High cost of bankruptcies a reason to save 'thrifts'

Savings-and-loan associations going down the drain? Mutual savings banks, hit by high interest rates, going bankrupt? "Let 'em," say some eager capitalists, including a few in the Reagan administration. These people believe in survival of the fittest, laissez faire free enterprise, with a minimum of government interference.

But Frank E. Morris, president of the Federal Reserve Bank of Boston, figures that that policy for the thrift institutions is not practical.

"Liquidation is a very costly solution if we have any number of these things going under," he said in an interview. "We have got to find another solution. The budget cost would be too great and Mr. Stockman wouldn't like that." He was referring to David Stockman, the tight-fisted director of the Office of Management and Budget.

The problem is that the deposits in these thrifts -- some $800 or so billion -- are insured by the federal government. But the Federal Savings and Loan Insurance Corporation has only some $6.5 billion in insurance reserves, Mr. Morris noted. Any substantial number of failures would run through these reserves quickly, and the government would have to make up the difference.

Morris reckons that the costs of liquidating thrifts has been running 20 or 30 percent of deposits. For instance, it is estimated that the cost of liquidating one Illinois thrift with $86 million in deposits will amount to some New York.

So, he believes, the federal government will be forced to rescue the thrifts from their present financial crunch. But how?

The thrift industry has been pushing in full-page advertisements in the Wall Street Journal and elsewhere for the All Savers Act, allowing all depository institutions -- savings-and-loans, savings banks, commercial banks, and credit unions -- to issue tax-free savings certificates. "The fairest tax cut of all," the ad claims. It would encourage savers to put their money in these institutions.

Morris believes that Congress and the administration will eventually -- perhaps after the budget and tax bills are passed -- have to reconsider rescue legislation proposed by the Federal Reserve and other regulatory agencies (Federal Home Loan Bank Board and the Federal Deposit Insurance Corporation). That bill would permit the regulatory agencies to inject fresh capital into endangered thrifts through buying subordinated debentures or preferred stock; and it would permit increased mergers, with out-of-state banks or thrifts being allowed to take over failing thrifts.

Interestingly, Mr. Morris does not have much sympathy for the thrift industry , which sometimes claims that it has been clobbered by government regulation.

"Essentially," he said, "they [mutual savings banks and savings-and-loan associations] got the regulations they wanted. They made a dinosaur out of the industry."

Morris recalls telling the National Association of Mutual Savings Banks at an annual convention in 1975 that "the hand- writing was on the wall . . . that Regulation Q was a crutch preventing them from adapting" to change in the nation's financial system. Regulation Q sets interest ceilings on regular deposits in banks and thrift institutions, giving the thrifts a quarter-percentage-point advantage over commercial banks. But "Reg Q" has meant that many savers have been fleeing the low interest on their thrift deposits for higher interest rates available from money-market funds or some other short- term investments. The thrifts have been left with diminishing deposits and assets -- such as mortgages -- earning lower-than- market interest rates.

Morris says the industry argument that its present difficulties are due to such regulations are "a bit of a cop-out." He maintains that the thrifts had opportunities in the past to bring about a better mix in their assets and liabilities but did not grasp them.

For instance, during a credit crunch in 1966, he recalls, the outflow of deposits seeking the higher interest rates available outside the thrifts "scared them to death for a few months. But when interest rates came down, all the urgency for restructuring the industry went out the window and they [industry executives] went out to play golf."

A similar pattern of alarm and ease followed interest increases in 1974-75, he noted.

The thrifts, he argued, should have fought harder to win variable-rate mortgages so that interest rates on their assets would rise somewhat faster along with interest rates on their liabilities -- their deposits. Savings banks could have put more money in corporate bonds, rather than low-interest mortgages. If Regulation Q had been removed, the thrift industry would have had more of an incentive to demand from state and federal regulatory authorities the power to invest in assets that offer less rigid returns.

"I don't have a lot of sympathy for the industry," he said.

Explaining the industry's problem, he said: "In the past, periods of tight money were very brief. The thrifts could batten down their hatches and pull through without too much damage. The problem now is a prolonged period of high interest rates. This is something a lot of thrift institutions are not prepared to deal with."

If interest rates stay at current high rates, or even at 13 or 14 percent, for another year or two or three, a "substantial number" of thrifts will have severe financial problems, he predicted.

Arguing for the bill proposed by the Fed and its sister regulatory agencies, Morris said: "I view the emergency situation with the thrifts as the first opening for interstate deposit banking."

Healthy financial institutions might be willing to take over a failing thrift , despite its low-interest assets, because of the opportunity to start an interstate operation in another state, he figures. "We would be creating a franchise value for them. The dogs would look a lot more attractive. . . ."

The Fed president opposes the tax- exempt all-savers certificate proposal now before Congress, because of its high revenue losses (in one bill the loss is made up by cutting another tax loophole). It would provide costly benefits to all financial institutions, healthy or not. The regulatory agencies' proposed legislation would be much less expensive because it would deal only with failing thrifts, he argued.

"There is a great diversity of situations among the thrifts," he said. "Some 10 or 15 percent are very weak. Another 10 or 15 percent are strong."

Initially, Morris noted, the Reagan administration supported the merger aspect of the legislation and opposed the capital injection idea. Following its capitalist ideology, it thought the thrifts should be allowed to go bankrupt or merge without government interference. The S&L organizations took the opposite standpoint on these two aspects of the bill.

However, Morris believes that the National Savings and Loan League has changed its mind and now supports the proposed bill. And he figures the administration, if faced with high budget costs from failing thrifts, "might be willing to hold its nose a bit" and eventually back the regulatory agencies' proposal.

By the way, Morris says one study indicated that thrifts in Massachusetts are in general stronger than institutions nationally. He suspects trouble is most likely to break out in New York or California, and recently jokingly told a colleague, Anthony Solomon, president of the New York Fed, that he would be glad "to let the New York Fed set the precedents" in rescuing thri fts.