Watchdogs for the Bankers


Contrasted to the federal government's lax and lacklusterregulation during the Reagan years, the state governments of the '80s were looking like regulatory Rambos. In they charged -- attorneys general and state regulatory agencies cracking down on monopolies, deceptive advertising, dangerous toys and chemicals, consumer fraud and much more.

But if we're to take a clue from the Rhode Island deposit-insurance debacle which broke in January, the states missed a beat -- a pretty big one. It's not that they weren't forewarned. In 1985, scores of non-federally insured banking institutions went belly-up in Ohio and Maryland. The private firms that had supposedly insured them simply couldn't cover the losses and failed themselves.

In both Ohio and Maryland, the state government itself felt obliged, morally if not legally, to step in and cover hundreds of millions of dollars of losses depositors had experienced. The warning was clear, and Virginia, Connecticut, Wisconsin, New Mexico and Utah moved to forbid either banks or credit unions from relying on privately run insurance funds.

But many states made no change. Among them was Rhode Island, which allowed a private insurer, the Rhode Island Share and Deposit Indemnity Corp., to continue insuring deposits in 35 credit unions and 10 state-chartered banks. Late last year it transpired that some $13 million had been embezzled from a Providence-based credit union, the Heritage Loan and Investment Company. The president, a politically well-connected figure in Rhode Island, is wanted for allegedly embezzling the funds.

Depositors made a heavy run on Heritage and other Rhode Island institutions that lacked federal insurance. The private insurer was soon out of reserves, and out of business. Just after his inauguration January 2, Gov. Bruce Sundlun, a Democrat, was obliged to call a bank holiday. Federal insurance was arranged for as many state-insured credit unions as the federal government's National Credit Union Administration would accept.

But Rhode Island was left holding the bag for the rest, including 11 of the state's largest credit unions, which had assets of $1.13 billion. They couldn't get coverage and stayed closed.

Gross negligence? It seems so. As early as 1985, a former director of criminal investigations for the Rhode Island attorney general's office reportedly warned Gov. Edward DiPrete, a Republican, of weaknesses in the private insurance company, and of connections between Heritage and organized crime. It turned out the president of Heritage was vice chair of the insurer, which hadn't audited Heritage for three years -- despite law requiring that it do so every 15 months. Evidence of the missing money was discovered last July but not reported to the state government until November.

A state can hardly just walk away from such a fiasco. Many of the depositors are blue-collar people, often of limited means with most or all of their life savings invested. Rhode Island quickly decided it would have to cover the depositors in Heritage and all other institutions that went under as Rhode Island Share and Deposit Indemnity sank. The total cost will be between $150 million and $1 billion -- in a state already facing a $162 million deficit in its $1.5 billion budget for this fiscal year.

Where, all this time, was the state's Department of Business Regulation? Where was the governor, when he received warnings? For that matter, where were the state legislators, the banking and insurance committees that should have been exercising oversight? Asleep at the switch, or listening to their political friends. What other explanation can there be?

Even after the Ohio, Maryland and Rhode Island debacles, 21 states -- Pennsylvania, Massachusetts, California, Florida, Georgia, Washington and Tennessee among them -- continue to allow some forms of private insurance for credit unions and state-chartered financial institutions.

The states could easily switch and require federal insurance. Or Congress could simply order that deposits in U.S. currency be insured by a federal government agency.

There's some argument against "going federal." Irregularities among credit unions are still fairly rare. Some claim state regulation is tougher than federal. And after the sloppy performance of federal bank regulators in the '80s, who is to say federal regulators are any smarter or more vigilant than their state counterparts?

Ultimately, however, there's just one deep pocket: Uncle Sam's. No private insurer can conceivably be strong enough to sustain multiple losses. The politics say that we, the taxpayers, will end up paying for every bank and credit-union failure anyway. Consistent federal regulatory standards at least ought to be easier to maintain than varying standards in 50 states.

Federal or state, the bottom line has to be surgical separation between bank regulation and political influence-peddling. Washington forgot that in regulating savings and loans, Rhode Island with its credit unions. The result is invariably the fleecing of the people -- us.

Neal R. Peirce writes a column on state and local government.

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