In 1986, executives of Silverado Banking, Savings and Loan, a fast-growing Denver thrift, told federal bank examiners that they had hired a less expensive firm to audit the books. But the new firm's report convinced the examiners that Silverado didn't want cheaper auditors, just more pliable ones.

The old auditors had said Silverado lost $20 million in 1985 because of problem loans. The new ones reported a dramatic turnaround for 1986: $15 million in profits and only minimal loan losses.

The brighter outlook delighted Silverado executives, who took home $2.7 million in bonuses out of the declared profits. But it bewildered the regulators, because real estate values that largely dictated Silverado's condition had fallen in 1986.

A year and a half later, when Silverado collapsed at a cost to the government now estimated at $1 billion, examiners discovered that Silverado executives hired the new auditors after those auditors sent a letter saying they agreed with Silverado on what could be counted as losses.

"This case appears to be a clear example . . . of opinion shopping," wrote the examiners, who termed the 1986 audit by Coopers & Lybrand, a New York-based firm, a "flagrant" failure. The firm's executives later told a congressional committee that its auditors had raised numerous "red flags" and correctly pointed up the factors that led to Silverado's downfall.

In the crazy, mixed-up world of savings and loans, the auditors were supposed to be the truth-sayers, who swept away puffery and illusion and laid bare the reality of a thrift's financial state. Many -- even most -- auditors hired by S&Ls upheld what the Supreme Court has described as their public duty to report an accurate financial picture.

But in some dramatic and costly cases, auditors acted more like magicians, who made profits materialize and losses disappear and held thrifts aloft in thin air. Misleading audits by top firms significantly boosted the cost of seven or more of the two dozen biggest S&L failures, according to independent studies, regulatory reviews and auditing experts.

"Some individual partners in individual firms look very bad," said Thomas R. Bloom, former chief accountant for the Federal Home Loan Bank Board, now a partner with the firm of Kenneth Leventhal & Co.

The result may be a shakeup of the accounting profession, affecting the way it is regulated, the responsibility it bears in reporting fraudulent transactions and the future prosperity of many firms.

The Securities and Exchange Commission has proposed that it oversee S&L audits instead of the Office of Thrift Supervision (OTS), arguing that it has more expertise in policing auditors than bank regulators.

The SEC also is pushing for an overhaul of auditing rules. And the House recently adopted a bill that would increase auditors' responsibility to report fraud and evaluate a company's internal controls, although because of a turf dispute between two congressional committees, the bill does not apply to auditors of banks and S&Ls.

"Elephants were walking through the living room and the accountants missed them," said Rep. Ron Wyden (D-Ore.), one of the bill's sponsors.

Most significantly, audit firms face the threat of massive civil judgments if the Federal Deposit Insurance Corp. (FDIC) or S&L investors can prove they were negligent. Few S&L defendants can match the liability insurance of audit partners, making them a prime legal target.

The FDIC and the former Federal Savings and Loan Insurance Corp. (FSLIC) have sued eight accounting firms, alleging that faulty audits hid the truth about insolvent S&Ls. Three defendants -- Arthur Young Co.; Deloitte, Haskins & Sells; and Touche Ross -- are grouped with the country's biggest firms, once known as the "Big Eight" and now called the "Big Six."

A spokesman for Ernst & Young, a new firm formed between Arthur Young and Ernst & Whinney, said Arthur Young's "audit services were performed in accordance with applicable standards." A spokesman for Deloitte & Touche, formed by the merger of Touche Ross and Deloitte, Haskins & Sells, said the firm is reserving its defense for the courtroom.

"Just because you have a business failure doesn't mean there is an audit failure," said Joseph F. Moraglio, a vice president of the American Institute of Certified Public Accountants (AICPA), the auditors' trade group. "Everybody is looking to point the finger and somebody said, 'Hey, by the way, the auditors were there. Let's blame them too.' "

In the gallery of S&L culprits, a prominent place is held by misguided government officials who decided to essentially deregulate the industry while expanding government insurance for deposits. But U.S. District Judge Stanley Sporkin, in an August decision involving Lincoln Savings and Loan of Irvine, Calif., set aside a spot for the auditors, asking: "Where were these professionals . . . ? Why didn't any of them speak up?"

