How much regulation now?

The ripples of anxiety now running through the country's financial system do real damage. They put upward pressure on interest rates, as investors worry about risk, and they increase strain at the system's weak points -- like the savings and loan associations that don't have federal deposit insurance. The current crisis among Maryland's privately insured S&Ls contributes to a sense of uneasiness that is as contagious as chicken pox.

The remedy for the S&L industry begins with tighter regulation. But that prescription collides with the Reagan administration's policy of reducing regulation and leaving competition to the market. The administration is going to have to decide whether it wants a greater degree of safety or wider competition with more failures.

It's important to note that nobody has lost -- or will lose -- a nickel of federally insured deposits. The federal government's resouces to guarantee those deposits are literally unlimited. But federal insurance doesn't cover every deposit. Some institutions -- for example, 102 Maryland S&Ls -- are outside the federal system. And federal insurance only covers deposits up to $100,000.

While those long lines of frightened depositors outside S&L branch offices are the most dramatic and visible evidence of a run, those people are not the big depositors. Big depositors operate by telephone and wire. They are usually professionals, and they hear about trouble long before the rest of the public. In the Maryland case, the lines of depositors on the sidewalks were the final stage of the run, not the beginning of it.

The events of the past two months show how the ripples reached Maryland. In Florida some investors began to get nervous about the money they had put into a brokerage called E.S.M. Government Securities. When they began pressing the brokerage, it collapsed, inflicting large losses on some of its depositors. One of them was a Cincinnati S&L that belonged to Ohio's system of private deposit insurance. That started a run on other S&Ls in the same system, inducing the governor to close all of them temporarily.

Investors began looking more carefully at the other state insurance systems. Quietly but rapidly they began pulling money out of several of the privately insured Maryland S&Ls. It was only after two months of this drain -- a silent run -- that one of them was forced to make management changes that made its distress public. That's the point at which the lines began to form in Maryland.

Beyond the cases of the failed institutions, there is a general pattern of great strain on the whole S&L industry. It has two causes. First, beginning in late 1979, interest rates rose sharply and fluctuated wildly as the United States began fighting inflation with tight monetary policy. Traditionally S&Ls had been stringently limited in the interest that they were allowed to pay on deposits. Without deregulation of their interest rates, they would shortly have been drained of deposits and gone broke. With deregulation, they were able to compete with the money funds and the banks -- but that put them under a fierce and unaccustomed presure to find high-yield investments. Most of these S&Ls were loaded with low-interest mortgages issued at fixed interest rates over the years. Mortgage lending alone would no longer keep them in business. The regulators, fearing massive failures, began relaxing the rules on the kinds of investments that S&Ls could make.

Guiding this process was the idea -- a hope rather than a clear policy -- that over time most S&Ls could evolve into commercial banks. They began to offer checking accounts to depositors. They began to make commercial loans and to go into many new and unfamiliar businesses.

As the rules now stand, a unary S&L holding company has wider power than a commercial bank, and operates with lower capital requirements. "It is a very attractive charter," comments Andrew S. Carron, a vice president of Shearson Lehman Brothers and a specialist on the S&L industry.

But as the S&Ls got into these new lines of business, Carron adds, by bad luck those lines of business turned less profitable. The strain on the S&Ls increased.

Richard T. Pratt, former chairman of the Federal Home Loan Bank Board, fears that the regulators will attempt to rescue weak S&Ls by merging them with strong ones -- resulting in an industry much less strong as a whole than it needs to be. Pratt emphasizes that while some S&Ls are not going to survive, others will remain strong and successful.

But the numbers of those in trouble are arresting. Pratt, citing a study by the staff of the Home Loan Bank Board, says that at the end of last year there were 438 federally insured S&Ls with negative net worth -- one out of every eight S&Ls in the country. There were another 856, he said, with net worth less than the 3 percent of assets that the federal regulations require.

The regulators face a dilemma. If they pressed harshly and rigorously for compliance, a lot of these S&Ls would fail immediately, setting off further waves of losses and fear. If they don't press hard enough, they permit hundreds of undercapitalized S&Ls to continue taking deposits.

The least dangerous way out requires much more stringent regulation -- narrowing, among other things, the investments that S&Ls are permitted to make -- and tightening enforcement. But that runs counter to all the inclinations and convictions of the Reagan administration.