Chapter 11

Banking Problems Banking Problems

in California in California

Introduction

California recorded major economic gains during the 1980s. In absolute terms, the

states growth during that decade was the most significant in its history, rivaled onlyin

percentage termsby the economic expansion prompted by World War II. One of the main

factors in the growth was an increase in funds flowing into the states defense-related industries and real estate markets. The boom of the 1980s reinforced Californians belief that

the state and its economy were different from other regions of the nation, some of which

were experiencing serious downturns during this period. This particular boom psychology

led many to downplay the prospects of a serious recession, which in fact occurred during

the early 1990s and was Californias most severe since the 1930s. 

Compared with the crises in the Southwest and the Northeast, Californias deep recession of the early 1990sdespite the effect on earnings of the banking sectorwas relatively mild in terms of bank failures. Only 47 banks failed during this period, all of them

fairly small. Several factors contributed to this result, including the sharp decline in interest

rates during the early 1990s, the localized nature of the recession, which was primarily concentrated in Southern California, and the dominance of the states four largest banking organizations, whose geographically diversified portfolios were in a better position than other

banks portfolios to withstand the rigors of the recession. Most of the failures were banks

chartered during the 1980s and/or community banks (those with less than $300 million in

assets) headquartered in Southern California. Failed banks had generally pursued aggressive real estate lending strategies, favoring higher-risk construction and commercial real estate loans over relatively more conservative residential real estate lending.

The first half of this chapter describes Californias economy in the 1980s, particularly

the defense-related industries and real estate markets; it also describes the lens through

which Californians viewed their states economy and its prospects. The second half of the

chapter reviews the performance of the California banking industry before and during the
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

380 History of the EightiesLessons for the Future

Figure 11.1

Changes in California Gross State Product versus

Changes in U.S. Gross Domestic Product,

1980–1994

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

1980 1982 1984 1986 1988 1990 1992 1994

Percent

-4

0

4

8

California

U.S.

1 Economic Report of the Governor, The State of California (1990), 49.

recession, with an emphasis on differences in the performance and failure experience of

various groups of banks within the states industry.

Economic Expansion, 19831989: Fundamentals

California outperformed the nation economically in the 1980s according to most measures, including output, income, population, and employment (see figure 11.1 and table

11.1). From 1983 to 1989, gross state product increased at an annual rate of 5.1 percent, far

above the national rate of 3.6 percent. Personal income grew at an average annual rate of

8.1 percent, nearly triple the 2.7 percent national rate. California attracted 6 million new

residents during the 1980s, accounting for nearly 25 percent of the national population increase. (Most of the new residents, drawn by employment opportunities, settled in Southern

California. Los Angeles County attracted more than 1.2 million of the new residents, while

neighboring counties also registered impressive gains.) Total employment advanced by 2.8

million, accounting for approximately 17 percent of all new jobs created nationally; and although Californias labor force increased by 20 percent (150 percent of the national average), its jobless index was halved: by early 1989, the states unemployment rate had

declined to 5.0 percent, its lowest in 20 years.1
Table 11.1

Three Economic Growth Measures, California and U.S., 19801994

(Percent)

Total Personal Population Non-Agricultural

Income Growth Growth Employment Growth

Year CA U.S. CA U.S. CA U.S.

1980 14.49 0.92 1.76 0.88 1.90 0.64

1981 8.82 2.74 2.61 1.28 1.38 0.82

1982 6.01 0.39 2.19 0.92 1.75 −1.76

1983 9.41 1.52 2.13 0.91 1.59 0.67

1984 10.39 5.99 1.94 0.86 6.10 4.72

1985 7.90 3.15 2.31 0.89 3.83 3.15

1986 6.66 2.94 2.49 0.92 2.54 2.0

1987 7.99 1.68 2.49 0.89 3.73 2.63

1988 7.95 2.84 2.47 0.91 1.99 3.18

1989 6.10 2.50 2.34 0.94 2.75 2.55

1990 7.74 1.47 2.35 1.24 5.80 1.41

1991 1.66 0.19 1.70 0.89 −4.56 −1.06

1992 6.59 2.80 1.62 1.14 −1.66 0.32

1993 1.34 1.74 0.99 1.08 −0.88 1.95

1994 4.15 3.86 0.68 0.99 0.75 2.98

Sources: U.S. Census Bureau, U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Bureau of Labor Statistics.

Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 381

2 David Hensley, Recovery Pushed Back to92, UCLA Business Forecasting Project (September 1991), 1. 3 The state added 525,000 new residents in 1980, 496,000 in 1981, and 527,000 in 1982 (for the years ending July 30). Approximately 55 percent of these population gains were attributable to migration (California Statistical Abstract [1995], 10,

12). This created a boom in the housing and construction industry during this period.

In fact, since World War II the state had almost always performed relatively well. In

the years between the end of World War II and 1989, all eight national recessions had triggered a corresponding downturn in California, but in only one casethe 1970 recession

had California fared worse than the nation.2 In two national recessions in the early 1980s

(the first from January to July 1980, the second from July 1981 to November 1982), just before the expansion of the 1980s, the downturns in California were milder than those in the

nation as a whole when measured by duration and employment losses. There were several

reasons that Californias economy fared better at those times than the national economy.

First, the state was strengthened by continued rapid population growth, expanding at twice

the national rate in the early 1980s.3 A second factor was a booming semiconductor industry headquartered in Silicon Valley. Finally, Californias employment distribution in the

early 1980s offered some protection in recessionary periods: the predominant industries
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382 History of the EightiesLessons for the Future

4 Economic Report of the Governor, The State of California (1983), 1. 5 Bank of America Corporation, Economic and Business Outlook (January 1989), 2. 6 A discussion of the three Californias is provided in Pacific Gas and Electric, Economic Outlook (May 1993). 7 SRI International, Understanding Changes in the Southern California Economy (1991), I-2.

were the less-cyclical ones, including finance, services, trade, and aerospace, whereas the

industries whose fortunes were closely tied to fluctuations of the national economyconstruction, non-aerospace manufacturing, and transportationwere somewhat underrepresented.4

Initially, Californias economic expansion was led by the defense-related manufacturing and construction industries, both of which more than counterbalanced agriculture and

consumer electronics, which were having problems. Then by 1986, as growth in defense

and construction decelerated, agriculture, commercial aviation, and consumer-goods manufacturing took over as the engines of growth for the state.5 In addition, foreign trade, particularly commerce with Pacific Rim nations, provided the state economy with crucial

support. During the 1980s, Los Angeles overtook New York as the nations leading port.

California is commonly referred to as the nations largest economy, accounting for approximately 13 percent of national output. But its economy is not monolithic and comprises

three distinct economies, one in each of the states three key areas.6 The first is the San

Francisco Bay area, with a mature, diversified economy that is home to Silicon Valley, the

world leader in high-tech manufacturing. The second is the Central Valley, which specializes in agriculture and food processing and lies between the coastal mountains and the

Sierra Nevada, stretching south from Sacramento to Bakersfield. Finally, there is the Los

Angeles Basin, which is the dominant region economically and accounts for 50 percent of

the states population. Its most important economic sectors include defense-related manufacturing (aircraft related, missiles, space vehicles, naval equipment), high-tech manufacturing (computer, office, communications equipment, electronic components), advanced

services (business, financial, health, tourism, and entertainment), construction, and consumer-goods manufacturing (furniture, apparel, and plastics).7 While all of California benefited from the economic expansion of the 1980s, the largest gains occurred in Southern

California, particularly Los Angeles County.

Defense-Related Manufacturing: Southern California

World War II transformed the states economy, particularly that of Southern California: manufacturing replaced agriculture as the dominant economic sector. With the Cold

War, a new emphasis was put on high technology in arms production, an activity California

had mastered during the war and one in which its dominance has never been challenged.

Then in 1980, the election of Ronald Reagan to the presidency signaled the beginning of a
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 383

Figure 11.2

Defense-Related Manufacturing Sector, FY 1980–1994

Source: California Statistical Abstract (1995).

