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The Savings and Loan (S&L) debacle has been called the costliest financial disaster in U.S. history. According to recent reports, total losses are expected to exceed $200 billion.
Unfortunately, the federal government has tried to shift the blame for this fiasco to the accountants. The Resolution Trust Corporation (WTC) has been suing accountants and lawyers aggressively to recover some of the losses. Recently, the Big 6 accounting firm of Ernst & Young paid $400 million to settle multiple claims by the WTC, Federal Deposit Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS) arising over the last 10 years.
Ernst & Young Chairman Ray Groves said, "Every major accounting firm will remember the S&L failures as a dark period for the profession." Further, "the situation was particularly unfortunate as the firms became scapegoats, while the real culprits were deregulation, tax laws, collapse of the real estate markets, and inadequate regulatory supervision."
THE REAL CULPRITS
Many articles in the popular press have blamed accounting fraud as a prime cause, although fraud accounts for only 3% of total losses. More careful analyses reveal that the crisis was caused by:
* The deregulation of the S&L industry and the encouragement of highly leveraged investments by the S&Ls.
* The decline of the real estate market nationwide.
* The decline of the high-yield bond market.
* The federal government's inept handling of the crisis through implementation in 1989 of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).(1)
In addition, it should be noted that during the late 1970s and early 1980s many S&Ls were in trouble already and never recovered. Their problems were caused by rapidly rising interest rates on deposited funds and locked-in low interest rates on loans. Thus, many S&Ls had a negative spread between the asset yields and the cost of funds that caused both a negative cash flow and a decrease in the value of the loans (the primary assets of the S&Ls). These decreases in S&L net worth prompted the adoption of some of the accounting methods discussed here as a means of keeping the S&Ls above government mandated minimum capital requirements.
RAP VS. GAAP
I believe a major mistake accountants made was to follow regulatory accounting principles (RAP) that were not in...