U.S. is liable for reneging on thrift deal Supreme Court says government must pay up to $10 billion

'A tremendous victory'

'89 law changed rules on thrifts enticed to save failing ones

July 02, 1996|By Lyle Denniston and Bill Atkinson | Lyle Denniston and Bill Atkinson,SUN STAFF

WASHINGTON -- The Supreme Court yesterday added some $10 billion to the taxpayers' bill for rescuing the savings and loan industry, ruling that the government must pay new damages because it broke its word to healthy thrifts that had agreed to salvage failing thrifts.

As of last year, the cost of bailing out the savings and loan industry after the crises of the 1980s had reached $140 billion. The new payments due from the federal government would add to that amount.

The court noted that the government had induced some thriving savings and loans to merge with failing thrifts by promising the healthy ones they could use favorable accounting methods. By a 7-2 vote, the court said the government breached those contracts in 1989, when Congress passed a law to reform the industry. That law barred further use of the accounting techniques, thus wiping out the inducements.

"The government undertook an obligation that it subsequently found itself unable to perform," the court said.

If thrifts deserve no damages for having lost the benefits the government had used to entice them into taking over the failing institutions, "it would have been madness for [them] to have engaged in these transactions," Justice David H. Souter wrote in the main opinion.

The court found nothing wrong with the 1989 law, saying Congress was free to change the way thrifts are regulated and that thrifts must obey that law. But, the court went on, the government had assumed the risk that changes in the law might prevent it from fulfilling its earlier guarantees, and thus public money must now be used to make up for its breach.

The court did say there was clear evidence that Congress passed the 1989 law so as to avoid the government's contract promises. The court stressed that the government could not be excused from paying damages for promises broken.

The court conceded that its ruling might "deter needed government regulation by raising its costs" but added that "all regulations have their costs," and, besides, Congress itself has indicated that the money would be forthcoming to pay off the thrifts.

"It is a tremendous victory," said Ronald Glancz, a banking and savings and loan attorney with Venable, Baetjer and Howard in Washington. "It is a great day for shareholders of these institutions. They are the ones who suffered the losses at the hands of the government."

The ruling came in a case involving three thrifts. All had been healthy, but two of them went under after the 1989 law's stricter financial obligations took effect and made them insolvent. The -- third stayed afloat by receiving an infusion of private money.

Some language in the court's main opinion indicated that the justices were dealing not only with the thrift industry but also with other industries that are heavily regulated. The ruling seemed to indicate, however, that the government could protect itself from escalating damage claims by writing its contracts more carefully.

The court sent the thrifts case back to lower courts to calculate how much damages the government must pay. In taking the case to the Supreme Court, the Justice Department said all pending cases involved about $10 billion in breach-of-contract claims.

The case involved deals that federal thrift regulators made with some financially sound institutions to persuade them to absorb those about to go under. The government did not have enough money in its deposit insurance account to pay off depositors if all the weak thrifts went under. So it turned instead to a plan to induce the stronger ones to merge.

In return for the stronger thrifts' assumptions of the failing ones' obligations, the government allowed the absorbing thrifts to adopt "accounting gimmicks," as the court labeled them, that sweetened the bargain for them. The key inducement was to let the thrifts carry an allowance for "goodwill" on their books to reduce their obligation to keep a set amount of capital in reserve.

The largely paper transactions that resulted were, as Thurman Connell, a former official of the Atlanta Federal Home Loan Bank, told a lower court, the "kind of engine that made this transaction go. Because without it, there wouldn't have been any train pulling out of the station, so to speak."

Those deals, however, were insufficient to shore up the industry. So Congress in 1989 enacted the Financial Institutions Reform, Recovery and Enforcement Act. That law nullified the accounting alterations that the takeover thrifts had been promised they could use for years to come.

Scores of thrifts then sued the government, claiming breach of contract. Ninety of those cases are pending in lower courts.

About one quarter of the thrifts that sued are no longer in business, said William Fulwider, a spokesman for the Office of Thrift Supervision, which regulates the nation's 1,416 S&Ls that have $762.9 billion in assets.

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