America's savings institutions, started in the last century by small bands of neighbors who wanted to deposit extra funds where they could earn some interest and provide loans for members to buy houses, are in a state of crisis.

Not since the Depression--when hundreds of banks were folding until Franklin D. Roosevelt took office and rushed through legislation to restore public confidence in the foundering banking system--has a major sector in the world of finance faced such severe pressure and the threat of failure. A respected Denver savings and loan executive says there "has been a silent run" on his industry for much of this year.

For the government, housing industry and consumers, saving the savings institutions will be one of the most substantial challenges to be faced in 1982. Americans have almost $700 billion of their savings on deposit at the S&Ls and savings banks.

But these savings institutions are expected to post collective losses for 1981 of $5 billion, with three out of four S&Ls and savings banks in the red for the year. In simple terms, it cost savings and loans $11.74 to attract each $100 during October. At the same time they received but $9.91 back on each $100 loaned.

Things are bad and "getting worse," said University of Georgia finance professor Robert R. Dince. Summing up the state of the savings industry today, he added: "By doing exactly what the government told them to do, they wound up in trouble. . . . The federal government created the world in which these guys are dying."

Most S&L leaders and analysts argue that things are not so bad. "I believe the worst is over," said San Francisco analyst Allan G. Bortel. Reagan administration officials have described the plight of savings institutions as a temporary phenomenon.

In a series of four articles starting today, The Washington Post will explore the current problems and possible solutions for an industry known collectively in the business world as "thrifts"--encompassing savings and loan associations and mutual savings banks. This article recounts the worst year in history for the business, while a second article in the Washington Business section tomorrow focuses on metropolitan Washington, where merger fever has broken out and interstate branching may come soon.

On Tuesday, the series will deal with the contrasts between New York State's critical savings bank problem and California's world of normally aggressive S&Ls, which are having problems, too. The final article on Wednesday will outline proposed industry and federal legislative remedies.

In Event of Failure

In terms of savings accounts or certificates, consumers have little to fear today from the industry crisis because of New Deal laws that established a pool of insurance funds (provided by the industry itself) to guarantee payment in the event of failure.

But the strain on the nation's financial system by weakness in a major sector already has had a traumatic impact on the nation's economy--particularly housing construction activity and residential real estate sales.

Already, consumers are beginning to learn about the new world of housing finance created by the savings industry crisis. It's a world where 30-year mortgages at fixed, low rates have disappeared. Far fewer Americans will be able to buy houses in future decades with the ease their parents encountered after World War II, because a much larger portion of take-home pay will have to be used to pay mortgages with interest rates that are linked to changes in the rate of inflation.

Savings institutions have provided the bulk of home mortgage financing in the United States for most of the 20th century. After World War II, in particular, federal tax and housing policies encouraged a partnership between the savings industry and home builders to build the nation's suburbs. House mortgages now held by the savings industry total $539 billion compared with $173 billion in all commercial banks.

But most of these mortgages were arranged with interest rate returns to the institutions that are far below today's cost of money. A decade ago, the typical house mortgage carried an interest cost to the purchaser of less than 6 percent. Passbook accounts at the corner S&L office paid a lower rate to savers, and the institution's operating expenses were paid for by the difference in rates.

But as inflation began to eat up more and more of any savings that an individual had in the 1970s, individual savers began to search for better paying places to put their money.

Ultimately, they were successful in forcing the government to establish a new set of interest-rate rules that in effect allow all consumers to earn interest at levels provided previously only to the wealthy or to corporations on very large deposits.

And this has required S&Ls and savings banks to pay much higher interest rates to attract the deposits that support mortgage loans. At the same time, there has been a banking revolution caused by the ease of electronic money transfer and automatic teller machines, the birth of money market mutual funds as a strong attraction for large and small savers, much higher operating expenses and encroachment into financial services by such outsiders as retailers, industrial companies and Wall Street securities firms.

Overnight, a rather relaxed business was thrust into a competitive environment of attracting money for which most savings executives were ill-prepared. The savings industry sought and won new powers, such as offering checking accounts with interest. Individual S&Ls have become more aggressive in fighting for deposits and their trade associations have been battling for government aid. Outsiders have been hired to provide broader management skills.

Little that has been done, however, has helped much in solving the current crisis. Short-term help, in the form of lower interest rates, finally is on the way. At best, however, it will be a number of months before the industry's long downward slide is reversed.

Even if the current recession is mild and the Reagan administration is successful in reining in the deficit, it will be too late for a significant number of savings and loan associations and savings banks across the country.

Institutions that are on the verge of collapse will be taken over by more healthy businesses and not necessarily traditional savings companies. National Steel Co. now owns S&Ls in three states, for example. Commercial banks are expected to acquire failing savings institutions, in some instances.

