Bank deregulation: Wash, rinse, repeat

With “bipartisan” bank deregulation rushing its way through Congress again (Why do bad bills progress so quickly?) I thought it time for a little history lesson. As if the 2008 housing debacle wasn’t enough to keep Congress understanding that the banks are rarely to be trusted, let’s go back a couple bank crises before that one, the forgotten one from the mid-1980s where the entire Savings and Loan business in the United States went belly up, taking many billions of taxpayer dollars with it. The short history lesson: bank de-regulation will come back and bite you in the rear every time.

If you have ever watched the incessant Christmas-time reruns of the Jimmy Stewart film It’s a Wonderful Life, you may recall that George Bailey, played by Stewart, owned a small financial “thrift” institution in the days before and after World War II called a “building and loan.” These institutions emerged to fill a void left by commercial banks, who typically preferred to loan money to local businesses on a short-term basis rather than extend long-term housing loans to consumers. Building and loan companies, also called “savings and loans” or “S&Ls,” solicited local consumer savers, often paying a slightly higher rate of return on deposits than did the local commercial bank.

In a 1980s “bipartisan” effort, Reagan anti-regulation ideologues allied with Fernand St Germain, a well-oiled powerful Democratic committee chair, to expand S&L deposit guarantees while reducing federal oversight. [1] Add to this underfunded state insurance funds for S&Ls who could not meet federal requirements, particularly in Ohio. The result was a collection of high-risk “thrift institutions,” offering high rates to depositors, while they in turn invested in risky ventures in order to support the high-cost deposits.

This is classic “moral hazard,” which I discussed recently in a post about corporate bankruptcy. The normal caution about putting depositor funds at risk goes out the door because the government is standing there to make you whole if things go poorly. And better yet, the S&L regulator is playing Sergeant Schultz from the old Hogan’s Heroes television show saying, “I see nothing!”

It only took one bad audit to start the dominoes falling. A Florida securities dealer called ESM paid well-above-average returns on millions of dollars of cash invested by municipalities such as Toledo, Ohio, and Beaumont, Texas, [2] as well as thrift institutions such as Ohio’s Home State Savings. [3] Through “creative accounting,” the failing ESM was able to hide its insolvency for at least six years, by which time it had $300 million of obligations it could not pay. ESM’s auditor was the prestigious CPA firm then known as Alexander Grant. The auditor in charge of the engagement over that period was apparently aware of the fraudulent hiding of ESM’s losses, but “coincidentally” had accepted “loans” in the amount of $200,000 from ESM.

When the ESM fraud finally came to light in 1985, S&Ls holding the unsecured ESM investments were faced with huge losses, big enough to bring down Ohio’s Home State Savings. Home State’s deposits were, in turn, guaranteed by the Ohio state-financed insurance fund, which proved inadequate to fund the bailout of Home State, let alone the other Ohio state-chartered savings institutions who proved to be equally shaky. A subsequent run on state-chartered banks (remember It’s a Wonderful Life?) in Ohio and Maryland brought down the state-sponsored insurance funds in both of those states. [4]

Seventy state-chartered Ohio thrift institutions were closed by the end of this process. By the late 1980s, the “disease” had spread to many federally-guaranteed thrift institutions as well, as the “creative accounting” techniques were also useful in avoiding federal regulators. This system collapse finally forced Congress to establish the Resolution Trust Corporation to sort out the mess, as the federal deposit guarantee funds were drying up. Estimates of the total cost vary, but The Wall Street Journal has estimated that the taxpayers had to make up $220 billion in unrecoverable losses, which would be about one-half of a trillion 2018 dollars. [5]

The independent CPA firms who had ignored the spreading “disease” in their audits tried to make the distinction between “business failure,” where the basic business conditions cause the business to fail, versus “audit failure,” where the CPA firm failed to conduct the audit according to “generally accepted auditing standards” (GAAS). However the U.S. General Accounting Office found, in a subsequent “audit of the auditors,” that the auditors had “failed to meet professional standards” in over 50 percent of the cases studied. [6]

In many ways, this now seems like ancient history. But similar audit problems re-surfaced in the 1990s with the “dot-com bubble,” and the spectacular crash of Enron in late 2001, the latter leading to the corporate death of the major CPA firm Arthur Andersen. And, of course, the banks went right back on a risky real estate financing splurge in the years leading up to the 2008 market crash, with very little challenge from their auditors.

In many of these cases of business collapse, you can find blatant violations of the Code of Professional Ethics of the AICPA, the organization to which most practicing American CPAs belong. Were these failures of the ethical code, or of the legal system, or of the personal morality of individual business people and their auditors? Or were they basic “moral hazard,” were “banks will be banks” as they try to privatize gains while socializing losses?

Or see it as basic probability. Reduced bank regulations and sloppy audits will directly increase the number of bank failures. You just don’t know which ones. Consumers and taxpayers will eventually pay the cost. And thus, we blindly “wash, rinse, and repeat.”

Regardless, Jimmy Stewart’s “Building and Loan” has largely disappeared from the American main street. At some point for George Bailey or his descendants, the angel’s bell stopped ringing.


  1. Bidgood, Jess. “Fernand St Germain, Legislator Tied to S.&L. Crisis, Dies at 86.” The New York Times, The New York Times, 21 Aug. 2014. The money quote here: “If you like old-fashioned, kind of tough, not always the cleanest but very efficient politicians, he’s your guy.”
  2. Sack, Robert J. and Robert Tangreti (1987, April). “ESM: Implications for the Profession.” Journal of Accountancy, vol. 163, no. 4, p. 94-96 (not online).
  3. Maggin, Donald L. (1986, October). “Greed on Trial.” Business Month, vol. 134, no. 4, p. 50-59 (not online).
  4. White, Lawrence J. (1991). The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. Oxford Univ. Press, p. 46.
  5. Thomas, Paulette (1992, November 9). “Hidden Treasures.” The Wall Street Journal, p. A1 (not online).
  6. Cottell, Phillip G. and Terry M. Perlin (1990). Accounting Ethics: A Practical Guide for Professionals. Quorum Books, p. 83. Note that the passage of time and the subsequent rise of the internet have made many of these sources hard to find, which, in this new world of data, makes history harder to reconstruct.

4 thoughts on “Bank deregulation: Wash, rinse, repeat

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