We Were Regulators Once: Ed Gray’s Finest Hour

We Were Regulators Once: Ed Gray’s Finest Hour
William K. Black
April 2, 2012


On April 2, 1987, four U.S. Senators met secretly with Federal Home Loan Bank Board (Bank Board) Chairman Edwin J. Gray in the offices of Senator DeConcini (D.AZ).  Senator Donald Riegle (D. MI) was a surprise no-show.  DeConcini was joined by Alan Cranston (D. CA), John Glenn (D. OH), and John McCain (R. AZ).  Keating hired Alan Greenspan as a lobbyist to help recruit the Keating Five.  The Senators held the meeting at the request of Charles Keating, who controlled Lincoln Savings (a California chartered S&L).  Lincoln Savings would become the mostexpensive failure of the S&L debacle due to Keating’s political cronies and Keating became the most infamous S&L fraud.  A week later, on April 9, all five Senators met with four of Lincoln Savings’ senior regulators.  I took the detailed notes of that meeting.  The Senators became infamous as “the Keating Five.”  A quarter-century later, few remember what the meetings involved.

The purpose of the April 2 meeting is known from contemporaneous documents prepared by Keating, the Senators, and their staffs.  The Bank Board’s examiners based in San Francisco had discovered the largest violation of our rules in our regulatory history.  Lincoln Savings had violated the direct investment rule by over $600 million.  Its managers tried to hide the violation from the examiners by forging scores of documents and hundreds of signatures.  Direct investments of this magnitude were always fatal (not because they were inherently so much more risky than lending, but because they were ideal “ammunition” for S&L accounting fraud.  Under Gray’s leadership, the agency was certain to take enforcement action against the violation and was likely to take over the S&L, remove Keating’s control, and sell the S&L with financial assistance from the S&L insurance fund (FSLIC).  This would lead to Keating being sued and prosecuted.  It would also end the lucrative political contributions that Keating was famous for providing to politicians.  The Keating Five were among the largest recipients of those contributions.

Keating explained to the Senators that if the Bank Board took enforcement action against the massive violation it would doom his control.  He asked them to convince the agency to take no enforcement action.  He asked them to broker a deal.  In return for immunity from enforcement actions Lincoln Savings would begin to make home loans.  (The “deal” was really naked political extortion, so Keating offered only a trivial quid pro quo.)  Keating knew that Gray’s term would expire on June 30, 2007 and that the Reagan administration had entered into a cynical political deal with Speaker of the House, Jim Wright, Jr., not to reappoint Gray.  The key statutory provision allowing the agency to appoint a conservator for state chartered S&L like Lincoln Savings had also expired.  The bill to recapitalize the FSLIC insurance fund (FSLIC Recap) had a provision restoring the agency’s full conservatorship powers.  Keating’s deployed the Keating Five in order to threaten the stall the FSLIC Recap bill.  If Keating could help stall the passage of the FSLIC Recap bill for only a few additional weeks he could block any action by Gray.  Keating and the Senators had reason to be confident that Gray would give in to the pressure.  The agency’s preeminent legislative priority was the passage of the FSLIC recapitalization bill (“FSLIC Recap”) that would give the agency the funds to close more of the worst frauds.  In March, we suffered a severe defeat in the House of Representatives on the size of recapitalization and the addition of provisions designed to gut our supervisory, enforcement, and closure powers.  The Senate was our only remaining hope.  Alan Cranston was the ranking Democrat on the Senate Banking Committee and Riegle was widely (and it turned out accurately) considered to be the likely next chairman of that key committee.  Cranston helped Jim Wright, Jr., then House Majority Leader (and imminent next Speaker of the House); kill the FSLIC Recap bill in 2006.  Cranston helped kill the bill at Keating’s request – a single senator could put a secret “hold” on a bill.  Gray had every reason to fear that the Keating Five could and would cripple the FSLIC Recap bill if he refused to accept the deal the Senators proposed.  Keating, in a prior meeting with the senior Treasury official managing the FSLIC Recap bill, threatened to use his influence over “five Senators” to harm the bill.  (To his credit, the Treasury official responded to the threat by throwing Keating out of his office and instructing the Treasury guards to bar him from entering the building.)

One of the Senators’ staffers alerted the Senator that Keating was trying to achieve through the Senators’ pressure what he had tried to achieve through his “mole” – Lee Henkel.  Keating’s political contributions to President Reagan and his recruitment of the Keating Five gave him exceptional influence with the administration.  He used that influence to get the administration to appoint Henkel as one of the three members of the Bank Board.  Henkel was Keating’s tax lawyer, a borrower from Lincoln Savings, and a partner of Lincoln Savings on a (bad) direct investment.  If we took enforcement action against Lincoln Savings’ violation of the direct investment rule Henkel would have been bankrupt.  Henkel, therefore, recused himself from matters in which Lincoln Savings was involved.  The government ethics attorney that drafted his recusal also represented Lincoln Savings.  Henkel proposed an amendment to the direct investment rule that had been drafted by Lincoln’s lawyers.  It was crafted to immunize Lincoln Savings from enforcement actions for violations of the rule.  I blew the whistle on Henkel and he resigned.  His resignation was covered in the press on April 1 – the day before the meeting with the Senators.  The Senators knew that Keating was using them because his earlier unethical efforts to gain immunity from enforcement had failed once they were exposed.