Speaking up can carry quite a penalty for an auditor -- the client may simply fire the audit firm. At many S&Ls, audit firms tried to walk the line between keeping clients and forcing thrift managers into increasingly damaging admissions. Some thrift executives changed auditors nearly as often as they changed limousines.

Charles H. Keating Jr., Lincoln's owner, hired three audit firms in five years and met with both pliancy and resistance, even within the same firm. One Arthur Young audit partner issued two years of "clean" opinions, then went to work for Keating for $930,000 a year, according to congressional testimony.

His successor insisted that Lincoln reduce its figures for profit and income on certain deals. When she proposed that, she told a House committee, Keating responded: "Lady, you've just lost a job." Then he asked her boss to replace her. The firm stuck by its auditor, and Keating hired a competitor.

Auditors like to portray themselves as kind of the Gary Coopers of the business world -- terse loners, symbols of integrity. They work behind the scenes for weeks, even months, then pass judgment on the accuracy of a firm's financial statement in often no more than three short paragraphs. Any elaboration is reserved for footnotes.

Their opinions carry great weight, because although auditors are paid by corporations and financial institutions, their responsibility goes beyond the client to the public. "The independent public accountant . . . owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public," the Supreme Court ruled in 1984. "This 'public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust."

Auditors themselves, with the SEC's approval, establish the general standards that govern their behavior and the specific rules on how to figure profits and losses. Generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS) are a befuddling maze, but the controlling maxim is simple common sense. Auditors are expected to see through deception to the guts of a transaction.

In other words, as Rep. John D. Dingell (D-Mich.) told one regulatory official, if "you have something that walks like a duck, swims like a duck, has feathers and eats like a duck, it is a duck."

At the worst S&Ls, managers bent on hiding losses and fraud could make a duck appear to be something totally different. The industry also was changing quite fast, so a duck today might be a goose tomorrow.

But in a 1989 study, the General Accounting Office found that auditors for six out of 11 thrifts didn't really try to determine what was going on. "They didn't do enough work, period," said David L. Clark, author of the GAO report. The congressional watchdog agency referred Arthur Young, Deloitte, Haskins & Sells, and Ernst & Whinney to regulators and professional groups for possible disciplinary action.

How far off were the auditors? Answers are hard to come by, because the last audits sometimes took place as long as 18 months before the thrifts collapsed. But the last auditors should at least have noted "early warning signs," said William J. Crawford, former California S&L commissioner. "Not that many times do you fail suddenly."

Those signs were missing from audits of 29 of 31 California thrifts that failed. According to Crawford, the auditors issued "clean" opinions on financial statements that gave little hint of impending collapse.

The GAO's study showed the auditors certified $44 million in combined net worth for 11 thrifts. But five to 17 months later, regulators determined those same S&Ls were in the hole by $1.5 billion, the GAO said.

Audit firms rightly point out that the government itself masked the thrift crisis with its own accounting system, adopted for regulators. The government has now jettisoned "regulatory accounting principles" (RAP) as an ill-begotten attempt to prop up the industry.

Although auditors were bound by GAAP, RAP communicated a lack of respect for real figures, said Frederick D. Wolf, GAO's former head of accounting. "RAP sort of set a mood of laxity," Wolf said.

The firm of Arthur Young has borne much of the criticism of audit practices. Besides Lincoln, the audit firm vouched for the financial statements for two other infamous thrifts: Western Savings Association and Vernon Savings & Loan, both of Dallas. In each case, the audit work has been criticized by the GAO, federal regulators or independent audits sponsored by the government.

D. Jeffrey Hirschberg, associate general counsel for Ernst & Young, said: "Arthur Young stands by the audits it did for Western, Vernon and Lincoln."

At Vernon, state bank examiners uncovered $200 million in delinquent loans in June 1986 that Arthur Young auditors missed, according to Al Dermody, an assistant deputy district director with the Office of Thrift Supervision. When the government shut down Vernon in early 1987, 90 percent of its loans were delinquent, Dermody said.

