and fight insider abuses. They even abolished the federal agencies that had overseen the S&Ls, the Federal Savings and Loan Insurance Corp. and the Federal Home Loan Bank Board. Take that!

But banks revolted, and in the end they won. After the S&L crisis, regulators decided that the riskier a commercial bank’s business was, the more of its own money it had to have for emergencies. We thought that was a great idea. But banks promptly set about gaming these regulations, with the full knowledge and approval of their regulators.

During the decade, banks shot down several efforts to make derivatives more transparent. By 1997 Congress had phased in interstate branching. In 1999 it allowed one company to own commercial banks, investment banks, insurance companies and other types of business.[5] By 2000 the rush to become Too Big To Fail was on. Between 2000 and 2007, the 10 largest U.S. financial institutions more than doubled in size.[6]

In July 2008, two months before the meltdown, Muolo and Orange County Register reporter Mathew Padilla authored “Chain of Blame” published by John Wiley & Sons, Inc. It is a detailed expose of the rise and fall of housing, in which they show how the nation’s largest investment and commercial banks and thrifts controlled the subprime pipeline, from the mortgage broker on Main Street to the traders on Wall Street.

As soon as we started digging into the financial crash, we started to feel very much at home.

Here was Federal Reserve Board Chairman Alan Greenspan extolling the brilliance of free markets and the financiers who manipulated them, just as 20 years earlier he had praised S&L deregulation[7] and his employer, Charles Keating, later convicted of fraud.

Here was Darrel Dochow, an S&L regulator who recommended playing ball with Keating and, 20 years later, did the same for the failing IndyMac.[8]

Here were the same trade associations – for banks, thrifts, appraisers, housing advocates, mortgage lenders and real estate brokers — pressuring Congress for favors.

Here was the same underfunded FDIC, running as fast as it could to catch up with the failures.

Here were some of the same economists, arguing that regulation, not deregulation, was the problem.

Here were the same white knights — real estate developers for the S&Ls; private equity investors for today’s banks — riding in on their chargers to buy a troubled thrift, bank or mortgage company and save the day.

Here was the same wholesale funding[9] – brokered deposits for S&Ls, repos for shadow banking – fueling the boom and bust cycles.

Here was the same solution for protecting taxpayers next time – “firewalls” separating banks from their risky affiliates in the S&L days, “ring-fencing” 20 years later.

And in both crises it was the devil who made them do it: In the S&L days it was tax policy and in the subprime days it was housing policy.

The scams were the same, too. You gotta love these guys. Evidently the wired geniuses of the new millennium fell back, in times of need, on the tried and true, like:

— “Dead horses for dead cows.” In  S&L days, developers bought each other’s real estate to pump up property values. In the subprime days, bankers bought each other’s credit default swaps and collateralized debt obligations.

— The “rolling loans that gathered no loss.” In the S&L days, thrifts kept loans from default by extending them. In the subprime days, banks kept loans from default by modifying them, a wrinkle they called “extend and pretend.”[10]

 — “Cash for trash.” In the S&L days, thrifts lent borrowers more money than they needed and required the borrower to use the extra cash to buy a troubled property on the thrift’s books. In the subprime days, banks made repo loans to borrowers, who used that money to buy troubled mortgage securities on the banks’ books and then used the troubled securities to collateralize the original repo loan from the bank.  Or banks got a repo loan from a trust, using troubled real estate loans as collateral, so the trust could turn the bad loans into AAA-rated securities, so the banks could use the repo loan to buy them and use them as collateral for another repo loan.[11] 

— ADC loans in the S&L days and SFDP loans in the subprime days. In the S&L days, the borrower’s interest payments were added to the amount of his  acquisition, development and construction loan. In the subprime days, the borrower’s down payment was added to the amount of the seller-funded downpayment program loan. Lenders racked up fees, property values inflated and construction escalated rapidly. As a result, in the S&L days we had “see-through” office buildings.[12] In the subprime days we had “see-through” condo towers.[13]

The regulators’ response didn’t change much either. In both periods, forbearance was the name of the game.[14] And when that failed, as it usually does, the solution to both the S&L and subprime crises was exactly the same:  Bring in the taxpayers.

