Seventeen months before the Maryland savings and loan industry was thrust into a crisis that threatened its financial well-being, the private corporation that insured most Maryland savings and loans began uncovering evidence of widespread risky investment practices by some of its members, according to internal corporation documents.

Those documents showed that for some S&Ls the situation was worsening throughout the first nine months of 1984. Meanwhile, during that time, top state regulatory officials were assuring legislators that the industry was in sound financial shape.

The investment practices prompted the staff of the private insurance firm -- called the Maryland Savings-Share Insurance Corp. (MSSIC) -- to issue written warnings last summer to three savings and loan firms, including two Baltimore-based thrifts now in conservatorship. The warnings, called "cease and desist" orders, demanded that they curb the number of investments in high-risk commercial real estate ventures they were making, the documents obtained by The Washington Post show.

But the most serious violator, Old Court Savings and Loan Inc. in Baltimore, failed to comply with the written MSSIC orders and was later forced into conservatorship by the state. More important, state regulators, who have primary responsibility for policing the industry, were aware of MSSIC's concerns about Old Court and the other two thrifts but did not act on them because they did not view the violations as threatening the financial solvency of the three institutions, according to a ranking state official.

The failure of state officials to respond more quickly to the warnings of problems at Old Court and the other institutions illustrates what critics charge was a virtual breakdown in Maryland's regulatory process, contributing to the collapse of the state's private insurance system for savings and loans.

Hampered by low pay, high staff turnover, bad morale and budget cuts imposed by the state legislature, the state Division of Savings and Loan Associations found itself unable to police a state industry that was exploding in growth because of deregulatory measures passed in Washington and Annapolis, according to several members of the division and industry officials. How Will It Play in Press?

MSSIC and state regulators also failed to move against violators such as Old Court in part because they viewed a major part of their job as protecting the industry from adverse publicity, according to interviews with some state officials and industry critics.

"The regulators, and I include MSSIC, saw themselves far more as protectors of the industry than as its policeman," said state Attorney General Stephen H. Sachs, whose office is conducting a criminal investigation into Old Court.

In a recent interview, Sachs compared MSSIC officials and regulators to "compulsive gamblers" in dealing with problems at Old Court. Their attitude, he said, was "one more roll of the dice, one more cut of the cards would make everything all right."

"There was always a concern among the board about how it would play in the press," recalled Nancy Erwin, a former member of the Board of Savings and Loan Association Commissioners, the body that oversees the division. "We always asked, 'What would happen if someone heard there was something wrong? What would people think? How would that affect the whole industry?' "

The state regulators, whose own guidelines in some cases were not as strict as MSSIC's, remained confident of the industry's soundness until this February, when they realized that officials of Old Court, the second-largest state-chartered thrift, were refusing to take corrective actions demanded first by MSSIC and later by the state.

By that time, word of unsecured insider loans and mismanagement had spread into the financial community, and shortly after that, a run on deposits began at Old Court and ultimately brought the entire thrift industry in the state to the brink of disaster.

That run prompted the state to place Old Court under a conservator, after which Gov. Harry Hughes called the General Assembly into emergency session to abolish MSSIC and replace it with a new state insurance agency. The activities at Old Court also are now the focus of a federal investigation as well as the probe by Sachs' office. Fewer State Regulators

While assets of MSSIC-insured thrifts exploded from $2.4 billion in 1980 to $8.9 billion last year, the state division's budget failed to keep pace, and the number of authorized state examiners was actually reduced, from 25 to 22. A division request for three additional examiners failed to win approval during this year's legislative session.

Defenders of the division argue that it operated at a disadvantage in the face of aggressive tactics employed by Old Court and other "go-go" savings and loans, who often were represented by major law firms and national accounting firms.

Low pay -- starting salary of $12,900 -- further exacerbated the problem, often resulting in vacancies. As of last week, five of the 19 field examiner slots were unfilled.

"There was a horrendous turnover problem," said David Wells, former director of the division until he left to become senior vice president of Key Federal Savings and Loan Association. "Examiners would go out, get a feel for the industry and then leave to get a better job in the private sector. I did the same thing."

"I make $25,000 a year," Alexander M. Watt Jr., a state examiner supervisor who has been with the division for 10 years, recently told a legislative committee. "If I go up to the president of Chevy Chase Savings and Loan, who probably makes $1 million, and tell him he doesn't know how to run his business, he'd laugh in my face."

Savings and loan division officials, moreover, contend they lacked authority to stem questionable practices. If a savings and loan refused to obey an order, the state division lacked the power to impose fines or issue cease-and-desist orders -- two enforcement tools available to MSSIC, the industry's own insurer.

"All we can do is write them a letter" when serious violations are detected, said one state examiner. "In extreme cases . . .[thrift] officials are called in and pretty much their fingers are slapped and they are told not to do it again."