Employment

Defense (Primary)

Contracts to

California

1980 1982 1984 1986 1988 1990 1992 1994

Employment

(Thousands)

Contracts

($Billions)

0

100

200

300

400

0

10

20

30

40

8 California Statistical Abstract, table H-8, 120. 9 The defense establishment in California was dominated by several large firmsfor example, Northrop, Hughes, Lockheed,

TRW, Rockwell, McDonnell-Douglas, and General Dynamicswith the resources to compete for such projects as the

Strategic Defense Initiative, the B-1 bomber, and the Trident missile. These organizations and their networks of smaller

subcontractors are concentrated in the Los Angeles area, which absorbs more than half of statewide defense spending. The

Commission on State Finance estimated that the top 20 defense-related contractors held 75 percent of the dollar value of

primary defense contracts (Commission on State Finance, Impact of Defense Cuts on California [1992], 1516). 10 James Dertouzos and Michael Dardia, Defense Spending, Aerospace and the California Economy (1993), 1516. 

major arms buildup during which large amounts of federal funds flowed into Californias

economy. The states share of primary defense contracts averaged 20 percent during the

1980s, a percentage share it has maintained since the mid-1950s.8 (The states share of National Aeronautics and Space Administration [NASA] expenditures was even greater.) In

Fiscal Year 1984, federal primary defense contracts in California were valued at $28.5 billion, more than double the volume just four years earlier (see figure 11.2).9

Defense-related manufacturing jobs are some of the most highly sought-after positions in the manufacturing industry. Employees generally possess high skill levels and are

well compensated. One study estimates that defense-related employees create 30 percent

more gross state product per worker than employees engaged in manufacturing, and nearly

double the per capita level of service jobs.10 Defense-related employment peaked in 1988 at
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384 History of the EightiesLessons for the Future

approximately 363,000 jobs, up 42 percent from 1980, with approximately 107,000 new

jobs created. At year-end 1988, defense-related manufacturing accounted for approximately

3 percent of the states total non-agricultural employment and approximately 17 percent of

its manufacturing employment. In Los Angeles County, defense-related manufacturing accounted for 7.5 percent of nonfarm employment and 33.4 percent of all manufacturing employment. The peak in defense expenditures was reached in Fiscal Year 1985: $29.1 billion.

By FY 1989, the amount had fallen to $23.1 billiona 21 percent decline (before inflation

is taken into account). However, the falloff in defense spending did not have an immediate

and substantial effect upon Californias economy, for two reasons. First, there is a substantial lag between the initial funding authorization and the actual disbursement of funds over

the life of a multiyear project. Second, strength in commercial aviation and increased

NASA expenditures also helped cushion the blow. Nevertheless, by the end of the decade

defense-related employment had declined 7.1 percent from the 1988 peak (figure 11.2).

The Construction Industry and Real Estate Markets

The 198389 expansion was also sparked by the revival of the construction industry.

In the early 1980s, Californias building industry had been hit hard by recession, high interest rates, and high rates of inflation. In 1982, only 85,700 new housing units were authorized (see figure 11.3), marking the fifth consecutive year of declining housing starts and

Figure 11.3

The California Construction Sector, 1980–1994

Sources: California Statistical Abstract (1995) and Construction Industry

Research Board.

1980 1982 1984 1986 1988 1990 1992 1994

0

100

200

300

400

500

600

Thousands

Employment

New Housing

Permits
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 385

11 Economic Report of the Governor (1983), 43. 12 For a more detailed examination of the tax issues, see Chapter 3.

13 Construction Industry Research Board, New Housing Units and Residential, Nonresidential, and Total Building Permit Valuations (November 13, 1995), 1. 14 Ibid. 

15 Center for Real Estate and Urban Economics, University of California at Berkeley, California Real Estate Opportunities in

the 1990s (1991), 34.

the lowest level of activity since 1954.11 In 1983, the construction industry started to rebound, responding to a declining interest-rate environment and a renewal of confidence in

the economy. The number of new housing permits issued doubled in 1983, rising to

172,600, and construction employment increased by 5 percent, reversing a three-year trend

of job losses. With further declines in interest rates and the apparent containment of inflation, the construction recovery gained momentum in 1984 and 1985, yielding substantial

gains in employment through the end of the decade. 

Much of the surge in construction activity in 1984 and 1985 was channeled into multifamily units, an unsurprising result in view of the shortages created by the decline in construction activity in the late 1970s and early 1980s and this activitys sensitivity to interest

costs and credit availability. Beyond cyclical considerations, the industry was anticipating

possible changes in the tax law that would reduce depreciation allowances and restrict real

estate tax shelters. According to the Construction Industry Research Board, permit authorizations for multifamily construction peaked in 1986 at 168,000 and then declined

throughout the rest of the decade and beyond, falling to 75,096 in 1989 (see figure 11.4).

The Tax Reform Act of 1986 eliminated many of the incentives for multifamily construction.12 Whereas multifamily building activity declined sharply after 1986, authorizations

for construction of single-family homes continued strong, peaking at 162,651 permits in

1989 (figure 11.4).13 Although an average of nearly 250,000 housing units were authorized

annually during the last seven years of the 1980s,14 supply failed to keep pace with growth

in employment, population, and household formation.15

The shortage of dwellings exerted upward pressure on housing prices. At the beginning of the 1980s, the median California home price ($99,550) was 60 percent above the national median ($62,600). (See figure 11.5.) In contrast, before 1970 the differential between

the median California and national home prices had been less than $2,000. The 1980 price

differential reflected substantial appreciation in California housing markets during the second half of the 1970s. Between 1982 and 1985 home prices in the state rose moderately, in

1986 they accelerated, and from 1987 to 1989 they increased at an unsustainable rate of 20
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386 History of the EightiesLessons for the Future

Figure 11.4

New Housing Permits, Multifamily versus

Single Family, California, 1978–1994

Source: Construction Industry Research Board.

1978 1980 1982 1984 1986 1988 1990 1992 1994

0

50

100

150

200

Units (Thousands)

Single-Family

Units

Multifamily

Units

San Francisco

Los Angeles

California

Central Valley

U.S.

Figure 11.5

Median Home Prices, California (Selected Markets)

and U.S., 1980–1994

Source: California Existing Single-Family

Housing Market: H

California Association of Realtors,

istorical Data Summaries, March 1995.

1980 1982 1984 1986 1988 1990 1992 1994

50

100

150

200

250

300

$Thousands
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 387

16 California Association of Realtors, California Existing Single-Family Housing Markets: Historical Data Summaries

(1995), 2.

17 George Salem and Donald Wang, California Banking: Industry Outlook (October 15, 1990), 12. 18 Center for Real Estate and Urban Economics, Real Estate Opportunities.

to 25 percent. At the end of the decade, the median home price in California was more than

double the national average: $196,120 versus $93,100.16

The substantial appreciation in home prices was not evenly distributed throughout the

state. The greatest appreciation occurred in coastal areasthe San Francisco Bay area and

Southern California from Santa Barbara to San Diego. In 1989, median home prices peaked

in San Francisco ($260,722) and Los Angeles ($214,831). While the disparity between

housing demand and supply was most acute in Californias coastal areas, supply and demand factors alone do not explain the surge in home prices at the end of the 1980s, which

was heavily influenced by speculation. For many Californians, private residences had become a preferred investment vehicle offering little perceived risk, easily available credit, interest costs subsidized by the federal tax code, and the opportunity to make only modest

down payments, thereby providing excellent leverage opportunities and producing large

profits. In the late 1980s in San Francisco and Los Angeles, speculation was rampant.17

Homes sold quickly and there were occasional bidding wars, as prospective buyers bid

above asking prices so as not to lose an opportunity for what appeared to be certain capital

gains.

The construction surge also encompassed office space, as California participated in

the office-building boom of the 1980s and mirrored developments in Texas, Boston, and

New York. At the beginning of the 1980s there was a significant shortage of office space, as

indicated by low vacancy rates in the states three largest office marketsLos Angeles (2.4

percent), San Francisco (2.5 percent), and San Diego (3.8 percent). (See figure 11.6.)

Office-space inventories grew rapidly in the remainder of the decade, as nearly 300 million

square feet of office space were added. In Los Angeles alone, between year-end 1979 and

year-end 1989, office-space inventories jumped from 61.8 million square feet to 139.4

million square feet. In San Francisco, office-space inventories increased by nearly 75 percent, rising to 65.3 million square feet (see table 11.2). Significant development also

occurred in San Diego, Santa Clara County (Silicon Valley), and Sacramento.18 And even

though vacancy rates peaked in 1986, the building continued. The rules of development

were turned upside down in the 1980s. As one commentator noted, Developers did not

borrow to build; all too often they built in order to borrow and borrow some more. Under

the old rules, developers acquired a site, completed construction plans, secured a major tenant, and then sought financing. In the 1980s, the financing was often secured first and then
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388 History of the EightiesLessons for the Future

Figure 11.6

Commercial Office Vacancy Rates, California

(Selected Markets) and U.S., 1980–1994

Source: CB Commercial/Torto Wheaton Research.

1980 1982 1984 1986 1988 1990 1992 1994

0

5

10

15

20

25

Percent

San

Francisco

Los U.S.

