S&L staying a float--and it's not some magic trick
The nation's savings-and-loan associations have been practicing something close to levitation; most have been floating above bankruptcy despite the lack of visible financial support.
Money market mutual funds and other high-yielding investments have drawn tens of billions of dollars out of S&L passbook accounts. The value of the low-interest mortgages in their portfolios has dropped precipitously as interest rates rose to record highs.
Yet the value of stocks om shareholder-owned S&Ls has remained positive. Nor have association executives been fleeing the industry in droves.
What's been keeping the industry afloat?
Well, it's not magic.
Partly it is hope - the hope and now the realization of congressional rescue efforts. The tax-free All Savers certificate is basically a massive government subsidy to the thrift institutions and commercial banks. The United States League of Savings Associations estimates that over the next 15 months that they are available, a total of $250 billion will flow into these certificates. About half will be deposited in the nation's 4,600 S&Ls.
H. Erich Heinemann, an economist with Morgan Stanley investment bankers, points out that if the average certificate investor is in the 40 percent tax bracket and if the $250 billion would otherwise be put into taxable investments yielding 15 percent, the loss to the Treasury would be $15 billion. That's far above the Treasury's estimated loss of $3 billion. It could make the administration's efforts to balance its budget even more difficult.
Another economist, Edward J. Kane at Ohio State University, points to some other factors helpful to the S&Ls.
First, he notes in a paper for the National Bureau of Economic Research, only a small fraction of mortgage loans remain outstanding until maturity in perhaps 20 or 30 years; many are prepaid at par. Then the S&L can use that prepaid money to make new loans at higher rates. Nonetheless, the average return on S&L mortgages was only 9.18 percent per year in the first half of 1980, and that average rises only slowly.
Second, S&Ls have unrealized capital gains in their branch office real estate. Also, today's high nominal interest rates mean that the book value of S&L certificate and nondeposit liabilties is overstated. This is the opposite of the case for antiquated mortgages, where S&L books overstate the value of these assets.
Third, Mr. Kane points out that S&Ls are already paying more for their deposits than the ''explicit'' interest rates on them. They have had to close the interest rate gap with financial competitors by giving ''implicit'' interest payments, such as merchandise premiums and subsidized account services. NOW accounts, for instance, often offer free or cheap checking privileges. Further, S&Ls expanded their costly branch office system enormously to keep and attract accounts. Customers were paid in convenience instead of interest.
Kane maintains that the biggest buttress to the S&L industry has been Federal Savings and Loan (FSLIC) insurance, not the extra 0.25 percent interest that S&Ls can pay on savings deposits as compared with what commercial banks can offer on similar deposits. This insurance, he argues, makes it possible for savings-and-loans to operate with little capital of their own because of the removal of much risk. Moreover, the out-of-pocket cost of that insurance is the same whether an S&L has a poor capital structure or a more adequate structure. This tempts S&Ls to operate with the minimum capital requirements demanded by the FSLIC.
Professor Kane finds that one cost of this system is that S&Ls tend not to dump their low-interest mortgages and take the losses because this would make their capital too low to qualify for FSLIC insurance. Otherwise, such losses could be taken and written off against income taxes. So S&Ls pay more taxes than they would need to if free to take losses. Kane terms this an ''implicit fee'' for federal insurance. Between 1965 and 1979, the S&Ls in effect transferred 2. 54 percent of their assets to the United States Treasury, he estimates.
''Had they retained these funds and invested them advantageously, their current condition would be less strained,'' Kane writes.
Because the value of S&L mortgages has in fact gone down badly with rising interest charges, the value of federal insurance has increased dramatically, becoming an even better bargain.
Because of this bargain and the other mitigating factors cited above, Kane figures the S&L industry is not in as bad shape as the simple statistics on book values might indicate. Moreover, now that interest rates are coming down, financial pressures may ease more.
Nonetheless, in a telephone interview, Mr. Kane suggested that the S&L industry will remain ''sick'' for some time. He expects the industry to undergo many mergers as the weaker S&Ls are taken over by other institutions. He would like to see Congress pass legislation allowing commercial banks to buy out S&Ls, including across state borders.
''Geographic restrictions on banking markets tend to insulate managers of inefficient institutions (especially mutual ones) from the discipline of takeover pressure,'' he states. ''They simultaneously limit the sellout options available to stockholders of inefficient institutions.''
Kane also approves the recent move of federal regulators to raise the ceiling on passbook interest rates more quickly. These ceilings are by law to be removed entirely by 1985. The thrift industry, he reckons, will become more competitive with other financial institutions by being able to offer market interest rates. Thus he was disappointed when Treasury Secretary Donald T. Regan last week urged delay in raising so-called Regulation Q ceilings.
Indeed, Kane fears that the powerful thrift and housings industries will successfully pressure Congress to extend the All Savers certificate beyond the scheduled 15 months. That, he maintains, would be a mistake, harming the S&L industry in the long run by allowing it to remain uncompetitive.