In found success in law, and in 1952 helped

Inthe late 1980s and early 1990s one of the largest financial scandals of alltime took place.  The primary nameassociated with the scandal was Charles Keating.  Five U.S.

senators, Alan Cranston ofCalifornia, Dennis DeConcini of Arizona, John Glenn of Ohio, John McCain ofArizona, and Donald Riegle of Michigan played a significant role in thescandal.  All five senators wereassociated with the Democratic Party aside from Republican, John McCain.   The industry at the center of the scandal wasthe savings and loan (S&L) industry. An S&L institution, also known as a thrift institution, providedmortgages and other loans, and accepted savings deposits.

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  Unlike their similar counterpart, commercialbanks, savings and loan companies were not managed by a board of directors butwere rather managed by the institution’s borrowers and depositors.              Charles Keating, the man at thecenter of the scandal, wore many hats over the course of his professional life,a financer, lawyer, banker, real estate developer, and activist, were only afew.  In 1948 Keating graduated lawschool at the University of Cincinnati College of Law.  Keating went on to marry and had six children.  Upon graduating Keating found success in law,and in 1952 helped found the Cincinnati law firm Keating, Meuthing .  Several years later in 1960Keating met Carl Linder, Jr.

, a successful businessman in the dairy industry.  Keating and Linder founded American FinancialCorporation (American).  American was a holdingcompany of financial instruments.  By1972 Keating had left the world of corporate law and joined American fulltime.  During the years of 1975 and 1976American faced several lawsuits brought by stockholders.  Accusations ranged from American engaging inunsecured loans to a suspicious $14 million loan from the Securities andExchange Commission (SEC).

  Shortly afterthis, in 1976, Keating resigned from the corporation.             Following his resignation, Keatingmoved to Arizona to purchase a struggling real-estate firm, AmericanContinental Homes.  The purchase was partof his resignation deal.  Keating foundgreat success in his new venture, American was making millions by the early 1980s.

  Keating maintained his charitable naturethrough his newfound success, making substantial donations to religious andpolitical organization.  More than $1million was donated to Mother Teresa’s endeavors in Keating’s name.  In 1984 American purchased a thrift bank calledLincoln Savings and Loan Association (Lincoln) for just over $50 million.  Prior to the purchase Lincoln had not beenperforming well, slow growth had plagued the thrift bank for severalyears.  Keating made an immediate effortto remedy the company, firing management and giving the association a freshstart.              Prior to purchasing Lincoln theS industry had been facing two significant problems. During the late1970s and into the early 1980s the S industry faced an increase ininterest rates and an increase in inflation rates.  In an effort to address these problems theindustry decided to decrease regulations.

 An article from the Cato Institute,headquartered in Washington, D.C., described the deregulation response thatS’s chose to take, “overregulation had bankrupted the industry; it waslogical to expect that greater freedom would enable S&L owners and managersto improve their financial health. Unfortunately, policymakers overlooked onecrucial step- recapitalization” (England, 38). Recapitalization is used in aneffort to increase the stability of a firm’s capital structure.

  For example, a firm may reshape the makeup oftheir debt and equity to improve their overall liquidity. According to anarticle from The Federal Reserve History, “S&Ls primarily made long-termfixed-rate mortgages. When interest rates rose, these mortgages lost aconsiderable amount of value, which essentially wiped out the S&L industry’snet worth” (Robinson, 2).  Keating hadentered the S industry shortly after the deregulations.

  This allowed Lincoln to engage in risky investments,such as purchasing high-yield junk bonds, and taking risky positions in realestate projects, in an attempt to derive higher gains.  As a result of the deregulation Lincoln wasable to raise their assets from $1.1 billion to around $5.5 billion.  By 1985 the Federal Home Loan Bank Board (FHLBB)took action, placing a cap on the dollar amount that S could legallyinvest in these highly volatile instruments.

 According to a Time article, “aninvestigation into Lincoln Savings and Loan uncovered flagrant violations ofthese regulations, exceeding the limit by over $615 million” (Fetini, 3).  Lincoln had violated the cap that the FHLBBhad placed on highly volatile instruments. The S industry had overextended itself.  As high-risk loans went unpaid S’sbegan to go bankrupt.  Around 23,000people lost more than a combined $200 million by purchasing AmericanContinental bonds, sold at the Lincoln branches.  For many people this was their lifesavings.