Merger Wave

Behind the takeovers of failing institutions and a wave of mergers that is consolidating weaker thrifts under the wings of stronger brethren, is an unprecedented accumulation of operating losses for the overall industry.

The nation's 4,400 savings and loan associations and 450 savings banks have just endured their worst quarter on record with operating losses of $1.35 billion for the July-September months this year. In October alone, the 3,800 federally insured S&Ls rolled up losses of $766 million.

Savings industry analysts have predicted that losses in the final six months of 1981 will be double the first-half losses of $1.5 billion.

Nine out of 10 mutual savings banks, concentrated geographically mostly in New York state and New England, are now operating in the red. Losses for 1981 are projected to reach $1.25 billion; customers withdrew $12 billion more than they deposited, or $1 for every $12 on deposit.

At last count, before regulators stopped internal publication of a "troubled" savings institution list in September, about 30 savings and loans were listed in critical condition by the Federal Savings and Loan Insurance Corp. (FSLIC), the agency that insures S&L deposits at member institutions through use of a pool of funds that the S&Ls are required to provide.

Approximately 200 savings and loans will be merged out of existence this year, 60 percent more than last year. This merger rate is expected to grow in 1982.

Mortgage loan activity this past month was off 65 percent from a year ago, with consumers simply unable to assume mortages that carry interest charges of 17 percent or more. Withdrawals from savings institutions exceeded deposits by $22.2 billion during the first 10 months of the year, forcing the industry to charge much higher interest rates on mortgages arranged with what few dollars were left to lend. One glimmer of hope came in October, when new savings exceeded withdrawals for the first month since last February because of the new All Savers certificates that were added to the new tax law as a specific measure to encourage S&L savings.

From the consumers' viewpoint, deposits are insured up to $100,000. Savings and mortgage accounts are automatically transferred to the acquiring institution in the event of a merger. Even uninsured deposits are protected in a merger. Only when liquidation occurs can depositors with accounts over $100,000 lose money, yet this did not happen in the one liquidation that occurred this year in Chicago.

Insurers' View

How bad is it from the insurers' viewpoint? Public fear that the federal agencies insuring the thrift industry could run out of money has led legislators to try to increase the FSLIC's borrowing authority from the Treasury, a move opposed by the administration.

FSLIC, which earns $1 billion annually on its $6.8 billion trust fund, insists it can do the job with existing funds. Thus far this year, it has put out more than $882 million in assistance in 22 mergers and one liquidation. Last year it spent $1.2 billion on 11 mergers. Another federal agency, the Federal Deposit Insurance Corp., which insures mutual savings banks, has spent $46 million net this year to merge the Greenwich and Central Savings Banks in New York City.

Because of the immense repercussions and the specter of a run on an institution if it were to exhaust its funds, FSLIC has sought out potential merger partners even across state lines--a break in federal regulatory policies that have blocked interstate branching for a generation--as well beginning a new program of sharing risks.

For example, FSLIC set a precedent for future mergers recently when it struck a deal with Glendale Federal S&L of San Francisco at no cost to the agency. In exchange for allowing Glendale access to the Florida market by acquiring a troubled S&L there, Glendale agreed to pay the FSLIC up to $38 million if interest rates drop 2 percentage points or more below current rates.

How bad is the situation from the point of view of savings institutions? The severity naturally depends on who is talking.

The Reagan administration believes the S&Ls and savings banks have "temporary and manageable" problems and that they will recover satisfactorily without additional government financial assistance.

Deputy Secretary of the Treasury R. T. McNamar and Assistant Secretary for Domestic Finance Roger Mehle maintain that the savings institutions have no problem so long as they maintain their cash flow--as long as people keep paying off their mortgages and the institutions can pay their bills.

Indeed, when interest income, mortgage principal repayments and borrowings are totaled, they more than offset the savings outflows.

Industry Assets

At the other end of the spectrum is economist Richard W. Kopcke of the Federal Reserve Bank of Boston. He took a look at the industry's assets earlier this fall and concluded that two-thirds of all thrifts were potentially insolvent if interest rates did not decline.

If they declined by 4 or 5 percentage points, as they have since, just one-third were potentially insolvent, he said. Kopcke estimated it would take a government subsidy of $80 billion to $120 billion to cover the industry's current and prospective losses and $30 billion to $50 billion just to bring assets up to the level of liabilities.

The New England economist arrived at these dismal projections by using current value reporting, an accounting system that reflects today's market value or what investors would pay for mortgages with interest rates well below those now being demanded.

Normally assets are carried at book or original value. The savings industry is unanimous in attacking current value reporting, saying it represents the liquidation value of assets of companies that are not about to be liquidated. By the same measurement, for example, many banks and insurance companies would be close to insolvency.