Until this past session of the legislature, the only real enforcement tools available to the state division were the power to put an institution in receivership or to appoint a conservator to take over its operation. State officials said they were reluctant to take such drastic action and industry officials realized that.

The state division "had either very devastating powers or none," said Francis X. Pugh of the state attorney general's office.

At the request of division officials, the legislature this past session enacted laws granting it increased enforcement powers, including the authority to issue cease-and-desist orders, a regulatory warning device designed to force compliance with laws and regulations.

Despite the handicaps the regulators were working under, some industry executives and critics say the state could have moved faster to avert the crisis.

Said F. William Kuethe Jr., the managing officer of Glen Burnie Savings and Loan: "Obviously the division knew about Old Court , but they didn't take positive action . . . . If you want to put out a little fire, you throw water on it real quick. You keep it from getting bigger." Kuethe has been in the savings and loan business since the late 1950s.

"The . . . insurance corporation [MSSIC] and the division people were just afraid to go against" Old Court's top officials, said an Old Court employe, who asked not to be identified. "As long as there were no major problems, everybody just let it go. There was a complete breakdown."

The documents obtained by The Post show that Old Court and two other thrifts, Merritt Commercial Savings and Loan Association of Baltimore and First Maryland Savings and Loan Inc. of Silver Spring, were sent cease-and-desist letters last August because they had exceeded MSSIC guidelines designed to prevent thrifts from concentrating an excessive amount of investments in high-risk ventures.

MSSIC rules limited commercial loans, which are more risky than the single-family residential loans that had formed the backbone of the savings and loan industry, to 40 percent of a savings and loan association's deposits. The limits on commercial loans imposed by MSSIC were designed to prevent an institution from concentrating excessive amounts of its deposits in such high-risk ventures. Over the Limit

The MSSIC report showed that from January to July 1984, Old Court's commercial loans ranged from 63.53 percent to 73.43 percent.

Merritt Commercial, which voluntarily put its operations under a state-appointed conservator this spring, had commercial loans ranging from 52.84 to 71.57 percent in that same period, according to the documents, and First Maryland's ranged from 63.99 percent to 74.06 percent.

MISSIC's cease-and-desist orders also cited violations by the three thrifts of a rule that limited construction loans to 25 percent of all commercial loans. During the first half of 1984, Old Court's percentage in that category ranged from 34.20 percent to 36.68 percent, Merritt's from 24.52 to 35.46 percent, and First Maryland's from 30.64 to 44.95 percent.

Additionally, the letter to Merritt cited it for exceeding a 25 percent limit on loan commitments and loans-in-progress, with six-month figures ranging from 26.73 to 33.98 percent.

More than three dozen other associations violated one or more of MSSIC's regulations for lending and other operating procedures at various times in that period, but none showed the kind of sustained violations of Old Court, Merritt or First Maryland.

The letters to Old Court and Merritt Commercial were dated Aug. 13, and the one to First Maryland was dated Aug. 31.

Officials at the state savings and loan division would not comment on the documents, but Charles Hogg II, who was president of MSSIC and now is employed by the new state insurance agency, said there was a "full exchange" of information between his organization and the state agency, which lacked MSSIC's computer capability.

Conservators operating Old Court and Merritt could not be reached for comment on the MSSIC letters. Julian Seidel, president of First Maryland, said his company agreed to comply with MSSIC's requests by investing in a greater share of residential loans. He said First Maryland's percentage of commerical loans had risen because residential loans had been scarce. He said the institution's financial solvency was never in danger and it is in the process of applying for federal insurance.

Several sources confirmed that the division was aware of the MSSIC letters, although they pointed out that because some division rules were less restrictive, they might not have been in violation of state guidelines. However, one ranking division official conceded, "With those numbers, they had to be out of bounds."

But division officials and others said the division was reluctant to take any action that might become known and cause the public to lose confidence in a thrift. Public Left in Dark

Last June, while the situation was clearly worsening for some of the S&Ls, division director Charles H. Brown Jr. told a legislative task force that "basically, the associations in Maryland appear to be in much better condition than those in the rest of the country. In the latter part of 1983 and into 1984 there was a complete turnaround in the earnings of the thrift industry, and most of our associations are again operating in the black."

Thus, the public was left in the dark, even as knowledgeable investors, many of them out-of-state residents who had been lured by a national advertising campaign boasting high interest rates, silently drained Old Court through the mail.

Among the many unsuspecting local victims was Carolyn Robinson, a Baltimore County resident who got a frantic telephone call from a friend in early April, warning her that Old Court was "in a lot of hot water." When her friend urged her to pull her money out, Robinson called the state division of savings and loan for advice.

"They told me absolutely not to worry," said Robinson, who had nearly $50,000 of her family's savings on deposit there. She said a state examiner told her, "Don't listen to rumors. They Old Court are A-1 and everything is solid. That's what we're here for."