By1987 Keating was seeking out past and current friends who had political powerin the industry.             It was at this point that the “KeatingFive” entered the picture.  The “KeatingFive” consisted of five U.S. senators who had all, at one point in time, had amutual relationship with Keating.

  Eachsenator had received a considerable amount in the form of campaign donationsand gifts from Keating, according to Fetini, Keating donated “close to $1.4million dollars in total” (Fetini, 4) to the campaigns of the fivesenators.              First there was Alan Cranston,senator of California.  Despite theirpolitical differences, Cranston and Keating formed a relationship over theirmutual interest in direct investment. During Cranston’s 1986 run for senator Keating contributed a last minuteline of credit in the amount of $300,000 for Cranston’s campaign.  In 1987 Cranston attended a meeting with Ed Gray,Bank Board Chairman, Glenn, McCain, and DeConcini regarding Keating and Lincoln’sproblems. Due to a battle with cancer Cranston was unable to testify on Keatingbehalf at the Senate Ethics Committee hearings in 1990.              Second was Dennis DeConcini, senatorof Arizona.

  DeConcini enjoyed Keating’sfriendship due to his political views. DeConcini was a democrat, therefore having Keating, a republican, as afriend helped him to appeal to more voters. During DeConcini’s 1982 campaign hereceived around $20,000 from Keating and an additional $48,000 for his 1988 campaign.  DeConcini met with Gray, and regulators todiscuss regulations that were holding Keating’s Lincoln Corporation back.  DeConcini argued that a company should not beput under by its regulators and therefore regulators should work with Lincolnin an effort to keep the S&L afloat.             Third was John Glen, senator of Ohio.

  Glen and Keating did not have much of apersonal relationship aside from the fact that Glenn was born in Ohio and theparent company of Lincoln, American Continental Corporation, was started inOhio. Out of all five senators, Glen accepted the least monetary contributionsfrom Keating. That said Keating did pay off around $34,000 of Glen’s debt,acquired during his presidential campaign. Keating also made a donation in the amount of $200,000 to anorganization that Glen was a spokesman for, Political Action Committee.  Glen did not assist Keating politicallyhowever he did express dissatisfaction to Ed Gray regarding the DirectInvestment law.  Glen made it clear onseveral occasions that he was disappointed in Gray and his lack of information.  This was beneficial for Keating, as Gray wasone of his largest opponents in the case.             Fourth was John McCain, senator ofArizona.

  Of the four other senators McCainwas said to be the closest with Keating. Over the course of McCain’s various campaigns Keating donated over$112,600 and allowed McCain and his family to vacation at his Bahamasresort.  In addition Keating allowedMcCain to use American Continental Corporation’s private jet.  In 1987 began to McCain’s receive complaintsfrom the Arizona League of Savings and Loans Associations regarding the BankBoard’s policies.  Shortly after, McCainmet with Senator DcConcini to discuss these complaints, many of which directlyrelated to Keating and Lincoln.  DeConciniwanted to take the issue to Gray but McCain did not want to commit to ameeting.  Lincoln’s Vice Presidentrecommended that McCain meet with Senator Riegle and Gray, however McCain onlyagreed to meet with Riegle privately. Shortly after it was made aware to McCain that Keating had referred tohim as a “wimp” when talking with Senator DeConcini.

  After this the friendship between Keating andMcCain ended.  In April of 1987 McCainattended a meeting with Gray and the four other senators.  He claimed that he attended this meeting notfor Keating, but for the thousands of jobs that ACC provided in Arizona.  Upon receiving information related to thecriminal action of Keating McCain stopped all contact with Keating and returnedall the donations and gifts that Keating had given to him.  In the end McCain testified againstKeaton.  McCain was the only senator whoagreed to testify.              Fifth was Donald Riegle, senator ofMichigan.  Keating was connected toRiegle through an investment that Keating had made in Riegle’s state,Michigan.

  Keating made a $37 millioninvestment in the Ponchetrain Hotel. Riegle first met Keating in 1985 at the opening of the hotel.  Later in Riegle’s political career Keatingheld a fundraiser for him at the Ponchetrain Hotel, raising around $30,000.  A few weeks later Riegle returned the fundsafter a newspaper story connected them to his recent meetings withKeating.  Riegle was invited by McCainand DeConcini to attend a meeting with regulators.  After attending the meeting Riegle broke off contactwith Keating and Lincoln.  In the endRiegle claimed that he could not remember the conversations that he had withKeating in an effort to avoid responsibility.