Angeles

San

Diego

19 Maggie Mahar, The Great Collapse, Commercial Real Estate Is on the Skids across the Nation, Barrons (July 22, 

1991): 11. 20 E & Y Kenneth Leventhal Real Estate Group, 1993 Japanese Disinvestment in U.S. Real Estate (1994), 7.

the other parts of the package were brought together. Furthermore, lenders often offered

100 percent financing.19

The most explosive growth in office space occurred in Los Angeles. Although savings

and loans and institutional investors provided some funding, Japanese banks and Japanese

investors became a major force in development. Using the wealth created by booming domestic real estate and equities markets, the Japanese moved aggressively overseas, acquiring premium properties and financing construction projects at prices that seemed modest in

comparison with prevailing real estate prices in Japan. Acquisitions were further facilitated

by easily available credit and the impressive purchasing power of the Japanese yen. Between 1985 and 1993, the Japanese invested $73.1 billion in U.S. real estate (see figure

11.7). Nearly 80 percent of the funds were invested during the four-year period 198790,

the peak coming in 1988 ($16.5 billion). Approximately one-third of the total investment

from 1985 to 1993 was concentrated in California ($25 billion).20 Japanese ownership of

California real estate increased rapidly: $5 billion in 1987, $6.5 billion in 1988, $10 billion
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 389

Table 11.2

Office Real Estate Market Trends,

Los Angeles County and San Francisco, 19801994

(Thousands of Square Feet)

Completions Stock

Year Los Angeles San Francisco* Los Angeles San Francisco*

1980 5,875 3,838 67,663 40,656

1981 6,786 1,492 74,449 42,148

1982 11,620 3,353 86,069 45,501

1983 7,233 4,238 93,302 49,739

1984 6,956 2,439 100,258 52,178

1985 9,901 2,739 110,159 54,917

1986 9,793 4,675 119,952 59,592

1987 6,246 1,820 126,198 61,412

1988 7,133 2,412 133,331 63,824

1989 6,054 1,487 139,385 65,311

1990 8,516 2,380 147,901 67,691

1991 7,711 428 155,612 68,119

1992 2,482 41 158,094 68,160

1993 257 0 158,351 68,160

1994 51 0 158,402 68,160

Source: The Office Outlook, vol. 2. CB Commercial/Torto Wheaton Research.

*Three-county total for Marin, San Francisco, and San Mateo Counties.

21 Ibid., 10.

22 Stephen S. Cohen, Clara Eugenia Garcia, and Oscar Loureiro, From Boom to Bust in the Golden State: The Structural Dimension of Californias Prolonged Recession, working paper 64, Berkeley Roundtable on the International Economy, University of California at Berkeley, September 1993, 9. 23 James Bates, Japans New Investment in U.S. Real Estate Down 61%, Los Angeles Times (February 21, 1992), A1. 24 Ralph T. King, Jr., Another Houston: Real-Estate Developers See the Next Disaster in Central Los Angeles, The Wall

Street Journal (August 27, 1991), 1. 25 James S. Granelli, Japans Banks Shaken by Fall in California Values, Los Angeles Times (March 18, 1993), A1.

in 1989, $13 billion in 1990, and $18 billion in 1991.21 In addition, analysts estimated that

in Los Angeles, Japanese commercial banks provided more than half of the commercial real

estate loans.22 By 1991, the Japanese investors owned approximately 45 percent of premium downtown Los Angeles office space.23 Japanese purchasers focused primarily on trophy properties: in 1989, Dai-ichi Mutual Life Insurance paid $530 per square foot for a

quarter-interest in First Interstate World Center, Los Angeless tallest building.24 In 1989, a

Japanese developer paid $850 million for the Pebble Beach resort near Monterey in Northern California (sold in 1992 for $500 million). The property was financed by Japanese financial institutions.25
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390 History of the EightiesLessons for the Future

Figure 11.7

Japanese Investment in U.S. Real Estate, 1985–1994

Source: E & Y Kenneth Leventhal Real Estate Group, “1994 Japanese

Investment in U.S. Real Estate,” exhibit 1 (1995).

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

0

5

10

15

20

$Billions

26 Cohen et al., Boom to Bust, 10.

27 U.S. Department of Commerce, Bureau of Economic Analysis, cited in California Statistical Abstract (1996), table D-1, 48. 

The overbuilding that occurred in the late 1980s had a strong speculative element. Despite high vacancy rates, building continued unabated. Investors, lenders, and developers

assumed that demand for office space would continue to increase and that real estate values

would likewise continue to increase. An additional indicator of the speculative nature of the

market was the price paid for office space: in Los Angeles and Orange Counties between

1985 and 1990, despite high vacancy rates and a substantial volume of office construction

nearing completion, sale prices rose from $234 to $303 per square foot.26

From Boom to Bust: But California Is Different

Californias economic gains in the 1980s reinforced a belief long held in the state that

California was different. The Golden State, it appeared, had always been rich. Californias

most famous boom, the first of many, was the Gold Rush of 1849. During the remainder of

the 19th century, agriculture and the railroads fostered substantial growth and created

wealth. During the 20th century, the most prominent sources of wealth were, in turn, the oil

industry, the entertainment industry, construction, defense/aerospace, and the computer

chip. If California had been a separate nation, its 1989 gross product of $703 billion27 would
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 391

28 David Hensley, Where Concerns Mount, Growth Continues, UCLA Business Forecasting Project (March 1990), 1. 29 Cohen et al., Boom to Bust, 4.

30 Hensley, Growth Continues, 1. 31 Salem and Wang, California Banking, 12.

have been surpassed by only six countries: the United States, Japan, Germany, France, Italy,

and the United Kingdom. And even by historical standards, the growth in the 1980s was impressivethe most significant the state had ever experienced. Only the economic expansion during World War II rivaled this growth (in percentage terms). What made Californias

economic achievement in the 1980s particularly striking was the national context. The Midwest, Texas and the Southwest, and the Northeast endured a series of recessions during the

1980s and early 1990s.

The underlying psychology of the boomthat California was differentmade it more

difficult for those inside the state to perceive on the horizon the early-warning signs of a serious recession.28 The relevance of the recent major downturns experienced by Texas and the

Northeast was often denied. The boom and then bust in Texas were viewed as having been

based essentially on a single commodity (oil), whereas California had a large, diverse economy, accounting for approximately one-eighth of national output. In the Northeast, the

boom of the 1980s (followed by the bust of the early 1990s) was seen as representing a recapture of economic ground lost in the 1970s when the economy was undermined by high

energy prices and a rapidly declining manufacturing sector. For these reasons, the parallels

between these areas and California were not taken seriously by many observers. For decades

California had been the very model of a successful and dynamic regional economy, continually growing, adapting, and overcoming obstacles to growth, generating new ideas and

converting them to sources of wealth.29 The boom in California in the 1980s had been preceded by the booms of the 1970s, the 1960s, and the 1950s. To many inside the state, just as

previous booms had not been followed by a bust, this one would not be, either.

By 1989, the California economy slowed and began showing signs of distress. The

initial problems emerged in precisely the sectors that had led the economic boom of the

1980s: defense-related manufacturing, construction, and commercial and residential real

estate markets. But these early-warning signs were interpreted very differently depending

on whether the analyst was based in California or elsewhere. In-state analysts, buoyed by

the achievements of the 1980s, generally anticipated continued growth.30 They minimized

the threat posed by declining defense expenditures, and provided justifications for current

real estate valuations. Analysts from outside were more circumspect in assessing the states

economy and prospects, particularly the price of residential real estate in coastal areas.31

These analysts, sensitive to what had happened in Texas and New England, questioned

whether Californias would be the next regional economy to face a serious downturn.
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392 History of the EightiesLessons for the Future

32 Bank of America Corporation, The California Economy in 1990: Surmounting the Challenges, Economic and Business

Outlook (January 1990), 1. 33 Ibid.

