My concern about the California data, as they stand right now, is that we have before us, in essence, only what would be called a univariate analysis. I don't know whether there may be other influences, other variables, which might be co-linear with direct investment, might be doing, have the same explanatory effect. I don't know enough right now. That's

what multivariate analysis is all about.

And so, on the basis of what I have

I'm not sure I know everything about the data.

I mean, I see what we have, but

MR. BLACK: And we don't disagree with any of them.

MR. GRAY: We're not disagreeing with you on that, but not at all-but here you have a state, in California, that has the most liberal direct investment law in the United States, and we, at least, looked at institutions with 5 percent of assets, or, in excess of 5 percent of assets in direct investments. I mean, I think it's very interesting I can't bring myself to believe that this is just a coincidence, when I look at this kind of material.

It seems to me, personally, to be rather compelling, particularly for an insurance underwriter, and particularly for an insurance underwriter that has a threshold -- not a limit, but a threshold that says you can exceed it anyway, if you come to the supervisory agent, and you request approval, and you meet the criteria that we're talking about. You know, this has been portrayed as some kind of limit. It is not a limit at all. And as I say, again, it is far, far more liberal than anything that they're talking about in our sister banking agency.

MR. QUILLIAN: Mr. Chairman.

MR. GRAY:

Maybe they know something we don't know.

MR. QUILLIAN: Mr. Chairman, if I may? I've been sitting here perfectly quiet. All of the discussion up to now has been supervisory, and economic analysis, and what-not, and comment about the insurance company. I must say that although this is not a legal point, I feel compelled to point out, that from my viewpoint at least, some of the insurance company analogy is well-taken, and some might be a bit of a stretch and not terribly helpful.

From the standpoint of the insurance analogy, you have pointed out, and it seems to me it's well pointed out and it's well to take into account, that we are in somewhat the situation of representing an insurance company whose existing obligations, contingent or otherwise, out-strip its resources on the order of at least five-to-one, maybe a good deal more. And so we are in a situation of trying to protect an insurance company which is indeed in a very fragile and precarious position. With respect to what an insurance company, another kind of insurance company, might do, one thing, of course, it might be able to do would be to cancel or not renew the policy. As you know, it is a very tedious procedure to go through, to cancel FSLIC insurance. It takes a long time and it's very difficult to accomplish.

And so unlike a private insurance company, we can't simply cancel or non-renew the policy. Another thing which a private insurance company could do, where the risk is excessive, or is perceived as excessive, is to raise the premium, and of course the FSLIC, in essence, did that awhile back by imposing the special assessment. But that's not really the same thing. That, as was said, we have, as you have pointed out again and again, what, in essence, is a group insurance scheme with the FSLIČ where all of the insured members pay the same premium regardless of the risk they impose on the system, and that premium, even with the special assessment included, is nowhere near enough income to cope with the burdens which the FSLIC has and is incurring; if our analysis is correct in large measure, certainly not in sole measure based on the additional risks that result from direct investment.

-

Mr. GRAY: Then I'd like to go beyond that. We are not talking about, here, money coming in from thrifts alone in premiums. We are talking about money that is insured by the United States, itself, and which the taxpayers have to stand behind, if there are not other means to deal with this problem, and, for that matter, recapitalize the fund. So, we're talking about institutions taking high risks, not on their own money as the figures show -- they are taking high risks on somebody else's money. the somebody else's money is involved in a loss, the ultimate somebody else's money is the taxpayers of this country, and the citizens of this country. And that's a little bit different from a private insurance company, since we're making comparisons.

And if

MR. HENKEL: Mr. Chairman, let me tell you, we're all in agreement on protecting FSLIC. I mean, all of us are dedicated to that.

MR. GRAY: Well, you know, the way you are dedicated to protecting FSLIC is to try to be a good underwriter. I mean, you know, you can't just say that "I'm interested in protecting FSLIC." I mean that--it takes actions, not just saying "I'm for protecting the FSLIC," and that's what we're here today to talk about. What are the actions we're going to take?

MR. HENKEL: I agree with that a hundred percent, but I'd like to pose this question. This direct investment reg was first passed January 31st, '85. The principal study we're talking about now, which tends to indicate increased thrift costs and failures was June or October of '86. We get contrary views now, and there's a big debate about whether direct investments do or do not cause failures.

I don't think we still know, and I pose the question: why didn't we start finding out January the 31st of '85, what really caused these things? Was it examination failure? Did we not close them quick enough? Did we not rout out the "bad guys?" Are direct investments indeed something we ought to stop completely?

MR. GRAY: Well, we're not talking about the reverse.

MR. PASSARELLI: One point you gotta keep in mind about the examination process, it's after the fact. I mean, these institutions already made their investments. They've incurred a risk, and the examination comes on after the fact. And then what has happened, these things mature, and when they mature, it's when the problem occurs.

MR. HENKEL: Oh, I understand.

MR. GRAY: Right.

MR. PASSARELLI: I mean that's the thing you gotta keep in mind. Everybody thinks about the examination/supervisory process as being the cure-all. It's not the cure-all because those people are operating. They operate independently. I mean, they perform, and based on the regulation, you realize they've got 10 percent of their investment in direct investments. That's a very large amount that they can invest in, and an institution can get those kind of investments, and when the examiner and the supervisory people get in there, those investments could actually not, uh, matured at the time to show the weakness that exists in those type investments. And I think you gotta keep that in mind.

