Will the Lessons Of Keating Five Go Unheeded?

With the four-year-old Keating Five scandal finally laid to rest last week, some observers are wondering whether the next scandal is already brewing.

The public rebuke of Sen. Alan Cranston and less severe penalties for four other senators hardly amounted to more than a wrist slapping. In fact, the most stinging assessment came from Sen. Cranston, who argued that his actions reflected the way members of Congress routinely treat well-heeled constituents.

At the same time, bank examiners outside the Capital Beltway were digesting a new directive on real estate valuation that is one of the President's initiatives against the so-called credit crunch.

In the rhetoric about a credit crunch some observers hear disturbing echoes of the deregulatory fervor that gave rise to a cadre of thrift bandits in the last decade. The warning should be obvious: getting swept up in the political ideology of the hour can open the door to trouble-makers with a convincing agenda.

Antiregulatory Rhetoric

Underscoring how ripe the political climate is for a new scandal, the directive was issued amid blasts of antiregulatory rhetoric from both parties, as politicians took up the rallying cry of credit-starved consituents.

Moreover, the administration is encouraging banks to appeal decisions they don't like.

The cost of such delays should have been the ultimate lesson of the senators' ill-fated intervention on behalf of developer Charles H. Keating's Lincoln Savings and Loan Association.

The recent Bush administration initiative may not smell as bad as five Senators secretly pressuring examiners on behalf of a big campaign contributor. But veteran Keating watchers recognize the talk of real estate "cycles" and "prospective values" as buzzwords from the S&L scandals now being used in the fight to allay the lingering credit crunch.

Another View

"That's called |denial,'" said Lawrence Connell, chief executive of Society for Savings Bancorp in Hartford, Conn.

Mr. Connell, who helped the bailout by managing a series of thrifts through their death throes -- including one S&L that bought loans from Lincoln -- said property valuation is as misunderstood today as it was when Mr. Keating was widely believed to be a victim of overzealous regulation.

"The problem is not the classification of assets," he said. "The real problem is that assets are not performing and there is excess supply."

The influence-peddling scandal involving five senators who received $1.3 million in campaign contributions was played out on national television.

All the intrigue started as a dispute over the arcane subject of real estate appraisals.

In a now-infamous April 1987 session in his Washington office, Sen. Dennis DeConcini homed in on appraisals almost immediately, according to Bank Board lawyer William Black's minutes, which appear as an appendix to "Inside Job," by Stephen Pizzo, Mary Fricker, and Paul Muolo.

|Grossly Unfair' Appraisals

The appraisals "appear to be grossly unfair," the Arizona Democrat said. "I know the particular property here. My family is in real estate. Lincoln is prepared to make a compromise with you."

Sen. John McCain, R-Ariz., pressed the examiners to consider the future value of the property. "Arizona is the second-fastest-growing state," he said. "Land values are skyrocketing. That has to be taken account of in appraisals."

Examiners responded then as they do now to similar charges. They said that appraisals did need to take into account future values, but that realistic assumptions had to be used. It was Mr. Keating who fraudulently inflated values, they said.

According to one appraiser who was involved in evaluating Lincoln's collateral around that time, the thrift's loan on the Phoenician Hotel in Phoenix would have required nightly rates of $500 to meet debt service.

|Performing Nonperformers'

Another tactic in the war against overzealous examiners has been to complain of the "performing nonperforming loan."

This term was coined in 1990, when bank examiners swept through the South requiring reserves against loans that were paid up to date.

The examiners explained that the payments seemed up to date because of interest reserves built into the loans and because some of the loans had been refinanced, or rolled over, by the thrift -- postponing payment of principal. Ultimately, though, the cash flow from the properties wouldn't service the debt, meaning writedowns were justified.

As supervisory agent Richard Sanchez characterized Lincoln's portfolio to the senators: "This is a ticking time bomb."

It has been reported that President Bush was spurred by constituents in the development business to take action against overzealous bank examiners.

They have complained loudly of difficulty in getting loans ever since the thrift-reform package of 1989 effectively took savings and loans out of the commercial real estate business.

Whereas in the mid-1980s Mr. Keating's advocates complained he was the victim of a vendetta by regulators, bankers and builders in the past two years have complained that bank examiners are overacting after the thrift crisis and forcing unfair writedowns.

In hindsight, it may seem unfair to compare the seemingly corrupt Lincoln Savings with the average bank that has a disagreement with examiners. But at the time, the five senators were in good company in believing that Mr. Keating might just be the victim of overregulation.

Mr. Keating's sympathizers included Alan Greenspan, now the Federal Reserve chairman, and Mother Teresa.

With real estate values perceived as perpetually on the rise, it didn't seem as obvious as it does today that Mr. Keating's estimates of the future prospects of his land investments might be greatly overblown.

Fortunately, the lesson of the Keating Five scandal may be that examiners need not buckle under to popular sentiment or political pressure.

Examiners took the latest directives and jawboning from Washington in stride, saying that for the most part the statement of policy spells out existing policies and will help them defend their conclusions more convincingly.

The directive won't encourage "forbearance," insisted Clifton A. Poole Jr., deputy comptroller in Atlanta. "It's really a more definitive statement of what would be current practice," he said. "It puts the onus on the financial institution" to provide evidence to justify a change.

One West Coast banker, who recently underwent an exam that resulted in a big increase in loan-loss reserves, predicted it would be "the path of least resistance" for examiners to remain as conservative as possible, regardless of political posturing in Washington.

After all, he said, examiners won't forget that the Senate denied reconfirmation to Comptroller Robert L. Clarke because he was seen as too lenient.

Nevertheless, a local regulatory official, speaking on condition of anonymity, acknowledged the "commonsense conclusion" that field-level examiners will be wary of the appeal provision, which allows banks to sidestep the usual regional channels.

If the political pressure to spur lending boils over as it did when powerful forces questioned the fairness of Lincoln's regulatory exam, the public could get burned again.

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