34 Golden State Worriers, Business Week (May 14, 1990): 35. 35 Salem and Wang, California Banking.

The debate among analysts is illustrated by contrasting statements on the effect of declining defense expenditures. Defense spending peaked in California in Fiscal Year 1985 but,

as noted above, the delay between appropriations and actual spending, strength in commercial

aviation, and increased NASA expenditures all kept the states economy from feeling the effect of the reduction in such spending. According to an analysis undertaken by the Bank of

America, there was no question that defense spending would continue to declinenevertheless, only a modest effect upon the state economy was anticipated.32 California had experienced a serious recession in the early 1970s, when real military spending fell by more than 10

percent in 1970 and 1971 as the Vietnam War moved toward a conclusion, but some analysts

based in the state argued that during the two decades since that time, the structure of the states

economy had been transformed and was now large and diverse enough to offer insulation

from problems in specific sectors.33 In addition, defense-related manufacturing accounted for

an increasingly smaller share of the state economy (between 1970 and 1990 it dropped from

approximately 15 percent of the gross state product to approximately 8 percent). Thus, future

cutbacks in that sector (in-state analysts maintained) would have less of an effect on the states

economy than cutbacks in the same sector had had 20 years earlier. In contrast, analysts who

were more cautious about the potential implications of reduced defense expenditures pointed

to New York State, which had been forced into a recessionary phase by problems in the securities industry after the October 1987 stock market crash even though, at the time, securities

activities accounted for only between 4 and 5 percent of state output.34

A second important issue in the debate over Californias near-term economic performance was current valuations of real estate assets. The future was most clearly seen by two

Prudential-Bache analysts, George Salem and Donald Wang.35 Their October 1990 report,

because it was so clearly at odds with the conventional wisdom, was both highly publicized

and highly controversial; they concluded that residential markets in California were substantially overvalued and that a price correction was under way. In the previous year, prices

in Californias coastal markets had fallen by 10 to 20 percent from mid-1989 peaks, and

Salem and Wang anticipated a total correction of 25 percent or more by year-end 1991.

They characterized commercial real estate markets, particularly Los Angeles, as overbuilt,

commanding declining rents, and failing to provide a sufficient return to satisfy institutional

investors. It followed, according to the two analysts, that major price revisions would ensue. Finally, Salem and Wang viewed real estate in California as analogous to oil in Texas,

in the sense thatbecause so much of household net worth in California was based on
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 393

36 Bank of America Corporation, The California Economy in 1990, 3. 37 Ibid.

38 Randall Johnston Pozdena, Why Home Prices Dont Fall (Much), FRBSF Weekly Letter (January 4, 1991): 12. 39 Ibid., 3.

home ownershipa drop in prices would have a major effect on consumption patterns, job

creation, and unemployment.

An analysis produced at the Bank of America responded that nonresidents, unable to

grasp the historical context, failed to understand the states real estate markets. California

home prices as a percentage of national home prices had increased at a faster rate between

1974 and 1981 than in the recent 1987 to mid-1989 boom. Prices had stalled during the

198182 recession, but there had been no significant deterioration.36 In addition, the authors of the analysis claimed that Californias residential real estate markets were not overbuilt: despite the authorization of nearly 250,000 housing permits annually during the

expansion, a significant shortfall in housing supply allegedly remained, resulting from employment and population growth during the 1980s.37

An economist at the Federal Reserve Bank of San Francisco also took issue with

Salem and Wang, arguing that relatively high home prices in California are easily explained by the comparative productivity of sites. Rejecting Salem and Wangs metaphor of

California real estate as an overvalued stock vulnerable to correction, the Federal Reserve

economist viewed the underlying land as a scarce production factor that was in limited supply and was given value by the high productivity of the area and competing uses. In fact,

the bulk of the sixfold increase in home prices in the prior 20 years could be explained by

movement in the gross state product.38 Finally, the historical movement of home prices during both the Great Depression and the more recent recession in Texas indicated significant

barriers to price rollbacks; these barriers included transactions costs and tax considerations.39

In summary, because of Californias economic successes in the 1980s and its history

of prosperity, few anticipated the depth of the coming recession, which would be the states

worst economic downturn since the Great Depression. After all, in the early 1980s, amid a

serious national recession, California had experienced only minor problems (except in the

building industry): was that not additional evidence of the states continuing strength? In

fact, however, the events of the 1980s may have made the state economy more vulnerable

to an economic correction. First, the influx of dollars increased the importance of constructiona highly cyclical industry. Second, the size of the defense establishment in California

made the state somewhat more vulnerable to events such as the end of the Cold War and the

consequent reduction in defense spending. Third, Japanese acquisitions and financing of

California real estate development, especially with respect to commercial real estate mar-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

394 History of the EightiesLessons for the Future

kets, made California more dependent on Japanese investments, so that the continued

health of the Japanese economy became a major factor in Californias economic future.

Recession, 19901994

Californias economy followed the nations into recession in December 1990 and was

seriously hurt. Employment peaked at the end of 1990, but for the last six months of that year

employment growth had been essentially flat, and some observers argued that the recession

probably began in mid-year. Between December 1990 and January 1994, employment in the

state declined by approximately 752,000, or nearly 6 percent of the total non-agricultural

employment base. The most substantial employment losses occurred in the manufacturing

sector (290,300, or 14 percent of total manufacturing employmentthe defense-related

manufacturing sector declined 126,000, or approximately 39 percent), trade (287,700, or 9

percent), and construction (116,000, or 21 percent). (See table 11.3.) The unemployment rate

peaked in September 1992 at 9.5 percent, up from 5.0 percent in January 1990.

Table 11.3

Recession-Related Employment Losses in California and Los Angeles County

Employment (Thousands) Change

December 1990 January 1994 (Percent)

California

Total non-agricultural 12,634 11,882 −6.0

Construction 540 424 −21.0

Manufacturing 2,028 1,738 −14.0

Defense-related 327 201 −39.0

Trade 3,069 2,782 −9.0

Financial services 812 795 −2.0

Services 3,416 3,421 0.0

Government 2,107 2,083 −1.0

Los Angeles County

Total non-agricultural 4,125 3,636 −11.9

Construction 130 94 −27.2

Manufacturing 811 633 −22.0

Defense-related 191 114 −40.3

Trade 958 806 −15.9

Financial services 276 246 −10.9

Services 1,188 1,119 −5.8

Government 543 534 −1.6

Source: California Employment Development Department.
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 395

40 Center for the Continuing Study of the California Economy, California Economic Growth (1994), 3-3. 41 Pacific Gas and Electric, Economic Outlook (January 1995), 9. 42 Cohen et al., Boom to Bust, 3.

43 Ibid., 89.

The recession in California had at least three principal causes: the 199091 national

recession, which reduced the demand for Californias goods and services; the substantial

decline in national defense spending, which affected California defense contractors, particularly those headquartered in Southern California; and the collapse of residential real estate

markets and overbuilt commercial markets, which had a major effect on the states construction industry.

40

The effects of the recession were unevenly distributed. The Central Valley region was

affected only marginally. The effect on the San Francisco Bay area was greater, but was still

cushioned somewhat by the diversified structure of the regional economy.

41 The effect on

the Los Angeles metropolitan area, in contrast, was severe. Between December 1990 and

January 1994, Los Angeles County lost 489,600 jobs, representing nearly 12 percent of its

total nonfarm employment base and 65 percent of the jobs lost in the whole state. Most seriously injured was the manufacturing sector, including defense-related manufacturing; also

deeply affected were trade, services, financial services, and construction (table 11.3).

A 1993 study posits specific structural problems within the local economy as the reason the California recession was longer and more severe than the national downturn.42 For

example, Southern California was particularly vulnerable to cutbacks in defense spending

because of the way the defense-related manufacturing industry was structured. Large bureaucratic organizations had been created to serve the unique needs of the industrys sole

client, the Department of Defense. Competition was limited, incentives to control costs

were lacking, and the emphasis was on accommodating the specifications of the buyer.

When defense spending was reduced, secondary markets for these products were difficult

to find. In contrast, the defense-related sector in Northern California was dominated by

much smaller, entrepreneurial firms that were forced to contain costs to a greater extent in

order to compete in the global marketplace.43

Southern Californias commercial and residential real estate markets were also vulnerable to correction because the former were substantially overbuilt and the latter eventually became overpriced. Commercial developers, investors, and lenders counted on

inflation and continued strong growth in office employment to make their projects viable.

During the 1990s, with real estate inflation subsiding and office employment declining,

commercial real estate markets were destabilized. In addition, Japans economy went into
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

396 History of the EightiesLessons for the Future

44 Japanese investment in U.S. real estate declined to $13 billion in 1990 and to $5 billion in 1991. New investment was

nonexistent in 1992 and 1993, with only limited funds disbursed to complete projects under construction. The Japanese

destabilized markets further by becoming sellers in 1993 and continuing to sell in 1994. E & Y Kenneth Leventhal Real Estate Group estimated disinvestment and restructurings by Japanese interests of $4.5 billion in California in 1993 and sales

of $3.14 billion in 1994, representing a liquidation of 30 percent of the $25 billion the Japanese had invested in California

real estate since 1985.

