Workers saving for their retirement lose on junk bonds
Editor's note: The following story ran Oct. 27, 1991, on Day Eight of the nine-day "America: What went wrong?" series published in the Inquirer.
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To better understand what the future holds for workers, let us return to summer 1986, to events that unfolded in two cities that are worlds apart - Seneca, Kan., and Washington, D. C.
It was the week of July 13, 1986.
On Friday of that week, in the sleepy Kansas town of Seneca (population 2,300), employees at the Community National Bank were processing paperwork for two self-directed individual retirement accounts for John G. Kass and his wife, Virginia.
The Kasses lived in Topeka, about 75 miles south of Seneca. He was a painter for the Veterans Administration hospital; she worked in the accounting department of the Santa Fe Railroad.
Their retirement accounts were among hundreds the bank was establishing for workers living in different sections of the country, but concentrated in the Midwest.
With the bank acting as trustee, John Kass invested $2,400 in senior subordinated debentures - a fancy name for a piece of paper that is a corporate IOU. His wife invested $2,500.
The debentures promised a hefty interest rate of 12.5 percent a year. They were issued by American Continental Corp. of Phoenix.
Actually, the Kasses had rolled over their IRAs from another small Kansas bank in yet a smaller Kansas town, the First National Bank of Onaga (town population: 700).
Like many others, the Kasses had opened their retirement accounts at the Onaga bank because it catered to the self-directed IRA business. With a self- directed IRA, future retirees tell the trustee - a bank, brokerage firm or insurance company - what stocks, bonds or other investments they want to put in their retirement account.
The Onaga bank encountered financial difficulties as a result of a portfolio of bad loans and was seized by federal regulators. Many of the IRAs, including the Kasses', were shifted to Seneca.
The Onaga bank was quickly reorganized and continued to service its IRAs. Now it had competition from Seneca.
As more and more people invested their retirement accounts in American Continental bonds because of the high interest rate they paid, processing the accounts became a sizable part of the work for both banks, which are in a region hard-pressed for jobs.
For the First National Bank of Onaga, the IRA business translated into jobs.
"We are a town of 700 people," said Owen E. Duer, the bank's executive vice president, "and we employ 12 people in our IRA department who would not even be here if it weren't for that department. So we are pretty tickled that we have this so we can employ people in our town. " In Seneca, the Community National Bank established a separate division, called the Retirement Plans Division, to process and monitor IRA investments.
During 1986, workers from around the country put more than a quarter- million dollars of their retirement money into American Continental bonds at the Seneca and Onaga banks.
Today, the money that John and Virginia Kass, Duane Hudson, Janice Butterfield, Norman Kaufmann, Eleanor Fox, Myron Danielson, Bonnie Dahl, Gerald Hubert, Patricia Kasubaski, Mary Dulebohn and others set aside for retirement is largely gone.
American Continental, a financial services holding company, filed for protection in U. S. Bankruptcy Court in Phoenix in April 1989. When the reorganization is completed, investors will receive pennies for every dollar they put into their IRAs.
During that same July 1986 week when the Community National Bank of Seneca was processing the paperwork for what would turn out to be worthless retirement accounts, Charles H. Keating Jr. was in Washington, doing what he did best - lobbying the people who write and revise the government rule book.
Keating was a Phoenix homebuilder, fund-raiser for friendly members of Congress and presidential candidates, proprietor of one of California's largest savings- and-loan institutions, crusader for decent literature, and chairman and chief executive officer of American Continental Corp.
Back in the 1950s, when he was a Cincinnati lawyer, Keating had founded Citizens for Decent Literature Inc. For years, he traveled the country identifying and denouncing smut - in 1964 he ranked Philadelphia third in obscene reading matter.
On Wednesday morning, July 16, 1986, Keating was making the rounds of Capitol Hill, railing against government regulators and their efforts to impose some controls on financial institutions, such as his Lincoln Savings & Loan Association.
Keating's American Continental had acquired Lincoln Savings & Loan, headquartered in Irvine, Calif., in 1984. He promptly abandoned the traditional savings-and-loan business of making home mortgages and opted instead for pouring hundreds of millions of dollars into junk bonds, luxury resort hotels, assorted real estate deals and foreign investments.
When the Federal Home Loan Bank Board, under chairman Edwin J. Gray, proposed a regulation limiting such investments, Keating mounted a banker's holy war against regulations in general and Gray in particular.
He enlisted an army of supporters to lobby both the Federal Home Loan Bank Board and Congress. The army included Donald Regan and Alan J. Greenspan. At the time, Regan was White House chief of staff and Greenspan was a private consultant and member of the President's Economic Policy Advisory Board.
That's the same Alan Greenspan who now, as chairman of the Federal Reserve Board, sets bank interest rates, thereby influencing the course of the economy and everyone's standard of living.
In a letter to the Federal Home Loan Bank Board on behalf of Keating's thrift, Greenspan wrote on Nov. 1, 1984:
"I understand that Lincoln Savings & Loan Association has requested that the board allow me to meet with it or its staff in order to discuss my view that the proposed rule (limiting thrift investments) is unwarranted and could prove harmful if put into effect. I hope that the board will agree to such a meeting . . . at the earliest possible time. " The high-powered lobbying notwithstanding, Edwin Gray and the bank board issued the rule.
By the summer of 1986, Keating was back in Washington, pushing for Gray's ouster, an end to the regulation on investments and the appointment of more friendly regulators. He had come up with his personal nominee for a seat on the three-member bank board.
