Last May 2, Charles H. Brown Jr., the Maryland government's chief regulator of savings and loans for nine years, was summoned to an emergency meeting with the governor, the attorney general and a host of other state and federal officials.
On the table was a secret report by a private insurance company detailing a financial crisis at Old Court Savings & Loan that threatened to destroy the giant Baltimore thrift and perhaps Maryland's entire savings and loan system. Brown had been reassuring everyone for months that the state's S&Ls were safe. Four weeks before the meeting, he received the report, but didn't show it to top state officials until the day before the meeting.
Attorney General Stephen H. Sachs angrily asked Brown why he had not alerted his superiors. "I don't really have an answer," Brown said, according to participants in the meeting.
It was not the first time Brown's division had kept a lid on information about Maryland savings and loan activities, according to state officials and government documents. For almost two years, the state Division of Savings and Loan Associations that Brown directed had been uncovering damaging information about several thrifts, including Old Court. But neither Brown nor other division officials shared the details with their superiors or the public.
The Division of Savings and Loan was the state government's principal overseer of an $8.9 billion thrift industry. Had it sounded an early alarm about financially shaky savings and loan firms, it might have prevented the crisis that began in May, some state and industry officials said.
But it was hamstrung by the inadequacy of its annual budget of $1 million. The starting salary for its 18 field examiners was $12,900 per year. The division coped with mounds of complicated financial records without a computer or even the sophisticated calculators used by federal auditors. It also was too protective of the industry it was regulating, according to state officials, and believed the industry's problems were manageable.
The division's shortcomings were only part of a larger regulatory breakdown at all levels of Maryland state government, according to interviews with more than 40 government officials, industry executives and others familiar with the crisis, as well as court records and state documents obtained under Maryland's Public Information Act.
Nearly everything that could go wrong did. The division's two parent agencies, the Board of Savings and Loan Association Commissioners and the Department of Licensing and Regulation, received only sketchy briefings from the division, and remained largely unaware of the severity of the S&Ls' problems. The office of Attorney General Sachs, counsel to the division, the S&L board and the licensing department, could have been a tough watchdog, but chose only to advise on minor technical matters.
Gov. Harry R. Hughes received a mild warning of some industry troubles from Brown in November 1984, but he never followed up.
The Maryland Savings-Share Insurance Corp. (MSSIC), the private insurance company that the state established to protect deposits and share information with the division, rarely disciplined problem S&Ls.
"The state effectively had no regulation," Sachs said. "The regulators were protecting a rotten industry rather than policing it. To them, their job was preserving public confidence."
The full story may never be known, but some answers may emerge within two weeks when a special investigative counsel, Wilbur D. Preston Jr., issues a report on the origins of the crisis.
"I have the feeling that no one is going to come out looking overwhelmingly wonderful in this," said John C. Cooper, the assistant attorney general assigned since March 1983 to the savings and loan board. Added his boss, Sachs, "It touches everybody."
But as public anger has mounted over the crisis, politicians and some of Brown's superiors have tended to point their fingers in Brown's direction.
During the summer, with the crisis under way, Hughes was so displeased with Brown's performance that the governor asked him to retire, Hughes said in an interview.
Several key figures in the crisis, including Brown, cited the state's investigation as the reason for declining to be interviewed.'He Loved the Industry'
At age 65, Brown often talked about retiring, and was periodically ill and absent from work before he left the division earlier this year. Brown had spent most of his working life in the banking and S&L field before starting a second career at age 56, when he became division director in 1976.
"Charlie was protective of the industry," said Nancy Erwin, a former member of the state's Board of S&L Commissioners. 'He loved the industry.'
Many who know Brown said he reflected the conservative style of savings and loans of an earlier era, and seemed less adept at working with a new generation of more aggressive and high-flying S&L executives.
During Brown's tenure at the division, "the whole thrift industry changed," said his longtime deputy, William S. LeCompte Jr., now acting director. "It was a different animal than it was when Charlie was in the industry."
"Charlie Brown is an honest guy, a basic simple guy," said one savings executive who knows Brown. "He was just not up to dealing with some of the slick talkers."