45 California Dreaming, on a Rainy Day, The Economist (June 23, 1990): 78. 46 California Association of Realtors, Historical Data Summaries, 18. 47 Ibid., 7.

48 Estimates provided by Michael Carney, Real Estate Research Council of Southern California, in a presentation at the UCLA

Business Forecast Meeting, December 13, 1995.

recession in 1990, with investors suffering major losses in equities and real estate; Japanese

lenders were forced to reassess the real estate strategy they had aggressively pursued in the

1980s. Japans marginally capitalized banksconfronted by major losses, that countrys

worst post-war recession, a rising interest-rate environment, a large portfolio of nonperforming assets, and pressure from financial markets and Japanese regulators to deal with

these issuessignificantly cut their lending and investments in U.S. real estate markets.44

The office market in Los Angeles County was undercut further when the completion

of substantial amounts of new office space (16.2 million square feet in 1990 and 1991

table 11.2) coincided with a wave of corporate restructurings that significantly reduced the

demand for office space. The result was declining rents, falling purchase prices, and higher

vacancy rates. (In San Francisco, local ordinances that restricted annual expansion of downtown office space to 475,000 square feetessentially, one buildinghad been in place

since 1986, saving developers from themselves.)45

In the residential sector, the substantial appreciation in California home prices during

the 1980s created a problem of affordability. Median home prices in the state peaked in

1991 at $200,660, approximately six times the nations average household income. As

prices increased, the market of potential buyers became narrower. According to the California Association of Realtors, only 14 percent of Los Angeles households in 1989 could afford to purchase a local median-price home.46 Because the decline in home prices in the

early 1990s was largely unanticipated, it was particularly worrisome to existing homeowners. The number of California home sales peaked in 1988 at 562,240, but uncertainty about

future real estate values reduced sales activity in 1991 to 425,420 homes.47 The Real Estate

Research Councils of Southern and Northern California estimated that between March

1990 and October 1995, average home prices declined by 21.1 percent in Southern California and 9.6 percent in Northern California.48
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 397

49 For convenience in analyzing the effects of the recession on the state banking industry, five complete years of data

199094are discussed to approximate the duration of the recession. 

50 All ROAs for the different banking groups discussed in this section for the 198089 and 199094 periods refer to weighted

average medians unless otherwise noted.

51 The Bank of America, First Interstate Bank, and, to a more limited extent, Security Pacific Bank all had a presence outside

of California. 

The Banking Industry: Profitability, Structure, and

Competition, 19801989

Because the recession primarily affected Southern California, most bank failures during the 199094 period occurred in this region.49 However, although the recession was the

states most severe since the 1930s, the banking crisis as measured by both the number of

bank failures and losses to the Bank Insurance Fund was relatively minor in comparison

with the crises in the Southwest and the Northeast. To this extent the California banking crisis was different from those in the other regions. Contributing to this result were the sharp

decline in interest rates during the early 1990s; the localized nature of the recession, which

was concentrated in Southern California; and the dominant presence in the state of four of

the largest banking organizations in the nation, whose geographic diversification both inside and outside the state mitigated the recessions effect on their overall operations.

Although Californias economic growth was strong during the 1980s, the overall performance of the states banking industry was relatively mediocre going into the recession of

the early 1990s. The weighted average median return on assets (ROA) for all California banks

over the 198089 period was 0.63 percent, which was substantially below the median return

for the U.S. banking industry (0.94 percent).50 (See table 11.4.) These subpar returns were

heavily influenced by the poor earnings record of the Bank of America (BoA) during most of

the decade, which averaged only 22 basis points over this period. However, from 1988 to

1990 the overall performance of the California banking industry improved significantly, and

the industrys ROA matched or exceeded the returns for the U.S. banking industry.

Table 11.4 also identifies the profitability of the various banking groups that played

roles in the provision of banking services within the state: established community banks

(those with less than $300 million in assets), banks chartered during the 1980s, and the four

statewide organizations. Community bank operations are generally restricted to localized

banking markets; because these institutions have limited geographic scope in comparison

with larger organizations, they have fewer opportunities to diversify their lending. Commercial banks chartered in the 1980s were also small, locally oriented organizations.

What distinguished them from community banks was their large number, which made them

a competitive force in the state banking industry. Finally, the four statewide organizations

dominated the California banking structure, their large branch networks operating within all

major markets as well as competing on an interstate basis (in three of the four cases).51
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

398 History of the EightiesLessons for the Future

Table 11.4

Median Return on Assets for U.S. and California Banking Industries, 19801994

(Percent)

Yearly Medians

Weighted Medians

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 19801989 19901994

U.S. Banking Industry 1.12 1.09 1.04 0.98 0.90 0.90 0.80 0.81 0.87 0.92 0.86 0.89 1.07 1.14 1.09 0.94 1.00

California Banking Industry 0.79 0.83 0.37 0.24 0.44 0.49 0.51 0.73 0.87 1.04 0.93 0.56 0.48 0.46 0.73 0.63 0.63

Established California

Community Banks* 0.95 0.94 0.47 0.38 0.59 0.64 0.73 0.85 0.98 1.16 1.02 0.74 0.67 0.49 0.76 0.76 0.75

California Banks Chartered

in the 1980s −0.53 0.45 0.10 0.06 0.23 0.27 0.35 0.64 0.82 1.00 0.92 0.55 0.38 0.32 0.62 0.44 0.57

California Big Four Banks 0.60 0.49 0.35 0.41 0.48 0.35 0.55 −0.55 1.14 1.28 1.11 −0.10 0.60 1.14 1.15 0.51 0.78

Bank of America 0.54 0.36 0.34 0.30 0.34 −0.41 −0.48 −0.96 0.91 1.21 0.91 0.98 1.00 1.14 1.15 0.22 1.04

First Interstate 0.65 0.61 0.36 0.52 0.62 0.67 0.77 −1.69 1.33 1.28 1.32 −0.24 0.07 0.96 0.97 0.51 0.62

Security Pacific 0.70 0.69 0.68 0.67 0.65 0.56 0.63 −0.15 1.12 1.31 0.80 −1.04





 0.69 −0.12

Wells Fargo 0.55 0.29 0.25 −0.07 −1.59 0.13 0.47 0.16 1.17 1.27 1.41 0.04 0.60 1.36 1.63 0.26 1.01

*California community banks are defined as institutions with less than $300 million in total assets.Acquired by Bank of America in 1992.Medians are weighted by number of banking organizations.
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 399

The ROA of the different banking groups in the state varied widely over the 198089

period. Community banks recorded an ROA of 0.76 percent, which exceeded the ROA for

all California institutions but fell short of the 0.94 return for the U.S. banking industry. In

contrast, the performance of banks that were chartered during the decade was relatively

poor. Over the entire 198089 period, this group recorded a median return on assets of only

44 basis points, below that of all the other groups within the state as well as the U.S. banking industry (table 11.4).

The dominant banking group in the state consisted of the statewide banking organizations, known collectively as the Big Four: Bank of America, First Interstate Bank,

Security Pacific Bank, and Wells Fargo Bank. At the beginning of the decade they accounted for approximately 72 percent of statewide assets and 70 percent of total income of all California banking organizations. Any discussion of the performance of the 

California banking industry during the 198089 period is therefore heavily weighted 

by the performance of these organizations. Their median ROA from 1980 to 1989 was 

51 basis points, substantially below the 94 basis point return for the U.S. banking industry.

In 1987 this group actually experienced a net loss on assets of 55 basis points, as most 

of these firms charged earnings to set aside reserves for potential losses on loans 

to less-developed countries. From 1988 to 1990, however, their returns rebounded 

strongly, with gains that substantially exceeded those for the U.S. banking industry (table

11.4). 

The below-average performance of the California banking industry from 1980 to

1989 was influenced by the intense competitive climate within the states banking and financial sectors. First and most especially, the newly deregulated California thrift industry

posed strong challenges for deposit and loan products. Second, as just mentioned, the vibrant economy produced a large number of new entrants in the form of newly chartered

banks that began operations in the first half of the 1980s. Finally, the increased market share

of the California subsidiaries of Japanese banks also enhanced competition. 

California thrift institutions, which are among the largest in the nation, have traditionally posed substantial competitive challenges to Californias commercial banks. At the beginning of the 1980s, four of the states ten largest depository institutions were thrifts; at

year-end 1984, thrift institutions controlled approximately 50 percent of the states total domestic deposits, while commercial banks held approximately 48 percent and credit unions

another 2 percent (see tables 11.5 and 11.6). Commercial banks in California have traditionally played an important role in providing residential and commercial mortgage credit.

