When the seven trustees of Houston's Hermann Hospital Estate met last December, they had a delicate matter -- indeed, a potential scandal -- on their hands.

A private investigator hired by the trustees to look into irregularities in the hospital's books had coaxed a confession from the estate's executive director, William B. Ryan Jr., that he had stolen $325,000 from the hospital.

Philip G. Warner recalls telling his fellow trustees at the December meeting how important it was to "resolve this as quickly and quietly as possible . . . to avoid bad publicity."

Warner, who also happens to be the editor in chief of the Houston Chronicle, the city's largest newspaper, says he proposed the following course of action: If Ryan would agree to a plea bargain, "let's go down there to the courthouse , run the indictment through quietly, have a judge standing by, let him plead guilty, take his probation and go on . . ."

That plea bargain never came off, and in early January, Houston television reporter Marvin Zindler -- the flamboyant muckraker burlesqued as "Watchdog" in the musical comedy "The Best Little Whorehouse in Texas" -- broke the Hermann Hospital story wide open.

So began the saga of a big city newspaper editor and his entangling alliances.

The hospital story has since snowballed into the biggest scandal to hit Houston in a decade. With a Harris County grand jury still investigating, there have already been four indictments, eight resignations of top hospital estate administrators, and a series of disclosures that the estate, which was set up 71 years ago for the benefit of the poor, has been spending less than 3 percent of its funds on charity cases while lavishing expensive trips, hunting retreats and a fleet of dirt bikes on some of its executives and trustees.

The story has been front-page news all the way -- in the Houston Post, the city's scrappy No. 2 paper in circulation and advertising.

The Chronicle has devoted at least as many column inches to the unfolding scandal but, except for the four news stories of the indictments, it has played its coverage on inside pages. It has yet to run an editorial on the subject.

Moreover, the lead reporter on the story, Olive Talley, resigned from the paper two weeks ago after Warner killed a story she had written about a $10,000 tab (including $3,100 for limousine rental) for a four-day trip to San Francisco that a former Hermann estate executive ran up entertaining five people, including Jo Murphy, a trustee of the Houston Endowment Inc., and her husband.

The Houston Endowment Inc. owns and publishes the Houston Chronicle.

"I felt like I would be compromising my integrity by staying at the paper after they killed that story," said Talley, who has been hired by the cross-town rival Post.

"I don't think that was a misuse of funds at all," Warner said in an interview, explaining his decision to spike the story. "Over the years the endowment has given $8.2 million to the hospital estate, and this trip was a form of saying thank you.

"There are 167 trips being looked at by the DA's office, and the only reason we got a tip on this one is that Jo Murphy has a connection with the Chronicle," he added, speculating that the tipster was trying to embarrass his newspaper.

Warner, 45, also said he sees no conflict of interest in serving on the board of the hospital while it is the subject of intense press scrutiny. "There is not an adversary relationship between the trustees and the media in this town," he said. "That's one of the great misconceptions. The board has been doing all it can to bring some of these matters to light."

(Warner did resign from the board last month, not because of a perceived conflict, he said, but because he learned in the course of the investigations of a little-noticed stipulation that board members are not supposed to be licensed lawyers -- which he is. In his letter of resignation, he said he will continue to work closely with the board, and expressed his hope to be able to return under an exemption for nonpracticing lawyers.)

The spiking of the story has created a morale problem among reporters and editors at the 500,000-circulation Chronicle, which over the years has developed the reputation of being a boosterish newspaper that "has far too many entangling alliances to ever dream of stirring up trouble," in the words of a former high-level newsroom employe.

The paper's owner, the Houston Endowment, is one of the largest charitable foundations in Texas, donating money to hospitals, universities, journalism departments, the arts. For the past 16 years it has been fighting a 1969 revision of the IRS code that would force it to divest itself of the newspaper by 1989. In the opinion of many Houston journalists, Warner, who has minimal newsroom experience, was made editor in chief to steer the long and so far unsuccessful effort to lobby an exemption from that provision of the tax code.

Two weeks ago, Chronicle city editor Don Mason wrote Warner a memo protesting the killing of the Jo Murphy story and bemoaning the loss of Talley. He said he has not received a response.

A letter was subsequently circulated in the newsroom asking for reassurances that reporters would be able to pursue stories wherever they led. According to newsroom sources, however, the letter attracted only 20 signatures, most of them from feature-page reporters, and was never sent to Warner.

"People have homes, babies," said one newsroom source, who asked not to be identified.

"There's an open, gaping, bleeding wound at the Chronicle right now," said Mary Flood, a reporter who has been covering the Hermann story for the Houston Post. "There's too much pain over there."

Warner disgreed. He said he perceived no morale problem, then added, "The mind-set of so many journalists is that you have to have an adversary relationship with the world. It just ain't so."

He likened the Houston Post's coverage of the hospital case to that of a "grocery store tabloid. Who are they to make a judgment on us when we are the proven leaders, we are the No. 1 newspaper south of the Mason-Dixon line? I am not going to be in a position of reacting at this newspaper. We set the tone and taste, based on our good, proven, conservative news judgment."

Talley said that in late January, Warner permitted the publication in the Chronicle of a story she wrote disclosing that the Hermann estate had purchased a fleet of dirt bikes and jeeps for the use of the trustees -- particularly Warner -- on ranch property it owns. Warner, a dirt bike enthusiast, said he used the vehicles to entertain potential contributors. He has not been accused of any wrongdoing.

"It was very awkward, but it made me proud that we went with the story," Talley recalled. "I thought that was surely the worst hurdle I was going to face. Apparently, I was wrong."

The Chronicle also published Warner's account of how, in December, he had hoped to minimize the publicity in the case. He said this week he made those comments before he realized that the scandal reached beyond Ryan.