It is an irony that the Division of Savings and Loan Associations was established in 1961 by the Maryland General Assembly to deal with an earlier generation of "slick talkers." An S&L scandal then denied 43,000 depositors access to their money and sent several state politicians to jail.
The division was designed to monitor and supervise the financial operations of savings associations through regular examinations of their books. By last year, the examinations were being conducted every 15 months. As an extra precaution, state law required thrifts with assets exceeding $5 million to be audited annually by a certified public accountant, and those audits were to be turned over to the division.
The division had a range of restrictive powers, including veto power over S&Ls' requests for new branches and over "insider" loans to their own officers. But under state law and their own rules, division officials had little real power to make changes if they didn't like what they saw inside an S&L.
Until this year, the S&L division did not even have the powers of its sister agency, the office of the Maryland Bank Commissioner. The bank commissioner could remove officers of errant banks and file cease-and-desist orders to stop unsafe practices. Brown had asked the General Assembly in 1984 to grant such powers, but was rebuffed until the 1985 session -- only weeks before the crisis hit.
Division officials also believed their regulatory powers had been clipped in 1983, when the S&L industry convinced the General Assembly in Annapolis to approve a minor change in state law giving thrifts broad new powers. After the industry's legislative victory, the attorney general's office cautioned the division and its parent board that tough new restrictions could be challenged successfully by the savings associations as violations of antitrust law. The Unthinkable Weapon
The division and its parent board did have one weapon for extreme cases of S&L mismangement. State law gave government regulators, working with the private insurer MSSIC, the power to oust managers of a wayward thrift and run it themselves. But that was regarded as an unthinkable option at the division.
"Enforcement powers -- we haven't any, other than the threat of having MSSIC close the doors," said acting director LeCompte. "That is just not viewed by me as ever being a possibility."
Because the division could impose almost no realistic penalties, thrifts operated in a "permissive atmosphere," said Assistant Attorney General Francis X. Pugh, chief counsel to the Department of Licensing and Regulation. "They had to have felt they could get away with it . . . . If you see a 'No Parking' sign and the penalty is a $5 fine, you may take your chances."
But some S&L executives said the division, even with its limited powers and resources, could have been more aggressive with problem S&Ls. They said the agencies could have taken over a chronically troubled thrift to set an example. They also suggested that the division and MSSIC could have sent examiners every day to harass noncomplying thrifts.
"Government does it all the time," said Henry A. Berliner Jr., head of the large Second National Building & Loan of Salisbury. "Regulators have enormous ability to influence conduct."
The division's weaknesses started surfacing in mid-1983, when its field examiners found that a number of fast-growing S&Ls, including Old Court, Merritt Commercial and First Maryland savings and loans were embarking on a range of activities that violated the division's and MSSIC's standards, according to state government and MSSIC records.
Examiners were most concerned in this period by the large number of loans to commercial ventures made by these savings and loans -- such as huge residential and office developments in Maryland and other parts of the country -- that were considered risky by many conservative savings institutions. They also were worried that some S&Ls were maintaining an imbalance between assets and liabilities, according to division documents and state officials.
The division's 1983 examination of Old Court, which was completed in the middle of that year, found "numerous and substantive" examples of "weak operational standards," MSSIC documents show.
At the July 14, 1983, meeting of the state Board of S&L Commissioners, several board members complained that a plan by Old Court to make a series of large investments in stocks and bonds -- up to $700,000 each -- was "possibly unsafe and unsound," according to board minutes.
Division director Brown informed the commissioners that they had no power to disapprove the investments but did say he "would discuss the amounts" with the thrift, the minutes said.
By October 1984, after the division had completed another exam of Old Court, the S&L commissioners were concerned enough about the association's health to summon two MSSIC officials to brief the board privately. Board Chairman W. Thomas Gisriel asked the MSSIC officials whether Old Court officers were making any loans to themselves. MSSIC President Charles C. Hogg II replied there was no self-dealing, according to board minutes.
Hogg was mistaken. Although Gisriel said he did not know it at the time, division examiners had already uncovered a host of risky "insider" loans made by Old Court to Levitt or Levitt-controlled companies.
"To say that Old Court had problems is true," LeCompte said. "But I can tell you the same statement would hold true for a large portion of the industry . . . . You've got tons of problems" in S&Ls in 1984.