For example, at year-end 1989 median real estate loans (not shown) represented approximately 33 percent of total assets at California banks, substantially above the 23 percent median total for the U.S. banking industry. 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

400 History of the EightiesLessons for the Future

Table 11.5

Ten Largest Depository Institutions in California,

December 31, 1979

Total Domestic

Deposits

Rank Name of Institution Location ($Billions)

1 Bank of America San Francisco $86.1

2 Security Pacific Bank Los Angeles 18.5

3 Wells Fargo Bank San Francisco 16.1

4 Crocker National Bank San Francisco 12.5

5 United California Bank Los Angeles 11.7

6 Home Savings of America Los Angeles 9.4

7 Great Western Savings Beverly Hills 7.4

8 American Savings & Loan Beverly Hills 7.3

9 Union Bank Los Angeles 4.5

10 California Federal Savings & Loan Los Angeles 4.5

Source: American Banker (February 21 and 26, 1980).

Table 11.6

Market Share of Total Domestic Deposits, by Type of Depository Institution in

California, 19841992

Total Domestic Deposits

Commercial Banks Thrift Institutions Credit Unions

Year ($Billions) (Percent) ($Billions) (Percent) ($Billions) (Percent)

1984 $177.4 48.3% $181.6 49.5% $ 8.3 2.3%

1985 185.8 47.9 191.6 49.4 10.8 2.8

1986 192.5 45.8 215.0 51.1 13.3 3.2

1987 191.3 42.7 241.7 54.0 14.9 3.3

1988 201.9 41.5 268.2 55.2 16.2 3.3

1989 217.9 43.0 270.6 53.4 17.9 3.5

1990 235.9 45.8 260.2 50.5 19.4 3.8

1991 245.9 48.1 242.0 47.4 22.9 4.5

1992 240.5 48.6 227.0 45.8 27.8 5.6

Source: Federal Reserve Bank of San Francisco.

During the early 1980s, while Congress was partly deregulating the thrift industry, the

California state assembly went much further by significantly expanding the powers of statechartered thrifts. The Nolan bill, which became effective on January 1, 1983, authorized

state-chartered thrifts to invest directly in real estate without limitation; previously, direct
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 401

52 California S&L Powers Bill to Governor, American Banker (June 15, 1982), 2. 53 Norman Strunk and Fred Case, Where Deregulation Went Wrong: A Look at the Causes behind Savings and Loan Failures

in the 1980s (1989), 57. In 1983 the California state legislature also expanded the power of state-chartered banks to make

direct investments in real estate, adding a provision to the state banking code to allow state banks to invest up to 100 percent of total equity and/or 10 percent of total assets directly into real estate. More than 100 state banks took advantage of

this provision, often with the encouragement of state officials. 54 Ibid., 58.

55 Office of Thrift Supervision. 

real estate investments had been limited to 12 percent of total assets.52 The legislation also

eliminated a 5-percent-of-total-assets ceiling on loans secured by commercial real estate. In

1982, when the Nolan bill was passed, seven of the states ten largest thrifts were statechartered.53

The attractiveness of the new powers was reflected in chartering patterns. The broad

discretion granted to state-chartered thrifts, coupled with access to federally insured deposits, attracted new investors to the California thrift industry.

54 In the five years after the

effective date of the Nolan bill, more than two-thirds of new thrifts (48 of 67) elected to be

state chartered. Partly as a result of the new entrants and expanded powers, thrift institutionsshare of statewide domestic deposits increased to 55 percent by year-end 1988, up almost 6 percentage points since 1984, while commercial banks market share dwindled to 42

percent (down approximately 7 points) (table 11.6). Yet despite the new thrift powers

granted at federal and state levels, the profit performance of California thrifts was relatively

poor during the 1980s. Their ROA averaged only 11 basis points from 1984 through 1989;

during the best year1985it was 46 basis points.55

The second factor affecting the competitive environment was trends in the number of

commercial banks. California began the decade of the 1980s with 240 commercial banks.

During the next ten years (198089) that number more than doubled, with a total of 299

new banks being charteredabout 87 percent of them (260) during the first six years of the

decade. More than half of the new banks were federally chartered (the remainder were state

chartered [see figure 11.8]) and most of the new banks were headquartered in Southern California (not shown). The large number of new entrants enhanced competition within the

state, but as a group, these newly chartered banks were outperformed by all other California banking groups (table 11.4). 

The third factor that intensified competition in the states banking industry was the

significantly increased presence of Japanese banks in the states banking markets. Between

1985 and 1990, assets of the nine California subsidiary banks owned by Japanese interests

rose from $11.8 billion to $37.8 billion. This substantial growth was accomplished primarily by acquisitions; and by 1989, Japanese interests owned four of Californias ten largest

commercial banks. To gain market share, the Japanese banks were often willing to sacrifice
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

402 History of the EightiesLessons for the Future

Figure 11.8

Newly Chartered Banks in California, 1980–1994

Number

Total

National

State

1980 1982 1984 1986 1988 1990 1992 1994

0

15

30

45

60

56 Robert Luke, Japanese Banks Tackle California Middle Market, American Banker (September 10, 1988). 57 For a discussion of the presence of Japanese banks in the California banking system, see Gary C. Zimmerman, The Growing Presence of Japanese Banks, FRBSF Weekly Letter (October 28, 1988). 

short-term profits, by pricing loans at 25 to 50 basis points below rates charged by their

competitors.56 In 1989, after five years of losses or marginal results, Japanese banks ROA

reached a high of 0.80 percent.57

Effects of the Recession on California Banking (I):

Troubled Banks

The condition of the California banking industry closely tracked changing economic

circumstances within the state. In 198586 only 72 (approximately 17 percent) of the states

banks received problem-bank ratings (CAMEL 4 and 5) (see table 11.7a). These institutions

accounted for less than 6 percent of the total number of problem banks nationally at that

time. As the state economy gained momentum during the second half of the decade, the

number of problem banks declined. In 1989, the industry registered a record income level

of $3.7 billion, while the number of problem institutions was half what it had been four

years earlier. With the California recession of the early 1990s, however, the number of problem institutions jumped dramatically, reaching a peak of 118 in 1992, or approximately 26

percent of the total number of California banks. In 1993 and 1994, as the state was recov-
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 403

Table 11.7a

CAMEL Ratings for All California Banks, 19811994

Report Number of California Problem Banks/Percentage of Total

Date CAMEL Rating

(Year-end) 1 2 3 4 5 Total

1981 53 181 41 12 1 288

18.4 62.8 14.2 4.2 0.3 100%

1982 52 175 55 28 11 321

16.2 54.5 17.1 8.7 3.4 100

1983 53 195 63 40 11 362

14.6 53.9 17.4 11.0 3.0 100

1984 45 197 94 44 12 392

11.5 50.3 24.0 11.2 3.1 100

1985 44 234 81 51 21 431

10.2 54.3 18.8 11.8 4.9 100

1986 41 261 87 53 19 461

8.9 56.6 18.9 11.5 4.1 100

1987 38 276 94 43 12 463

8.2 59.6 20.3 9.3 2.6 100

1988 49 285 86 37 2 459

10.7 62.1 18.7 8.1 0.4 100

1989 56 300 68 31 5 460

12.2 65.2 14.8 6.7 1.1 100

1990 51 294 74 28 8 455

11.2 64.6 16.3 6.2 1.8 100

1991 36 245 100 68 10 459

7.8 53.4 21.8 14.8 2.2 100

1992 17 203 110 96 22 448

3.8 45.3 24.6 21.4 4.9 100

1993 26 189 110 77 22 424

6.1 44.6 25.9 18.2 5.2 100

1994 25 202 92 59 26 404

6.2 50.0 22.8 14.6 6.4 100

Note: Examination ratings were obtained from the FDICs historical database. In some Instances examination

ratings were missing; however, from 92 to 99 percent of banks ratings were in the database. As a result, the

number of CAMEL-rated banks each year was slightly smaller than the total number of California banks in

other tables.

ering from the recession, the number of problem banks was declining relatively slowly. In

1993 and 1994, problem banks still accounted for 23 and 21 percent, respectively, of all

banks in the state.