We support prosecuting fraud. Who doesn’t? But honestly we can’t see that the threat of criminal prosecution does much to deter a gold digger with the gleam of riches in his eye. Our justice system prosecuted more than 1,000 cases of fraud from the S&L scandal. That didn’t stop today’s financial cartel from cooking their books, selling rotten securities to unsuspecting investors, forcing losses on competitors, tricking borrowers with indecipherable contracts, snookering public agencies into taking on risk and debt, and helping clients break tax laws.

We also applaud bank regulators’ vows to be quicker, tougher, smarter next time. But history has taught us not to hang our hats on that one. It’s hard to blame the financial crisis on deregulation when everyone in central casting was so heavily regulated. Teams of bank regulators worked full time at the large commercial banks. The New York Federal Reserve Bank, headed by Timothy Geithner and a board of directors made up of people like Lehman Brothers CEO Richard Fuld, was intimately involved with the shadow institutions on a daily basis. All of the problems the banking system has faced in recent – and S&LS decades ago – were widely studied, heavily debated and well known for years.[15]  Regulators had the knowledge and authority they needed to head off disaster. They just didn’t use it.[16]

If these people didn’t learn their lesson after scores of S&Ls were abducted by a band of crooks, we give up. They will never learn.[17]

What’s our solution? It’s the same as it was 22 years ago: Be careful about deregulation and get rid of bank secrecy.

Think there’s any chance of that happening?

Mary Fricker
Editor, RepoWatch

[1] Pizzo, Stephen, Mary Fricker and Paul Muolo, “Inside Job, the Looting of America’s Savings and Loans,” McGraw-Hill Publishing Company 1989, HarperCollinsPublishers 1990. Please read the HarperCollins paperback, which was updated, and not the hard cover by McGraw-Hill or the Kindle version, which hide or delete important footnotes.

[2] Shadow banking includes money market funds, securities broker-dealers, investment and commercial banks and their holding companies, finance companies and mortgage brokers, issuers of asset backed securities (ABS) and asset backed commercial paper (ABCPaper), derivative product companies, hedge funds, off-the-books businesses variously known as trusts, special purpose entities, special purpose vehicles, variable interest entities, conduits and structured investment vehicles, and any other kind of financial company that borrows short-term and lends long-term outside the federal financial safety net of FDIC insurance and Federal Reserve discount window loans. Most of the borrowing by these shadow bankers is done on the repurchase market.

[3] Vernon Savings and Loan of Dallas swelled to $1.7 billion in assets before regulators finally closed it down in 1987. Inside Job, HarperCollins pg. 493. 

[4] Today four American banks are among the world’s largest. Remind us again how we have benefitted from that …?

[5] Regulators had already been allowing these structures on a piecemeal basis.

[7] In “Inside Job” we wrote: “He (Greenspan) wrote that deregulation was working just as planned, and that now was not the time to get cold feet just because a few problems had popped up. Greenspan went on to name 17 thrifts, including (Keating’s Lincoln Savings & Loan), that had reported record profits and were prospering under deregulation. Four years later, 16 of the 17 thrifts Greenspan had mentioned in his letter would be out of business.” Evidently Greenspan didn’t feel any lesson was to be learned there.

[8] By 2008 Dochow was top thrift regulator in the western states, where he oversaw some of the most dramatic flame-outs including Washington Mutual, Countrywide Financial, IndyMac and Downey Savings and Loan.

[14] Forbearance meant that regulators gave troubled institutions second, third, fourth, and fifth chances to run up losses.

[15] If you doubt this, just read “Infectious Greed” by Frank Partnoy, written in 2003 and published by Time Books.

[16] Even Bernanke, who has been on the Federal Reserve Board since 2002 and was an advisor to the New York Federal Reserve Bank from 1990-2002, admits he and other regulators didn’t do their jobs.

[17] Fortunately for this nation there have been some fine exceptions, like Ed Gray, Bill Black and Michael Patriarca in the S&L days.


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