One thrift with plenty of problems was Community Savings & Loan of Bethesda, which was one part of a gigantic real estate empire called EPIC. Starting in 1983, Community violated six key Maryland laws and regulations governing thrifts, a pattern that was "a contributing cause" in Community's collapse last August, according to a lawsuit filed last month by the state of Maryland against former Community officials.
It remains unclear how much the division knew about these problems, but a former EPIC official said his EPIC colleagues did not take the division seriously. The company's executives "could push the state people around, do a jig around them," he said.
Some S&L executives endlessly delayed responding to requests for documents or reforms in lending practices, according to division documents and sources. Brown and his office sometimes sent such letters to S&Ls asking for replies in a month, but some thrifts wouldn't respond for six months, and even then inadequately, sources said.
"It was a paperwork triangle," said one former thrift official. Problem associations were "just violating the rules and saying, 'Do something about it.' . . . A lot of times the regulators just gave up. These letters didn't have much effect. It was a long, dragged-out thing."
Moreover, division officials often "would just take the association's word on how they were improving things," one current division employe said. Between examinations, "we'd never go out and check to see if they did what they said they'd do" about violations. 'Same Problem as Last Year'
Division examiners sometimes noted the same complaints and violations year after year.
"If I saw the same thing for two years," the division employe said, "I'd just write in my examination comments, 'Same problem as last year. No improvement.' "
"There was just nothing . . . about the division that suggested these guys were able to cope, never mind whether they were willing" to regulate aggressively, Sachs said. "Charlie Brown at his best did not ever strike me as somebody who saw himself as a cop."
State officials said Brown and LeCompte often put a rosy face on the S&L industry, and tried to keep damaging information from the public out of fear that it would cause depositor runs.
Last March 21, after Assistant Attorney General Robert deV. Frierson asked LeCompte whether the state's S&L system was safe, LeCompte said in a hand-written reply that the industry was sound but that officials had to work to maintain the public's confidence in thrifts. LeCompte urged Frierson not to "injure" confidence in the savings system by speaking negatively about S&Ls.
Eight days later, Brown wrote a letter to a congressional subcommittee studying the collapse of Ohio S&Ls earlier that month, saying, "Presently we do not have any associations that we feel have severe operating problems." His statement came six weeks after division examiners had begun uncovering extremely damaging information in Old Court's books in an emergency audit, and only six weeks before Old Court's collapse.
Jay FitzGerald, a member of the state's Board of S&L Commissioners, said Brown viewed thrifts' problems as unrelated to one another and not part of any pattern. "Once a problem went away, he just wiped it out of his mind," FitzGerald said.
One division employe said that if an examiner's report stressed problems at an S&L, "Brown would say, 'You're panicking' or 'you're overzealous. Things aren't as they look. Just because the loan is delinquent doesn't mean it's a bad loan.' "
The division employe recalled that just days before Old Court went under, LeCompte was telling staff members that Old Court "can work it out, they're very profitable. Try to keep the confidence up. We can handle it."
LeCompte has maintained that position even now. In an interview last month, he said Old Court never had "life-threatening" problems in its last months. LeCompte argued that if the press had not made Old Court's problems public in early May -- prompting depositor runs and the state takeover -- MSSIC and the division could have kept the thrift alive through quiet shifts in management.
Many in state government and industry would dispute that view. State examiners, who already had found damaging information about Old Court in a 1984 examination, returned in the first months of 1985 to find even more indications of its financial frailty.
Along the way, though, the examiners at Old Court continually were hampered by missing or incomplete files, state officials said. Many of the files they did find were in hopeless disarray, offering only fragmentary glimpses of Old Court's complex real estate portfolio.
A number of examiners were so disillusioned by the division, and so fearful they'd be blamed later for being lax, that they kept copies of their examination notes, according to S&L Commissioner Erwin and a division source. Preston's office has received these notes as part of its investigation, sources said.
The division was weakened by the fact that many of its 30 employes were so underpaid that they took second jobs. Most left after a few years, usually to work for S&Ls. One examiner hired by the division a few months ago, at a starting salary of $14,000, left after two days to return to the state agency he had quit, and another left recently after three weeks. Unsuccessful Lobbying Efforts
Year after year, Brown, MSSIC's Hogg and some S&L executives lobbied in Annapolis for more funds for the division, but they were unsuccessful.