In contrast to what happened in the recession in the Southwest, where commercial

bank equity capital and reserves declined as the crisis intensified, in California the banks
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

404 History of the EightiesLessons for the Future

Table 11.7b

CAMEL 4- and 5-Rated Institutions, California Banks versus 

Banks in Rest of U.S., 19811994

Report Number of Problem Banks/Percentage of Total

Date

(Year-end) California Banks Other Banks Total

1981 13 220 233

5.6 94.4 100%

1982 39 436 475

8.2 91.8 100

1983 51 611 662

7.7 92.3 100

1984 56 836 892

6.3 93.7 100

1985 72 1,151 1,223

5.9 94.1 100

1986 72 1,388 1,460

4.9 95.1 100

1987 55 1,245 1,300

4.2 95.8 100

1988 39 1,085 1,124

3.5 96.5 100

1989 36 1,001 1,037

3.5 96.5 100

1990 36 1,019 1,055

3.4 96.6 100

1991 78 993 1,071

7.3 92.7 100

1992 118 614 732

16.1 83.9 100

1993 99 292 391

25.3 74.7 100

1994 85 138 223

38.1 61.9 100

levels of capital and reserves increased significantly during the 1980s and throughout the recession years. These increases offered some support for the notion that the states banking

industry had been relatively undercapitalized in the 1980s. For example, in 1986, 36 percent

of Californias banks had equity capital and reserve ratios at or below 7 percent, whereas

only 19 percent of the U.S. banking industry had similar ratios (see tables 11.8a and 11.8b).
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 405

Table 11.8a

Equity and Reserves to Assets, California Banks, 19801994

Report Number of U.S. Banks/ Percentage of Total

Date Equity Capital and Reserves to Total Assets

(Year-end) <5.0 5.07.0 7.09.0 9.011.0 > 11.0 Total

1980 12 63 75 43 88 281

4.3 22.4 26.7 15.3 31.3 100%

1981 9 65 70 38 130 312

2.9 20.8 22.4 12.2 41.7 100

1982 17 63 76 40 165 361

4.7 17.5 21.1 11.1 45.7 100

1983 21 92 84 59 152 408

5.2 22.6 20.6 14.5 37.3 100

1984 17 89 117 79 150 452

3.8 19.7 25.9 17.5 33.2 100

1985 22 106 143 86 124 481

4.6 22.0 29.7 17.9 25.8 100

1986 30 145 146 74 89 484

6.2 30.0 30.2 15.3 18.4 100

1987 13 79 201 88 102 483

2.7 16.4 41.6 18.2 21.1 100

1988 14 80 198 88 93 473

3.0 16.9 41.9 18.6 19.7 100

1989 10 81 188 98 102 479

2.1 16.9 39.3 20.5 21.3 100

1990 8 46 198 119 111 482

1.7 9.5 41.1 24.7 23.0 100

1991 16 47 178 108 131 480

3.3 9.8 37.1 22.5 27.3 100

1992 13 31 137 142 132 455

2.9 6.8 30.1 31.2 29.0 100

1993 7 22 119 141 136 425

1.7 5.2 28.0 33.2 32.0 100

1994 5 21 104 125 149 404

1.2 5.2 25.7 30.9 36.9 100

Note: Data exclude Bank of America, First Interstate, Security Pacific, and Wells Fargo banks.

Capital levels improved during the second half of the 1980s as Californias banks moved

closer to industry benchmarks. At year-end 1989, only 19 percent of Californias commercial banks had equity and reserve positions at or below 7 percent; the percentage of banks
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

406 History of the EightiesLessons for the Future

Table 11.8b

Equity and Reserves to Assets, U.S. Banks, 19801994

Report Number of U.S. Banks/ Percentage of Total

Date Equity Capital and Reserves to Total Assets

(Year-end) <5.0 5.07.0 7.09.0 9.011.0 > 11.0 Total

1980 154 1,847 6,300 3,963 2,494 14,758

1.0 12.5 42.7 26.9 16.9 100%

1981 212 1,872 6,223 3,857 2,581 14,745

1.4 12.7 42.2 26.2 17.5 100

1982 257 1,953 5,972 3,821 2,765 14,768

1.7 13.2 40.4 25.9 18.7 100

1983 243 2,341 5,688 3,583 2,892 14,747

1.7 15.9 38.6 24.3 19.6 100

1984 230 2,249 5,801 3,530 2,964 14,774

1.6 15.2 39.3 23.9 20.1 100

1985 211 2,084 5,842 3,641 3,018 14,796

1.4 14.1 39.5 24.6 20.4 100

1986 324 2,402 5,609 3,466 2,867 14,668

2.2 16.4 38.2 23.6 19.6 100

1987 381 1,749 5,494 3,463 3,099 14,186

2.7 12.3 38.7 24.4 21.9 100

1988 409 1,517 5,214 3,412 3,061 13,613

3.0 11.1 38.3 25.1 22.5 100

1989 310 1,390 4,939 3,426 3,131 13,196

2.4 10.5 37.4 26.0 23.7 100

1990 266 1,278 5,005 3,263 3,003 12,815

2.1 10.0 39.1 25.5 23.4 100

1991 181 1,066 4,705 3,405 3,013 12,370

1.5 8.6 38.0 27.5 24.4 100

1992 88 717 4,150 3,781 3,245 11,981

0.7 6.0 34.6 31.6 27.1 100

1993 27 404 3,416 4,034 3,671 11,552

0.2 3.5 29.6 34.9 31.8 100

1994 38 545 3,232 3,573 3,674 11,062

0.3 4.9 29.2 32.3 33.2 100

declined continuously until, at year-end 1994, approximately 6 percent of banks had positions at or below 7 percent.
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 407

58 See Chapters 2 and 12 .

The improvement in ratios of equity capital and reserves, especially after 1991, may

be partly explained by the phase-in of risk-based capital standards and the passage of the

Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). This legislation imposed severe restrictions on undercapitalized banks.58 In addition, FDICIA-mandated risk-related deposit insurance premiums in the early 1990s also gave banks an

incentive to improve their capital positions.

Effects of the Recession on 

California Banking (II): By Bank Group

The California recession affected the performance of individual banking groups differently. Community banks and banks chartered during the 1980s, especially those headquartered in Southern California, were most affected by the recession, as reflected in the

number of bank failures. Most of the large statewide organizations, with more-diversified

loan portfolios, came through in satisfactory condition.

During the 199094 period, commercial banks headquartered in Southern California

were generally less successful than those headquartered elsewhere. Banks located outside

of Southern Californias six counties recorded a median ROA of 0.83 percent, in comparison with only 0.45 percent for banks located in the six southern counties (see table 11.9). 

Over the 199094 period, California community banks as a group earned a median return of 75 basis points on assets, significantly higher than the 63 basis points earned by the

state banking industry during that same period (table 11.4). Performance varied, however,

between the community banks inside and those outside Southern California. Those located

within Southern California had a median ROA of only 0.58 percent, while those headquartered outside of Southern California recorded an ROA of 0.95 percent (table 11.9). Banks

chartered during the 1980s, which were weakened by their poor earnings during most of the

decade, were especially vulnerable to a downturn in the economy. This group averaged only

57 basis points on assets over the 199094 period (table 11.4). Those located in Southern

California were particularly affected, earning only 25 basis points on assetssubstantially

lower than the 81 basis points earned by those located outside of Southern California (table

11.9). Given the relatively poor performance of this group and then the recession of the

early 1990s, it is not surprising that California banks chartered during the 1980s accounted

for 29 of the 47 bank failures in the state during this period. 

The recession had only a relatively modest effect on the profitability of the Big Four,

which outperformed all other groups during this period. The Big Four recorded a median re-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

408 History of the EightiesLessons for the Future

Table 11.9

Median Return on Assets for California Banking Groups and U.S., 19901994

Weighted Medians*

1990 1991 1992 1993 1994 19901994

Southern California Banks 0.92% 0.51% 0.17% 0.04% 0.56% 0.45%

Rest of California Banks 0.95 0.75 0.74 0.80 0.93 0.83

U.S. Banking Industry 0.86 0.89 1.07 1.14 1.09 1.00

California Community Banks

Southern California 1.01 0.56 0.48 0.15 0.53 0.58

Rest of California 1.06 0.94 0.85 0.92 0.98 0.95

Banks Chartered in the 1980s

Southern California 0.87 0.47 0.05 0.48 0.17 0.25

Rest of California 0.98 0.67 0.71 0.76 0.95 0.81

Note: Southern California includes Los Angeles, Orange, Riverside, San Bernadino, Ventura, and San Diego Counties.

Rest of California includes all remaining counties.

*Medians are weighted by number of banking organizations.

59 Bank of America and First Interstate Bank were the most diversified of the four organizations. Security Pacific Bank had

some limited out-of-state holdings, while Wells Fargo Bank was primarily concentrated in California. 60 During the 1980s the Bank of America was, and in the 1990s continued to be, Californias dominant financial institution.