MR. HENKEL: Oh, I understand what you're saying, but all I want to know is, what caused the problem? Was it crooks? Was it--you know--was it really direct investments? What was it?

MR. PASSARELLI: Well, basically, what you'll find out on all these cases is that they weren't properly underwriting, they didn't have the proper feasibility. I mean, lots of those things that you're going to recognize in this. That's what makes these high-risk type of activity. They didn't do the necessary underwriting that would actually provide the protection to the institution and to the FSLIC. In other words, these are after the fact, and the people who made these loans didn't prepare the necessary underwriting, didn't maintain proper records, they didn't do the proper inspection. They didn't do everything that's prudent. And I think that's the problem. And there's where the weakness comes about. Lots of these institutions, they think they can handle--like, for example, you talked about Sunrise. That institution came into existence--within three or four years, they became a million, four. In other words, that kind of activity

MR. GRAY: A billion, a billion four.

MR. PASSARELLI: I mean a billion, four. I mean, the whole point is this: with that kind of investment activity, you go in there, it's afterthe-fact. They've made their investments.

MR. GRAY: Well, I think there's another point here, too. If we are going to get the definitive study on everything, we'll be out of business long before we reach that point, and it'll be all an academic matter. Now let me say one other thing. It's interesting that we're talking about direct investments here because we're only talking about state-chartered institutions. We're not talking about federals.

Interesting that in 1982, when the Congress passed the Garn-St Germain Act, it did not increase the ability of federally-chartered institutions to make direct investments in excess of 3 percent of assets. And I will have to ask the staff, but it seems to me, that in terms of the kinds of losses that we have suffered in this fund--many of the biggest losses have not come from federally-chartered institutions, but rather from state-chartered institutions.

Is that your general belief, staff, around the table?

MR. BLACK: It's clearly our experience in the losses we deal with in litigation, there's no question about it. Passarelli, Mr. Passarelli -

MR. GRAY: Is that generally correct that these are statechartered institutions, the ones that have the authority that go well beyond anything that Congress provided in its law for federally-chartered institutions?

MR. BLACK: Right. I'd also say that this is the most studied regulation in terms of econometric analysis of any regulation, in the Board's history, by a very considerable margin; a very substantial. amount of OPER's resources have been devoted to try to do studies and they didn't just stop the first time around. They did follow-up studies. The studies continued to go forward so if you want to talk about after-the-fact how much was lost on each direct investment--you have to remember a place like Sunrise, you're talking about at least hundreds of individual assets, which, even today, may be two years from being sold and may not even be appraised at this point. You will be gone, if you're wrong, before you get those numbers.

MR. PASSARELLI: I think another point you gotta be bringing out here is, the good operators, they can continue to make these investments. That's the thing you gotta keep in mind. We've got a system in place that provides for the good operators to continue to make these kinds of loans, and we're not restricting those people. Those people can manage and present their kind of business plan, how they want to make additional investments in excess of 10 percent. We review it, and we give approval to it. It's those people who are not good operators; who do not underwrite the loan properly; who do not maintain proper recordkeeping. Those are the kind of people that we're actually controlling. The good operators continue to make these kind of investments and we bless them.

MR. GRAY: Well, let me take that one step further. Bob, I believe that you have done a very recent study that talks about institutions that have tangible net worth. That's where basically you back out from GAAP, generally accepted accounting principles you back out goodwill.

Do we know how much goodwill we have in this industry, in total?

MR. SAHADI: Yes. Let me give you some numbers here.

MR. GRAY:

Let me characterize in my view goodwill as being in very, very, very substantial part, nothing more than hot air.

MR. SAHADI: We have $50 billion in regulatory net worth in this industry. $25 billion of that is goodwill. So, exactly half.

MR. GRAY: So, exactly half of the net worth that we have in this industry is goodwill. Hot air. All right.

GAAP.

MR. NEUBERGER: Which is included in GAAP. Goodwill is included in

MR. GRAY: Oh, I understand it's included in GAAP, but I'm just saying it doesn't protect the FSLIC--hot air does not protect the FSLIC.

MR. NEUBERGER: That's correct.

MR. GRAY: It's not a cushion. Now, let me go step a step further. You did a study of the number of institutions we have in the industry with tangible net worth without goodwill, GAAP without goodwill, and I believe you found it was something like 880 institutions.

MR. SAHADI: Well, I divided them into three categories. I looked at institutions in California, Texas, and all the other institutions. There were 2700 institutions nationwide other than in those two states. Of those 2700, 881 have tangible net worth greater than 6 percent.

MR. GRAY:

All right. Now, I'm getting at something because I'm taking off and going a step further from where you were. We're talking about good operators being able to exceed the threshold, and 60 percent have been able to that.

Now, let's take our net worth standard, which we had in our net worth regulation, which was adopted several months ago; and let's assume, for purposes of this discussion, that instead of regulatory net worth at 6 percent, we're going to take tangible net worth at 6 percent. People who have their own money on the line, tangible net worth, 6 percent; how many institutions in California with their own money on the line, very strong in terms of tangible net worth, have chosen to exceed 10 percent of assets in direct investments?

MR. SAHADI: 73 institutions in California who have tangible net worth greater than 6 percent. Of those 73, eight institutions with tangible net worth.

MR. GRAY:

Only eight institutions. Can you give us what figure is

in Texas?