"We could not be adequately examined by $12,000-a-year examiners," said Jerry Whitlock, president of John Hanson Savings and Loan of Greenbelt, in an interview. "The industry was supportive of bringing in sophisticated top-grade examiners, paying them right and letting them go in and do the job the way it should be done."
"The division was understaffed, undermanned and outgunned," said Second National's Berliner. "There were not enough people even to take care of branch applications, much less to go in and do an audit."
Hogg wrote letters to state legislators and key state officials in September 1984 saying that he "strongly" believed the division needed more funds for higher staff salaries.
Frederick L. Dewberry, Brown's boss as secretary of the parent agency, the Department of Licensing and Regulation, said that same month that he "personally will do everything possible" to raise division funding.
In Dewberry's view, there were other problems besides low pay at the division. Dewberry said Brown never once warned him that any Maryland thrifts were having serious problems.
Dewberry, a Maryland state government veteran, said that when he took over as secretary in July 1984, he visited Brown and other division chiefs and delivered what he called his "canned speech."
"Fred Dewberry's number one rule is no surprises," he recalled telling Brown. "I told everybody I want to know immediately as soon as you see any indication of serious problems developing."
Dewberry said that in response, Brown handed him a copy of his testimony, upbeat in tone, before a state legislative committee that summer. Brown also said his one concern about the S&Ls was that the industry had grown in size so rapidly, Dewberry said.
"That's absolutely the only indication I got from Charlie Brown about a concern he had," Dewberry said. "As far as any type of specific or even a generality about the problems, not one word."
Dewberry said he was shocked, along with Hughes and Sachs, when he learned in early May that Brown had not forwarded the damaging report on Old Court's troubles. Dewberry said he first saw the report at the Annapolis meeting where Sachs angrily questioned Brown.
"I went right through the floor," Dewberry said. "I leaned over to Charlie and said, 'What the ---- goes on here, Charlie? How come I haven't seen that letter? . . . I should have had that letter to the governor.' He didn't have an answer."
Dewberry's predecessor as department secretary, John J. Corbley, declined to comment.
Members of the division's other parent body, the Board of Savings and Loan Commissioners, said they also were shocked last spring by what they learned from division officials about the problem thrifts.
It wasn't until April 4 that the board received the first official details of Old Court's deep financial trouble. That warning from Brown and Hogg came almost two years after division examiners began detecting a number of abuses, and seven months after the division had a picture of Old Court's peril.
Nancy Erwin, a Baltimore housewife on the board, said the panel was stunned by what it learned about Old Court in that April meeting.
"I can remember thinking what a total shock this is," Erwin said. In the previous year, she said, Brown had made only vague references to Old Court. For a Few Hours a Month
The nine board members appointed by the governor, four members from the public sector and five from industry, met for only a few hours a month, and received $50 a month for their trouble. The board spent much of its time discussing the fine points of regulations, such as those on S&L advertising.
In executive sessions, the board sometimes discussed ways in which certain thrifts were violating a particular state rule. Board members never asked for detailed examination reports, and received only sketchy reports on the associations' financial condition.
"We never really had any in-depth report on the problem S&Ls," said Jay FitzGerald, an S&L executive on the board. "We had to rely 99.9 percent on the division staff."
When board members asked Brown about troubled S&Ls over the years, "we were told, 'There's no problem, [the S&Ls] have a handle on it.' "
"I've never seen an examination report," FitzGerald said. "I never had any occasion. We never had any time."
Board Chairman Gisriel, also an S&L executive, said damaging information about thrifts bubbled up to Brown, but stopped there.
"We asked specific questions, and no one would volunteer any information to us," Gisriel said. "Charlie Brown and Charlie Hogg didn't tell us what they found."
It wasn't until two months ago that board members, interviewing division employes for a successor to Brown, learned that examiners had been reporting S&L abuses for about two years. Erwin said board members were stunned by that news too.
"You felt, 'What was I doing here?' " she recalled. "Later, I was walking around the house saying, 'Why?' . . . Obviously, there was some breakdown in the system."
