A high-interest, high-wire act by a handful of Maryland savings and loans has thrown the state into the worst financial crisis in its history, forcing the General Assembly to prop up the safety net that protects depositors.
Trying to grow rapidly by paying some of the highest interest rates in the nation, the highfliers lost their bal-ance when depositors became nervous about the protection provided by the Maryland Savings-Share Insurance Corp.
The ability of MSSIC to protect depositors was thrown into question when a similar private insurance fund in Ohio was wiped out by the failure of a single savings and loan, forcing the state to declare America's first bank holiday since the Great Depression.
Funds began draining out of Old Court Savings and Loan -- where the crisis began -- almost immediately after the Ohio bank holiday in mid-March, according to documents filed when the state placed Old Court under conservatorship.
By the end of March, Old Court had lost $15.8 million in deposits, though it was another five weeks before lines of depositors began showing up outside its suburban Baltimore branches and the run began in public.
By the end of March, Old Court's own cash account was overdrawn by more than $2 million, an extraordinary event for a financial institution.
The first money to go probably was withdrawn by out-of-state depositors who decided after the Ohio fiasco that federal deposit insurance was more important than high interest rates, said Paul Bauer, publisher of a Miami newsletter that advises savers on where to get the best rates.
Bauer's Savers Rate News is the bible of what bankers call the "hot money" crowd -- sophisticated investors across the nation who shop and bank by mail, putting their money wherever it will earn the best rate, rather than in their hometown bank.
For months, Bauer's list of the top rates had been dominated by Maryland names: Old Court, Merritt Commercial Savings and Loan, Fairfax Savings, Custom Savings, Severn S&L, First Maryland S&L, Hopkins S&L and Eastern Savings. Virtually every issue showed some Maryland association paying the highest interest rate in the nation for every category of savings.
Bauer began cautioning his subscribers about the soundness of MSSIC insurance right after developments in Ohio, when a run on a Cincinnati savings and loan forced the state to declare a bank holiday for the privately insured thrift industry. Bauer dropped Old Court -- and for a time Merritt -- from his listings when he could not obtain information about its financial strength.
The same Maryland laws and MSSIC regulations that allow the state-chartered, privately insured associations to pay higher interest rates than federally insured S&Ls also give them two other dangerous advantages: They do not have to disclose their financial condition and they are free to invest virtually unlimited amounts of their customers' money in ventures that are off-limits or severely restricted for federally chartered S&Ls.
The Federal Home Loan Bank Board makes public the balance sheet of associations it regulates every three months, but Maryland law forbids any such disclosure by the state Divison of Savings and Loan Associations or by MSSIC.
A change in that law was called for more than a year ago by Henry Berliner, president of Second National Building and Loan of Annapolis. Berliner, a Washington lawyer and chairman of the Pennsylvania Avenue Development Corp., heads the only MSSIC member that has sold stock to the public and thus must make its finances public.
"The bank knows how good a credit risk you are," argued Berliner. "Isn't the public entitled to that same degree of knowledge about the same financial institution that goes to the public and borrows the public's savings for the bank's use?"
The call for public disclosure was rejected during the last session of the Maryland General Assembly when a special study committee looked into rewriting the savings and loan regulations. The lawmakers did vote in new power to restrict runaway savings and loans, but those do not go into effect until July 1, by which time the Maryland S&L crisis may be history.
One of those new laws will allow the state savings and loan division to issue cease-and-desist orders to halt unsafe or unsound banking practices. Until that law goes into effect, however, Maryland regulators must chose between a scolding and capital punishment; the state's only options at present are to make recommendations or take over an institution and put it into conservatorship.
The latter action finally was taken with Old Court after depositors became anxious about their deposits. But state regulators first tried to use their powers of persuasion when they became nervous about the other side of Old Court's balance sheet -- the way it was investing its money.
State regulators were investigating Old Court long before the Ohio crisis and in late March sent Old Court a bill of particulars detailing what they felt was a pattern of mismanagement and risky investments.
The letter outlining Old Court's difficulties was dated March 22, yet a week later -- on March 29 -- Maryland officials assured a congressional committee that all was well in the state. "Presently, we do not have any associations that we feel have severe operating problems," said Charles H. Brown, director of the Division of Savings and Loan Associations.
When they audited Old Court in January, state examiners found almost $6 million in unsecured loans to insiders and another $5.7 million in overdrafts to insiders -- the same practice that brought down Bert Lance as Jimmy Carter's director of the Office of Management and Budget. Such practices are illegal at a federally chartered bank.
State officials also expressed concern about the almost $2 million that Old Court paid in fees last year to its chief investors -- Jeffrey Levitt and Allen Pearlstein, who each own 41 percent of Old Court's stock. But what proved to be the fatal flaw at Old Court was the heavy concentration in real estate investments that was uncovered by the state authorities.
Old Court had put the equivalent of 69.63 percent of its total deposits in commercial, construction and land development loans, in direct violation of the 40 percent ceiling imposed by MSSIC on such risky ventures. State officials and MSSIC executives have yet to explain how Old Court managed to go so far beyond the limit before something was done.
Old Court used its state-granted authority not only to make loans for construction projects, but to directly invest depositors' money in them as a partner, setting up more than 70 companies to do so. Precisely how much Old Court put into direct investment has not been determined, but state officials say it is many times the 2 percent of assets permitted by the Federal Home Loan Bank Board.
Just as Old Court drew many of its deposits from outside its Baltimore base, it invested in projects up and down the East Coast. One of the loans specificially cited by state regulators is a $5 million investment in Villa Poinciana, a 27,000-acre Florida home project.
The trouble with such heavy real estate investments is not only that such projects might fail, but that it is impossible to get money out quickly. When Old Court's depositors began withdrawing funds, the S&L rapidly ran out of cash, and it could not easily borrow against its land and construction investments.
The Old Court data that was made public for the first time when the state took over shows how dramatically it differed from conventional federally insured associations of the same size, such as Washington Federal Savings and Loan.
Washington Federal and Old Court both have total assets of about $700 million, but the two are in almost totally different businesses. Washington Federal President William Sinclair says he is basically a mortgage banker, making many home mortgages, selling most of them to other investors and keeping some for its own portfolio.
Washington Federal makes money on loan fees and by servicing the mortgages (collecting payments) and finances very little real estate development, which has been the primary business of Old Court.
Washington Federal owns $396 million in home mortgages, while Old Court has only $248 million. While Washington Federal has $156 million in Government National Mortgage Association securities that can quickly be converted to cash, Old Court had only $37 million in GNMAs.
Old Court has $130 million in land development loans -- 10 times the $13 million put into such ventures by Washington Federal. Washington Federal is limited to making direct investments of only about $15 million, compared with no limit on the direct investments of Old Court.