E.S.M. Government Securities Inc. came under the scrutiny of a number of federal and state agencies several times since its founding in late 1976, but that scrutiny had little impact on the company's operations, according to testimony at a congressional hearing yesterday.
The government securities trading firm was allowed to continue its free-wheeling practices until last month, when it collapsed -- setting off a chain of events including a major financial crisis in Ohio.
"E.S.M. could have been stopped," Rep. Doug Barnard (D-Ga.) said yesterday during hearings Barnard's House Commerce, Consumer and Monetary Affairs Subcommittee into the Ohio financial panic and its relationship to the E.S.M. collapse.
The Office of the Comptroller of the Currency in 1977 issued a warning to the federally chartered banks it regulates, warning them against the "types of transactions and financing arrangements being offered by E.S.M.," Senior Deputy Comptroller for Bank Supervision H. Joe Selby told the House panel.
The Securities and Exchange Commission, which unsuccessfully brought a case against E.S.M. in 1979, said last month that the unregulated government securities dealer had been hiding its losses for years, using phony accounting practices. The dealer regularly pledged the same securities as collateral for loans from several of its customers.
When the firm was forced out of business last month, some of its customers lost a total of $300 million because the securities they thought E.S.M. held for them did not exist.
The biggest loser was Home State Savings Bank, a $1.4 billion thrift institution in Ohio that lost $145 million as a result of its dealing with E.S.M., which is based in Ft. Lauderdale, Fla. Home State was one of 72 privately insured savings institutions in Ohio and its losses alone were enough to wipe out the Ohio Deposit Guarantee Fund.
After a run on Home State forced its closure, depositors began to withdraw their money from the 71 other institutions insured by the private fund. Gov. Richard Celeste closed the remaining privately insured S&Ls, which may not reopen until they qualify for federal insurance or are merged into healthier institutions.
Celeste told the subcommittee yesterday that the "federal government must provide greater oversight of those who make the market for goverment securities." He said that Home State would be in existence today if it were not for E.S.M.
But officials from other private insurance funds said the problem was with Ohio regulators, who knew of Home State's relationship with E.S.M. as far back as 1980, when the institution had a $100 million investment with E.S.M. That investment grew to $680 million, even though Ohio savings and loan regulators and officials of the private insurance fund told Home State to reduce its investment and in 1984 got the board to agree to do so. After the agreement, the thrift institution again increased its exposure.
Donald R. Beason, president of Financial Institutions Assurance Corp. of North Carolina -- which insures deposits in four southern states -- said the "first time we found a failure to follow an agreement, we would have replaced the officers."
Donald Hunsche, executive vice president of the Ohio fund, said he only had the power to counsel Home State, that he could not compel the institution to end its E.S.M. relationship.
Preston Martin, vice chairman of the Federal Reserve Board, said the Federal Reserve Board supports the move by several states, including Ohio now, to replace private deposit insurance with federal insurance.
The Federal Deposit Insurance Corp. and the Federal Savings and Loan Insurance Corp. already insure most of the deposits in the nation, including most in Ohio.
The Federal Reserve and the Securities and Exchange Commission are in the middle of a study of the government securities market to see whether it should be regulated.
But E.S.M. and its practices, unlike those of other government securities firms that have failed in recent years, were well known to a variety of regulators.
Selby said bank examiners uncovered speculative investments E.S.M. officials sold to the National Bank of Florida in late 1976 and moved to protect six national banks from engaging in E.S.M. transactions when E.S.M. executives Robert Seneca and Ronnie Ewton moved to buy the banks' parent company in 1977