"You feel kind of stupid, saying, 'Gee, maybe we should have known,' " FitzGerald said. "But I don't know how we could have. The whole thing snuck up on us."
The state attorney general's office also was taken by surprise, for a variety of reasons.
First, division and industry officials were always leery of sharing sensitive information with Attorney General Sachs, who they viewed as an overly zealous prosecutor with political ambitions. Brown may have believed Sachs would be ham-handed in dealing with industry problems, Assistant Attorney General Pugh said.
"Charlie Brown viewed Steve Sachs as a person who was capable of taking action that maybe Charlie Brown would consider precipitous . . . and that he would create a run," said Pugh, chief counsel to the Department of Licensing and Regulation.
Sachs also never heard any warnings from another state lawyer at the licensing and regulation department, Assistant Attorney General John C. Cooper, who had responsibility for the division and the S&L board.
Cooper estimated he spent an average of one day a week on savings and loan matters, splitting his remaining hours working with the Maryland Racing Commission and agencies overseeing cosmetologists, barbers, certified public accountants and hearing aid dealers.
Moreover, Cooper, Pugh and Pugh's deputy, Robert deV. Frierson, did not see themselves as regulators as much as lawyers for regulators. Assistant attorneys general at state agencies spend most of their time giving officials advice on legal issues and ensuring that rules and regulations comply with the law.
Cooper said he saw himself as a legal resource for the division and board, available to review regulations, new thrift charters, and other matters for compliance with state law.
Cooper said he was generally aware of financial problems in the U.S. savings industry and maintained a file of clippings on the subject. But he said he did not learn of the large number of serious violations by Old Court until April of this year, when the Board of S&L Commissioners did.
Sachs said he regrets Cooper's failure to probe beyond the narrow confines of his official duties as counsel, and accepts his share of the blame for that.
"Do I wish he had come to me and said, 'Hey boss, this is none of my business but . . . ?' You bet I do. . . . Cooper could have been more aggressive. But context is very important, and what his responsibilities were need to be understood. . . . I wish he had taken a more ambitious view of his responsibilities. But he didn't -- and that's my responsibility and I don't walk away from it."
While Sachs accepts some responsbility, Gov. Harry Hughes, the state's chief executive, has not done so. Hughes said he and his staff also were taken by surprise, and had to grapple with the problem only after it was too late.
"At no time did anybody ever bring this problem to my office as a crisis, until after it all hit in May," Hughes told reporters in late October. "Throughout all the months of March and April and even before, we were being reassured that we did not have the problem that was prevalent in Ohio and the savings and loan industry in Maryland was sound."
But a trusted advisor to Hughes did warn the governor of severe problems in the industry as early as October 1984. Letter From a Trouble-Shooter
On Oct. 5, 1984, Baltimore lawyer George W. Liebmann wrote the governor a four-page memorandum that warned of dangerous "self-dealing" by several "high-flying" thrifts. Liebmann, a corporate lawyer, ran Hughes' transition team when the governor entered office in 1979 and was an administration trouble-shooter until earlier this year.
Liebmann's memo mentioned no thrift by name, but was prompted by previous dealings the lawyer had with representatives of Merritt, Commercial and Old Court savings and loans, he said later. Liebmann wrote in the memo that the "extreme permissiveness" of Maryland law amounted to "a blank check" for S&Ls.
Hughes said he read the memo, then sent it down bureaucratic channels to Brown for comment. In his Nov. 21 reply, Brown agreed with Liebmann's main concern, saying "insider loans . . . should be prohibited altogether."
But Brown also suggested that the industry was sound and protected by a "very dedicated" MSSIC board that oversaw the industry "very closely."
Neither Liebmann's memo nor Brown's reply "sounded enough alarm" to Hughes or his staff, the governor said.
Pugh, one of the most respected of Sachs' corps of government lawyers, also reviewed the Liebmann memo but said many of the concerns it raised were addressed by S&L legislation being prepared for the upcoming General Assembly session.
In the months since the crisis hit, Hughes has placed the blame for the debacle squarely on government regulators such as Brown and on S&L "high-rollers."
"Even a governor is human," Hughes said. "I don't think you can point the full blame on any person, including the governor."Staff writer Tom Kenworthy contributed to this report.