When officials at Community Savings & Loan of Bethesda ran up against the insistence of federal regulators that they sell off a real estate investment affiliate to qualify for federal deposit insurance, they were at the end of a long road for the industry that began with deregulation and led savings associations into increasingly high-risk investments.
The regulators' demand that Equity Programs Investment Corp. be sold triggered serious problems at the S&L. After EPIC reported it was delinquent on more than $1 billion in payments on mortgages and mortgage-backed securities, depositors rushed to Community to withdraw their funds. EPIC is a real estate investment affiliate that set up tax-sheltered housing partnerships.
The requirement to get rid of EPIC did not appear to be a singling out of Community, however. In the past several years, the Federal Home Loan Bank Board has shown increasing concern over the growth of real estate and other risky investments in the formerly staid savings and loan industry.
Bank board officials have refused to discuss the Community situation, saying only that EPIC is not a normal type of investment for a federally insured institution.
Bank board Chairman Edwin J. Gray was unavailable for comment yesterday. But in recent remarks, Gray has conveyed concern over thrifts' increasing use of so-called direct investments, rather than traditional debt investment, to fund their operations. In response to this growth, the bank board established more stringent regulations governing these types of investments, provoking both approval and criticism in the industry.
According to industry sources, the growth of direct investment can be traced to the recent deregulation of interest rates, which increased the pressure on savings institutions to turn away from traditional low-yielding home mortgages. Recent federal and state laws triggered much of this growth by granting thrifts the authority to invest in equity securities and real estate development, among other investments.
Although direct investments -- particularly in commercial real estate and development -- can be more profitable than normal investments, they also are more risky and have contributed to some of the more spectacular savings and loan failures in recent years, including that of Old Court Savings and Loan in Baltimore. They also are not very liquid investments, which means they can be hard to convert to needed cash.
The main reason the board is concerned over such investments is that many of the savings and loans engaged heavily in the practice are insured by the Federal Savings and Loan Insurance Corp., which is under bank board supervision.
In comments released with new rules on investments by savings institutions, the bank board said: "The exercise of these nontraditional investment powers can expose institutions and the FSLIC to a degree of risk inconsistent with the purposes of" the federal law establishing federal deposit insurance.
In order to underwrite more efficiently the risk of FSLIC losses, the board recently issued a new rule granting its banks greater authority to review direct investments by state-chartered thrifts it insures.
While the rule has been criticized by some in the industry as an intrusion on the powers of state regulators, others have said the board's move was a prudent step.
"The industry, generally speaking, has welcomed a role of the bank board stepping in to moderate some of the excesses," said Mark Clark, a senior vice president at the U.S. League of Savings Institutions.
Clark contended, however, that the extent of actual direct investment has been overstated. Although such investments have been responsible for several collapses, he cited 1984 figures showing that only 19 of the more than 3,500 savings institutions nationwide have more then 10 percent of their assets in real estate investments -- the benchmark figure for federal review.
Gary Driggs, president of the Phoenix-based Western Savings and Loan, which is heavily involved in direct investments, also said he generally approved of the bank board's regulatory efforts, saying that they will solve as much of the problem as can be solved by federal regulation.
He added, however, that it is "inappropriate to characterize the problem of the savings and loan industry as primary related to direct investments. Historically, bank and savings and loan failures have primarily been caused by dishonesty and stupidity" -- problems that can not be solved by regulation.
Despite tighter regulation, critics of the bank board have charged that the agency has not been vigorous enough in its efforts to curb the direct-investment problem. Several members of Congress, for instance, have criticized Gray and the board for not heading off the collapse of Beverly Hills Savings and Loan Association, which was bailed out by the government after collapsing from risky real estate ventures.