Gray had no counter-leverage against Keating’s use of the Senators and Keating’s threat to use them to block the FSLIC Recap bill.  Gray’s negotiating position was hopeless.  Keating and the Senators must have been confident he would cave.  Instead, Gray had his finest hour.  He said no to the deal.  He declined to get into a debate about Lincoln Savings, saying that he regulated 3000 S&Ls and that if the Senators were really interested in the facts they should meet with Lincoln Savings’ field regulators.  This called the Senators’ bluff.  They claimed that they were seeking the facts, so if they failed to be briefed by us (Lincoln’s field regulators) their position would become untenable.

Meeting with us, however, threw away their carefully crafted tactical advantages.  Gray was instructed by DeConcini’s office to come to the April 2 meeting with no staff.  The Senators excluded their staffs from the April 2 meeting.  (Both actions are rare, even in national security briefings.)  The tactical goal was to make sure that it was the word of five, united, Senators (from both parties) against one regulator accused of being vindictive towards Keating.  The Senators’ version of facts was sure to prevail.  The ability to cover up the true nature of the meeting was important given the unprincipled nature of the meeting – preventing enforcement action against an unprecedentedly large violation of rules that always proved fatal to the S&L.

The four Senators who attended the April 2 meeting lied about the meeting once it became public.  They smeared Gray, claiming that his accurate description of their proposing Keating’s deal at the April 2 meeting was the delusional ravings of a failed regulator engaged in a vendetta against Keating.  Their denials (except for Senator McCain’s) were redolent with contempt for Gray – the only honest man in the room at the April 2 meeting.  None of them ever had the integrity to apologize to Gray for their lies and smears.

The Senators again proposed Keating’s proposed deal at the April 9 meeting.  There were four of us to witness their statement and my notes of the meeting (which each of the Senators agreed were accurate) confirmed their statements.  Investigation revealed that DeConcini made his April 2 presentation proposing the deal from a “cheat sheet” prepared by his staff that was a synopsis of Keating’s proposed deal in one of his memoranda to the Senators.

Unfortunately, both the Keating Five got away with their lies about the April 2 meeting and their lies and smears about Gray.  Far worse, however, was the fact that Keating’s “extortion by politicians” proved successful with Gray’s successor, M. Danny Wall.  Wall was Senator Garn’s banking aide.  Keating used the Senators to add to the political pressure on Wall.  Senator Cranston arranged a late afternoon meeting in January 1988 between Keating and Wall.  Senator Glenn arranged a luncheon meeting the same day that put together Speaker Wright, Keating, and Glenn.

Wright followed up the lunch meeting by inviting Keating to join him and his staff in his House offices.  Wright dominated both meetings with Keating, demanding that Keating sue Gray and me and take every effort to get me fired.  Keating, of course, was only too happy to oblige.  At the late afternoon meeting with Wall in January 1988, Keating began the meeting by emphasizing that he had just come from a meeting with Speaker Wright and stating that Wall and the agency would get along with the Speaker far better if Wall dealt with “a red-headed lawyer in San Francisco” (me).

Immediately after that meeting, which showed Wall that Keating had the support of the Keating Five and Speaker Wright, Wall instructed his staff to reach “an amicable resolution” with Keating.  Keating, of course, had all the leverage under these instructions and he insisted that Wall enter into an abject surrender.  The Bank Board removed our jurisdiction over Lincoln Savings when we refused to withdraw our recommendation that the agency take over Lincoln Savings.  It entered into an agreement that was, in essence, a “cease and desist” order against the agency.  All of these actions were unprecedented.  Freed of any effective supervision, Lincoln Savings’ frauds expanded rapidly and it became the most expensive S&L failure during the debacle.  Wall refused to take any enforcement action against Lincoln Savings’ violation of the direct investment rule.  Keating’s use of the Keating Five and Speaker Wright to extort Wall was a spectacular tactical success.  Note that Senators Cranston and Glenn and Speaker Wright continued to carry Keating’s water nine months after we informed the Senators at the April 9, 1987 meeting that Keating was directing a criminal enterprise involving backdated documents and forgeries.

The Senate ethics committee knew that the Senators had lied about the April 2 meeting and smeared Gray.  Their response to the lies and the smear was to engage in an even greater smear.  The Democratic Chair of the Committee claimed that the regulators had entrapped the Senators.  The Committee appeared to believe that it was routine and fine for Senators to knowingly lie and to smear their honest critics.

Ed Gray’s reregulation of the S&L industry prevented the debacle and the frauds driving the debacle from growing to the point where they would have caused a severe recession.  He paid an enormous personal cost for his actions, which saved roughly a trillion dollars.  He was left unemployed and unemployable.  Gray predicted in the mid-1980s that this would be his fate.  Ed Gray, however, does not have to avoid mirrors.  He would take the same actions again.

We were regulators once, and we served the nation.  The irony is that it was Ed Gray who saved Ronald Reagan from ignominy. But for Gray, Reagan’s deregulatory policies would have produced a financial catastrophe.  Reagan famously claimed the scariest words in the English language are “I’m from the government, and I’m here to help you.”  Millions of government employees serve this nation.  Hundreds of thousands of them routinely risk their lives for people they do not even know.  They are, in fact, here to help you when you are most in need of help.  That fact isn’t scary; it is a vital part of why America became such a great nation.

As regulators, one of the paradoxes we always found disconcerting was that the extreme right praises public employees if we wear uniforms and demonizes us if we wear other forms of work clothes.  I propose that the regulatory agencies adopt “uniform of the day” rules.  We can all wear our khaki uniforms with pride and the EPA’s regulators can earn their chevrons by enforcing the laws bravely against Chevron.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

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