Costly breach of contract S&L debacle: Supreme Court says U.S. must pay for changing thrift takeover rules.

July 13, 1996

A CONTRACT IS a binding agreement. Yet Congress ignored this basic legal principle in 1989 when it rushed to clamp down on shaky savings and loans and ended up changing the ground rules affecting earlier takeovers of failed S&Ls.

Congress not only wiped out wobbly S&Ls but also many healthy ones that had -- at the government's urging -- bought insolvent thrifts in exchange for favorable accounting rules.

You can't alter terms of a contract in mid-stream, the Supreme Court declared. Congress' blunder could cost taxpayers up to $20 billion to compensate S&Ls that failed or were badly damaged after Congress altered the S&L rules, turning assets into liabilities overnight.

Congress had every right to revamp the law, said Justice David Souter for the court, but Washington is liable for damage caused by altering existing contracts. No healthy S&L would have taken over insolvent thrifts knowing the government could well cancel accounting gimmicks that made the deal worthwhile.

Take the case of Glendale Federal. Regulators asked it to buy a failing thrift, bad debts and all, in 1981. In exchange, Glendale received $750 million in "regulatory goodwill" -- an accounting device to make the deal viable. Without it, Justice Souter said, the deal would have been "irrational." Indeed, after Congress later wiped out "regulatory goodwill," Glendale had to sell assets and raise capital to survive.

Regulators didn't have the money, and Congress didn't have the will, to shut down floundering S&Ls in the early 1980s. Thus, the accounting gimmicks. When President Bush decided to end this subterfuge, he got Congress to change accounting rules -- but this altered S&L deals signed years earlier.

The federal government cannot renege on a contract, the court ruled. This decision could impact other government contracts because it will make it harder for Washington to change the rules of a signed agreement years later.

In retrospect, regulators shouldn't have used accounting tricks to get rid of failed S&Ls. But once these deals were consummated, Washington had to honor them. That's how a contract works, as Congress was reminded by the court. It was an expensive reminder.

Pub Date: 7/13/96

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