The investment banking firm of Goldman Sachs has concluded that even if assets are carried at a market value, savings and loans still have a positive net worth of $20 billion because of certain "intangibles" that do not show up on the balance sheet.

These intangibles include good will, unrealized appreciation of real estate, advances from the Federal Home Loan Bank Board (which regulates federal S&Ls) at just over the Treasury's cost, and FSLIC insurance that has thus far covered all savings, even those above the $100,000 limit. Add in a $35-billion cash flow and the industry has total resources of $75 billion that could be used if there is a run on institutions, said Goldman Sachs senior financial economist John Paulus.

"There has been a silent run going on for some time," responds Kenneth Thygerson, vice president of Western Federal S&L of Denver. This loss of public confidence--as evidenced by lower ratings from the Standard & Poor's organization and the very high rates needed to attract jumbo certificates and retail repurchase accounts--results from negative earnings, he maintains. He rejects the argument that liquidity is the only important measure.

And New York State Superintendent of Banks Muriel Siebert was alarmed enough by the situation to hold an unusual news conference last month announcing a $372 million loss by savings banks in her state in the third quarter and urging creation of a presidential commission to consider the industry's future.

The U.S. League of Savings Associations, a trade organization for savings and loans, warned federal regulators last month that "many of our nation's thrift institutions are in precarious condition today. There is every reason to expect continued negative earnings performance for several more months even if market rates continue their recent and welcome decline."

But league President William B. O'Connell, in common with most industry executives, deplored the type of publicity Siebert called down upon the industry. The league prefers to remind the public that its members have $29 billion in reserves and thus are not going to declare bankruptcy tomorrow. In fact, S&Ls could continue to lose money at the same rate they are now doing and not run out of money for 10 years.

Roots of Problem

The current problems of the savings and loan industry are rooted in government policy and regulations that proved to be archaic at least a decade ago. Known more commonly in the past as the building loan industry, S&Ls came under government supervision with the establishment of the Bank Board by Congress in 1932. In the years that followed, S&Ls have operated in a regulatory straitjacket.

Strict regulations have been imposed on the industry which, unlike other financial services segments, has been required to invest primarily in residential housing. In exchange for operating under those regulations, and to ensure a continuous flow of funds for housing, S&Ls were permitted to pay a quarter percentage point more than commecial banks on deposits.

Until recent years, S&L executives ran a fairly simple operation--taking in deposits for short periods at relatively low rates of interest and lending those funds at marginally higher rates for long periods of up to 30 years.

That practice flourished as interest rates remained relatively low and as the housing industry boomed between the end of World War II and the late 1970s. But it proved to be the Achilles heel of the S&Ls' fairly simple operation once inflation got out of hand.

In the past three years, some of the heavy restrictions have been lifted as regulators began to realize that competitive forces and sharp swings in interest rates posed serious threats. But those changes weren't enough to help the S&Ls cope with inflation.

Congress "failed miserably" by insisting that the S&Ls operate as specialized sources of mortgage funds in exchange for the quarter percentage point differential, said a consultant to the industry. The industry's problem developed, he added, "when it got stuck with all of those low-yielding mortgages."

How did they get stuck with those mortgages?

"The uncharitable answer is that the thrift managers were lulled to sleep by Reg Q," declared a senior official with a Washington financial services consulting firm, using financial jargon for the Federal Reserve Board's Regulation Q that authorized federal ceilings on interest rates.

For savings institutions, government officials implemented these ceilings as a means of ensuring a continuous flow of funds for housing finance.

S&Ls probably should have begun charging higher mortgage rates as soon as it became clear that the spread was narrowing between their cost of funds and their yields.

On the other hand, if mortgage rates had been higher, S&Ls might still be confronted by the same problems, perhaps not as serious. Federally insured institutions continued to borrow short and lend long until adjustable-rate-mortgage authority was granted this year.

The University of Georgia's Dince questioned management's complacency and lack of innovation. "These guys just followed the railroad to perdition," he remarked.

But some managers did take risks only to have them boomerang. Last year, for example, some S&Ls invested in long-term government bonds as interest rates began to fall. But as the cost of money rose, they were locked into those bonds.

Speculation in the financial markets was named as a principal reason for the involuntary merger of Washington Federal S&L of Cleveland and the liquidation of Economy S&L of Chicago this year.

Bank Board Chairman Richard T. Pratt defended management of the S&L sector by comparing it with that in other industries and insisting that it's no better or worse. "I think that we can't require that any industry be universally populated by the world's best managers," Pratt said in an interview.

"One shouldn't have to be the best manager in an industry just to survive and that's almost the condition that we came to at the peak of this last interest rate cycle," he asserted.