            As a result of the S&L crisisThe Financial Institutions Reform, Recovery, and Enforcement Act of 1989(FIRREA) was enacted.  This act wasestablished in an effort to pay back depositors who had lost money due to thecrisis.  As of today, FIRREA aids theJustice Department in investigating poor quality loans.  When all was said and done the FHLBB found Keatingguilty of many violations.  By 1989 Americanwas bankrupt and the FHLBB seized Lincoln. Life savings evaporated and investors suffered complete financialturmoil. Keating attributed government regulators for the demise ofLincoln.

  In 1991 Keating was convictedof 17 counts of fraud.  It was at thistime that Mother Teresa, a recipient of Keating’s large donations, came to hisdefense.  Mother Teresa asked to courtsto take into consideration the millions of dollars of charitable donations thatKeating had gave.  In 1992 Keating wasgiven a 10-year prison sentence, the maximum possible.  Keating was given an early release afterserving four and a half years.             There were several parties who were atfault in this case.  First and foremostCharles Keating.

  Not only did Keatingbreak the law, Keating put the livelihood of thousands of American’s and theirfamilies in turmoil. Second, the five senators, Alan Cranston, DennisDeConcini, John Glenn, John McCain, and Donald Riegle, were at fault for theirrole in the collapse of the S&L industry. The senators acted unethically in advising the Federal Home Loan BankBoard to not pursue charges against Keating and his Lincoln S&L association.

  The senators felt as though they owed Keatingsomething for his lavish donations.  Finally,and perhaps most importantly, the system failed the S&L industry.  At the time necessary laws and regulationswere not set in place to ensure the security of the industry.  Preventing such an economic crisis is anextremely difficult task as regulators can never be sure how large a futuredefault will be.

  Currently, in an effortto come as close as possible to calculating potential defaults regulators usestatistical models.  During this time thereserve requirement also failed the S&L industry.  A larger reserve requirement could havepotentially reduced the impact of the scandal. That said, there is a trade off associated with raising the capitalrequirements.  An article from The Washington Post, explains that, “larger capital requirements reduceloan volume and raise interest rates” (Guttentag, 5).  Finding a balance between reserves andinterest rates is not an easy task and is constantly being assessed.              Researching the collapse of theS&L industry has made me more aware of the complexity of financial institutions.

  There is a constant balance that must beachieved between regulating the industry and allowing the free market to takeplace.  Charles Keating’s role in thecollapse industry has reminded me of the power that money has over people.  Keating may not have been an inherently badperson but under the control of money Keating made choices that ruined his ownlife and the lives of thousands of other Americans.  Senators, Alan Cranston, Dennis DeConcini,John Glenn, John McCain, and Donald Riegle have reminded me of the dangers ofpower, status, and control.  Again, thesemen may not have been inherently bad people but when faced with the decision tosupport Keating and his unethical investing practices in order to receive campaignbenefits all five men succeeded.  Afterresearching the unfortunately events that led up to the collapse of the Sindustry it is clear that there is much to learn.  Had society learned it’s lesson the financialcrisis of 2008 may not have been as severe or perhaps may not have transpiredat all.

  Today, the Federal Reserve hasrequired large banks to hold higher levels of capital.  Jack Guttentag, professor of finance at theWharton School of the University of Pennsylvania, argues that more advanced regulatorytools are need.  In his article,Guttentag suggests “We should take a hard look at applying the system used toregulate mortgage insurance companies to mortgage lenders. Under this system,lenders would be required to allocate a portion of every dollar they receive ininterest above some base rate to a reserve account that would not be touchablefor 10 years except in an emergency.” (Guttentag, 4).  Under this system as the interest rateincrease the allocation of funds to the reserve account would also increase.

  This appears to be a strong proposal.  In the future, developing more fittingregulatory tools to prevent or reduce the severity of future financial crisesmust be a priority.  Charles Keating andthe “Keating Five” have left us with an important lesson on the importance ofregulations, a system of checks and balances, and the flawed nature of mankind.