His candidate was Lee H. Henkel Jr., an Atlanta lawyer and businessman. During the first administration of President Richard M. Nixon, Henkel had served as general counsel for the Internal Revenue Service and assistant general counsel of the U.S. Treasury Department.
Henkel, who was active in Republican politics, had worked with Keating in 1980, when both men were backing John B. Connally's bid for the GOP presidential nomination. Henkel also had borrowed millions of dollars from Lincoln Savings & Loan to help underwrite some of his investments.
So it was that on July 16, 1986, Keating set off to the Senate to sell Henkel.
First, he met with Paula Hawkins (R., Fla.). Then, he met with Donald W. Riegle Jr. (D., Mich.). Then he met with Alan Cranston (D., Calif.).
Later, Keating's forces would give Hawkins $8,000 in campaign contributions, Riegle $78,250 - and Cranston $1.3 million.
In the weeks that followed, Keating lobbied other lawmakers on behalf of Henkel. His perseverance paid off on Oct. 7, 1986, when President Ronald Reagan tapped Henkel for a seat on the board.
Henkel was no sooner in office than he proposed new banking rules that would have granted immunity to Lincoln Savings for some of its past lending practices. It seemed that Lincoln had put nearly twice as much money into risky investments as was allowed under the regulation still in effect.
For months, federal bank examiners had been poring over Lincoln's books, asking annoying questions about the institution's investments and missing paperwork.
Henkel's attempt to help backfired. When his financial ties to Lincoln were disclosed, and Sen. William Proxmire (D., Wis.) demanded a Justice Department investigation, Henkel resigned from the bank board.
But Keating's lobbying and incessant attacks on his nemesis, Edwin Gray, had had their effect. Gray left the bank board in June 1987 when his term expired. He was replaced by another Keating ally, M. Danny Wall, the former staff director of the Senate banking committee.
Over the next two years, Wall's actions would protect Keating and his company from the federal auditors who correctly saw that Lincoln's investment practices would bring down the thrift.
Lincoln eventually was seized by federal regulators; its bailout will cost taxpayers an estimated $1 billion or more. And American Continental went into Bankruptcy Court. The bankruptcy case is the largest in Arizona history and one of the half-dozen largest, in terms of paperwork, in U. S. history.
In addition to the hundreds of people who put their retirement money in American Continental bonds, more than 20,000 others, most residents of California, purchased the bonds as a general investment.
In California, where the debentures were sold at Lincoln Savings & Loan branches, many unsuspecting buyers thought the bonds - like their savings accounts - were insured by the federal government.
So, too, did some of the people who bought the bonds for their retirement accounts - including the folks in and around little Seneca, Kan.
They were not.
Owen Duer, the First National Bank of Onaga official, said that a lot of people were confused, assuming that, because their IRA was in a federally insured bank, the account, too, was insured.
Many IRAs are, indeed, backed by the government, but only when they are placed in accounts that are federally insured.
After the American Continental bankruptcy filing, Duer said, "we had lots of phone calls. I can remember one gentleman who just swore up and down that he was insured by the (Federal Deposit Insurance Corp.), and I assured him that he wasn't, and that I didn't make that investment. " "He was only insured by FDIC if I made that investment for him. He chose to make that investment. He felt just because we were a bank, anything he did with us became insured. . . . " Duer emphasized that the banks acted only as custodians: "We do whatever the customer or his representative says to do with the assets in his IRA. The only thing we do is the paperwork and the government reporting. We make no recommendations on whether to buy or sell. . . . That's the sum total of our involvement. " Duer said it's possible that the people selling the bonds led the buyers to believe that because a bank was acting as custodian, the IRA was insured. Or perhaps the salespeople did nothing to discourage a buyer who jumped to that conclusion.
But how was it, exactly, that people in Iowa and Michigan and Nebraska and Arizona opened IRAs in Onaga and Seneca, Kan., and invested their future in a piece of Charles Keating's financial empire?
Local and regional brokerage firms, among them the Offerman Co. of Minneapolis, sold the bonds. The two Kansas banks acted as custodians.
John Kass, the Topeka painter who put his IRA money in American Continental bonds, remembers the broker's spiel well:
"He said, 'John, I think this is pretty good. I think we ought to get into this. It's paying 13 percent . . .' or whatever it was. He said his boss had a lot of shares in it. He said it was a real good deal. " The broker's pitch notwithstanding, Kass might have chosen a different investment if he had heard the views a year earlier of the man in charge of the company issuing the bonds.
During an appearance before a congressional committee in February 1985, Charles Keating, the American Continental chairman, spoke critically of subordinated debentures: "I do not happen to think (a) subordinated debenture is viable capital. I think it is a sham. " Out in the heartland, the story was a bit different.
Another Topeka resident, Duane Hudson, a former telephone company lineman, said he was told that American Continental bonds were "as good as gold. " "He (the broker) told me this will be there when you retire. You'll have your investment. . . . The risk was never mentioned. It was just the same as though you had put it in a bank. He said that with institutions of that size, there is never any worry.
"I guess these were junk bonds, but they weren't sold to me as junk bonds," said an embittered Hudson. "These were sold to me as a security so when I retired I would have some money. I didn't want my IRA in anything that was risky. And that's why I'm bitter.
"I didn't know what a junk bond was from anything else, but I do now."