The Money Funds

In the past couple of years, a major problem for savings institutions has been the attraction of some deposits to the money market funds, which have grown from a mere $4 billion in 1978 to $185 billion today in deposits. For as little as $500, an investor earned as much as 20 percent or more at times this year by investing in a money market fund, substantially more than a passbook savings account paying only 5 1/2 percent.

As small investors turned to the money market funds in greater numbers, the S&Ls tried vainly to have curbs put on the funds, which, while supervised by the Securities and Exchange Commission, are regulated less stringently and do not have to set aside reserves to cover possible losses in the future.

As one response to the plight of the S&Ls, regulators authorized them to issue a six-month money market certificate in 1978--a decision that the industry would just as soon forget.

The money market certificates were designed to make the S&Ls more competitive by enabling them to offer a market rate of return on minimum deposits of $10,000. Early last year, S&Ls were also authorized to offer 2 1/2-year certificates.

The net effect of the certificates was a significant increase in the S&Ls' cost of funds. Although the certificates stemmed the outflow of funds for a while, associations had to come to grips with cash flow problems because of their rising costs.

In retrospect, deregulation of the liability side of the balance sheet through the creation of certificates of deposit sensitive to money market rates was a colossal error. "Things got totally reversed," said Jay Janis, former chairman of the bank board and now president of California Federal Savings and Loan in Beverly Hills. "The asset side should have been deregulated first. It wasn't because of pressure from constituent groups who opposed variable rate mortgages and lack of understanding by Congress."

How bad will the situation get? Interest rates on six-month Treasury bills have fallen from a record 15.8 percent on Sept. 4 to 10.7 percent on Nov. 30, although they edged higher last week. Two-thirds of all deposits are now in high interest certificates. According to finance professor Dince, it will be six months before the majority of these are rolled over at lower interest rates. "At least the thrifts won't be drowning; they'll be treading water," he said. Until then, savings institutions will be hard pressed to reduce their cost of funds and consequently improve their earnings. In October it cost them an average of 11.74 percent to buy money, while they were earning but 9.91 percent on their mortgages.

Operating profits or losses for thrifts are expressed by changes in net worth, also commonly called reserves or surpluses or retained earnings. FSLIC- insured savings and loans had a net worth of $32.4 billion in December 1980; by June that had fallen to $30.7 billion.

Jonathan Grey, an analyst with Sanford C. Bernstein & Co., predicted that losses should abate in the first half of 1982 to under $1.5 billion. The rate of losses has bottomed out, he says, but the rate of improvement isn't sufficient to save many institutions that are still marginally solvent today. Judy Mackey of Townsend Greenspan & Co. puts losses at $1.5 billion in the third quarter this year, $2 billion in the fourth, and $500 million in the first quarter of 1982. A return to marginal profits will begin in the second quarter, and the year as a whole should be slightly positive provided Treasury bill interest rates fall to the 9 percent level and remain there for some time--a big if.

Bortel, a San Francisco analyst with Shearson/American Express, projected a $5 billion loss this year, followed by a $1 billion to $1.25 billion profit next year, mostly in the second half.

On the deposit side, the statistics showing a mammoth $22 billion outflow during the first 10 months can be misleading because of accounting methods. It is not clear, for example, how much of that money left S&Ls and went to money market mutual funds--which increased by $106 billion during the same period--and how much stayed within S&L walls in the form of noninsured investments in retail repurchase agreements, a nondeposit offering by many S&Ls that amounted to a short-term investment at money market rates.

All Savers accounts were authorized by Congress as a way to assist the savings industry as well as a way to build up deposits. The industry estimated $238 billion would be deposited in these accounts over 15 months. The first month's response of $35 billion has been followed by increasing apathy caused by sinking interest rates.

Yet All Savers did contribute approximately $22 billion to savings institutions and helped make the savings flow positive at savings and loans in October.

For mutual savings banks, All Savers put a halt to the $1 billion drain of the previous four months and resulted in a "relatively small" outflow of $100 million, in the words of their trade association.

The prospect of All Savers being a major factor in the savings institutions' financial future now appears slight. Instead, savings institutions are looking eagerly to Individual Retirement Accounts (IRAs) as a source of long term funds. Projections for contributions to all forms of IRAs range from $25 billion to $80 billion annually, after a change in tax laws on New Year's Day 1982 that opens up these retirement accounts to a much broader slice of the working population.

Mortgage Defaults

Mortgage loan closings and commitments remained depressed in October, because of a lack of funds, high interest rates and a moribund housing market. However, in recent weeks, major S&Ls in California began reducing their home financing rates to under the 17 percent level. The industry has been reluctant to lower rates out of a desire to guard against future volatility and make up some lost profits.

Not until mortgage rates hit 13 percent or less, however, is the public expected to begin seeking to borrow again in large numbers.