An FDIC lawsuit alleges in part that Arthur Young auditors allowed Western's managers to maintain insufficient reserves in the event that loans turned bad, even though not one of the 200 biggest loans that came due in 1985 was paid off except with a fresh loan from Western.

At Lincoln, Arthur Young's first two audits were "proof positive that any thrift in America could obtain a clean audit opinion despite being grossly insolvent," said William K. Black, now senior deputy chief counsel for OTS, in testimony before a congressional committee last year.

One way Lincoln operated was to conduct transactions so that they canceled each other out but allowed the S&L to book a profit, according to a government-sponsored audit by Kenneth Leventhal & Co. The audit firm did not review or pass judgment on Arthur Young's work, but said its conclusions were very different.

Leventhal auditors found that Lincoln manufactured $135 million in profits on 15 transactions alone. This became clear, the audit firm said, once one understood that Lincoln was indirectly funding its own real estate sales by providing benefits, usually in the form of loans, to the buyers. In other words, cash went out one door in the form of a loan and came in the other door as payment for real estate, the auditors found.

The Leventhal report cited several hints that the profit figures were misleading. For one thing, Lincoln was selling barren desert land that studies showed would not be developed in this century. But some buyers were paying twice or three times the appraised value of the land.

Even if one missed the link between the loans and the real estate purchases, some of the loans were "risky beyond belief," a Leventhal auditor testified before a congressional committee. One investment firm received a $10 million loan, even though the firm had a net worth of only $30,000 and total assets of $87,000. The only collateral the borrower put up was the property it bought from Lincoln.

A common practice at other thrifts was to rename real estate investments as loans. The transactions in question were called acquisition, development and construction, or ADC, loans. Typically, ADC borrowers had little or no equity in the property involved and assumed little risk in taking out the loan. They put up no down payment. The S&L paid their loan points and fees. The S&L paid the interest on the loan for two or three years. In exchange, the borrower gave the S&L an interest in the development.

The trade group AICPA advised auditors to treat many such loans as investments, because thrifts were essentially shouldering the risk for a real estate project in expectation of a payoff down the road. But S&L executives successfully pressured some audit firms to label them loans, which did wonders for S&L profit and loss statements. The S&Ls could book the loan fees and interest as income, even though it was their own money. The show of income helped justify the executives' high salaries, bonuses and dividends, said Black of OTS.

"The overall impact of bad ADC . . . loans was that the thrift booked tremendous income from paying itself points and interest, while making highly risky loans with a tremendous danger of default, covering up the risk of default through an interest reserve, and creating strong incentives for the borrower to walk away from the project if any problems developed," Black told a congressional subcommittee.

The FDIC has sued Touche Ross and Deloitte, Haskins & Sells, largely over their treatment of ADC loans. At Beverly Hills Savings and Loan, Touche Ross auditors initially characterized ADC loans as investments, but switched after thrift executives altered the transactions somewhat and advised them a competing audit firm had a more liberal policy.

Deloitte, Haskins & Sells allowed Sunrise Savings and Loan in Florida to book $60 million in false income from ADC loans, federal regulators told a congressional committee in 1985. Had Deloitte auditors accounted for the transactions properly, it "would have hit at the very heart" of Sunrise and brought its risky lending "to a virtual halt," the regulators said.

Silverado's true condition was hidden under inflated appraisals for property purchased by the thrift or put up as collateral for loans, according to bank examination reports. Coopers & Lybrand accepted the appraisals, but bank examiners ordered new ones that forced officials to recognize $63 million in additional losses, the reports said.

Coopers & Lybrand also failed to force Silverado officials to confront how much they could expect to collect from collateral when loans became troubled, a mistake that hid $29 million in losses in 1986, the examiners said.

The FDIC, which filed a negligence suit against Neil Bush, President Bush's son, and 10 other Silverado directors or officers last month, is considering adding Coopers & Lybrand as a defendant, officials said.

Examiners said auditors from the firm's Denver office lacked the "expertise for this complex assignment."