At the end of 1984 the bank operated 1,070 branches in California, accounting for 37 percent of statewide deposits and 49

percent of the net income earned by banks in the state. But the 1980s were a difficult period for the Bank of America, which

absorbed large losses in 1985 ($431 million), 1986 ($442 million), and 1987 ($780 million). In 1988, after selling a number of subsidiaries, the Bank of America resumed profitable operations, which have continued through the 1990s. 

turn on assets of 78 basis points from 1990 to 1994, above the ROA of the other groups in

the state (table 11.4). The statewide operations of the Big Four provided a diversified earnings base that offered some protection from the recession. For some members of this group,

especially the Bank of America, earnings gathered from multistate operations provided additional support.59 Generally, loan losses recorded mostly from Southern California units

were offset or reduced by gains obtained from units located in other regions of California as

well as in other states.

However, performance varied significantly among the four organizations. The bestperforming were the Bank of America and Wells Fargo, both headquartered in Northern

California. These organizations coupled diversity of statewide operations with considerable

skill in containing credit losses. The Bank of America was not seriously affected by the recession, with an ROA of more than 1.0 percent from 1990 to 1994.60 Net income on California operations totaled $1.33 billion in 1992, $1.56 billion in 1993, and $1.70 billion in
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 409

61 See description of the credit process for commercial real estate in Bank of America Corporation, Annual Report (1992), 25. 62 Smith Barney, California Banking Report (October 18, 1990), 8. 63 Janet Lewis, The War for California, Institutional Investor (July 1990): 90. 64 Ralph T. King, Jr., New Bank Behemoth Has Big Burdens, Rich Potential, The Wall Street Journal (April 23, 1992), 1.

1994. After experiencing massive losses in the mid-1980s, the Bank of America instituted a

rigorous system of credit controls.61 An industry report prepared by Smith Barney stated:

Thanks to its ill-fated commercial real estate lending, [Bank of America] was too busy

overhauling its systems to make many [commercial real estate] loans in the 19851987 period. And it returned to the market with a conservative attitude. Once bitten, twice shy, or so

we hope.62 For Wells Fargo Bank, the fact that it focused on the California market made it

especially vulnerable to the 199094 recession, particularly given its extensive commercial

real estate exposure. The recessions effect upon Wells Fargo was felt principally in 1991,

when net income was only $23 million and ROA only 0.04 percent. The bank rebounded in

1992 (net income of $306 million, an ROA of 0.60 percent) and in 1993 and 1994 was one

of the nations most profitable banks.

First Interstate Bank and Security Pacific Bank, both headquartered in Los Angeles,

were considerably more damaged by the recession than the two organizations based in San

Francisco. Unlike Wells Fargo, First Interstate Bank was not focused entirely upon its California operations. It sought a national presence and was operating in 16 states in 1989. During the 1980s, it moved into new geographic markets by licensing its name and services to

banks not owned by the holding company. To a certain extent, the earnings from its interstate operations helped cushion the effect of the recession on loan losses in its primary marketSouthern California. Nevertheless, during the recession First Interstate incurred a loss

in 1991 (-0.24 ROA) and resumed marginally profitable operations in 1992 (0.07 percent

ROA). The bank made a full recovery in 1993 and 1994, with returns on assets of almost 1

percent. (In 1995 First Interstate was purchased by Wells Fargo.)

Security Pacific, the states fourth major organization, focused its strategy during the

1980s primarily on serving retail customers and middle-market business firms in California.63 Despite the organizations solid profit performance during the 1980s, the recession

had a major effect on Security Pacifics operations and its heavy concentration of loan exposures within the state. Security Pacific was the only major California bank that was

threatened by failure during the early 1990s, registering a loss on assets of 1.04 percent

($555 million) in 1991. In 1992, weakened by the recession, it was purchased by the Bank

of America. Before the acquisition, which The Wall Street Journal characterized as a salvage operation, the Security Pacific holding company had posted total losses of $1.41 billion in its three preceding quarters.64 After the acquisition, as a result of the continuing

recognition of loss in Security Pacifics loan portfolio, the Bank of America eventually
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

410 History of the EightiesLessons for the Future

Figure 11.9

California Bank Failures, 1980–1995

1980 1982 1984 1986 1988 1990 1992 1994

0

5

10

15

20

Number

65 Bank of America Corporation, Annual Report (1992), 48.

charged $3.6 billion of the $4.2 billion acquisition price to goodwill.65 Nevertheless, the

three large banks that then remained rebounded strongly during 1994, the final year of the

recession. Wells Fargo, Bank of America, and First Interstate had ROAs of 1.63 percent,

1.15 percent, and 0.97 percent, respectively, while all U.S. banks earned 1.11 percent on assets (table 11.4). 

Effects of the Recession on 

California Banking (III): Failed Banks

Given the severity of the California recession, the number and size of bank failures in

California were relatively modest. Over the 199094 period, only 47 banks with total assets

of $3.5 billion failed (see figure 11.9 and table 11.10). Total resolution costs to the FDIC

amounted to $766 million. All failed institutions were relatively smallthe largest had assets of only $564 million; 10 banks had assets between $100 million and $200 million; the

remaining 36 banks had assets under $100 million. The sharp decline in interest rates in the

early 1990s played a role in reducing the number of bank failures in California and else-
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 411

Table 11.10

Bank Failures in California by Region, 19901994

Resolution

Assets Costs

Institution Failure Date ($Thousands) ($Thousands) County

Northern California

1 Alvarado Bank* 01/25/91 $ 30,499 $ 4,323 Contra Costa

2 Financial Center Bank NA* 05/04/92 198,802 26,895 San Francisco

3 Statewide Thrift & Loan Co.* 11/13/92 10,335 2,341 Santa Clara

4 American Bank & Trust Co. 06/18/93 35,577 6,261 San Mateo

5 Regent Thrift & Loan Assn.* 09/17/93 7,383 1,429 San Francisco

6 Barbary Coast National Bank* 05/19/94 10,453 656 San Francisco

Total $ 293,049 $ 41,905

Central Valley

1 Placer Bank of Commerce* 03/27/92 $ 29,447 $ 5,340 Placer

2 Valley Commercial Bank* 04/24/92 25,495 4,852 San Joaquin

Total $54,942 $ 10,192

Southern California

1 Wilshire Bank National Assn.* 05/31/90 $ 22,818 $ 3,435 Los Angeles

2 Merchant Bank of California* 06/08/90 52,501 3,745 Los Angeles

3 First Pacific Bank 08/10/90 112,980 43,514 Los Angeles

4 Far Western Bank* 12/14/90 157,763 25,398 Orange

5 Manilabank California* 03/08/91 20,144 4,067 Los Angeles

6 Landmark Thrift & Loan Assn. 07/12/91 13,974 2,143 San Diego

7 Mission Valley Bank NA* 10/24/91 40,637 14,241 Orange

8 Assured Thrift & Loan Assn. 01/03/92 51,956 18,810 Orange

9 Independence Bank 01/30/92 564,201 139,551 Los Angeles

10 Mission Viejo National Bank* 02/28/92 98,283 29,957 Orange

11 United Mercantile B & T Co. NA* 03/20/92 30,218 9,893 Los Angeles

12 Bank of Beverly Hills 04/03/92 118,136 31,686 Los Angeles

13 North American Thrift & Loan 05/29/92 21,337 4,496 Orange

14 American Interstate Bank 06/12/92 40,943 7,239 Orange

15 Huntington Pacific Th&L Assn. 12/04/92 40,980 16,064 Orange

16 Columbia National Bank* 01/22/93 45,880 16,844 Los Angeles

17 First American Capital Bk. NA* 03/04/93 26,355 6,946 Orange

18 Olympic National Bank* 04/02/93 84,025 23,641 Los Angeles

19 Premier Bank* 04/08/93 51,174 9,219 Los Angeles

20 First Western Bank NA* 04/15/93 14,298 3,319 San Diego

21 American Commerce NB* 04/30/93 137,774 28,434 Orange

22 Wilshire Center Bank NA* 05/06/93 9,239 5,431 Los Angeles

23 Palos Verdes National Bank* 05/20/93 49,630 11,081 Los Angeles

24 Capital Bank of California* 06/18/93 200,138 62,163 Los Angeles

25 City Thrift & Loan Assn. 07/09/93 41,676 18,046 Los Angeles

26 First La Mesa Bank* 07/09/93 77,361 15,334 San Diego

27 Maritime Bank of California* 08/27/93 30,857 6,987 Los Angeles

28 Western United National Bank* 09/24/93 19,386 6,463 Los Angeles

29 Brentwood Thrift & Loan Assn. 10/15/93 12,972 3,271 Los Angeles

30 Mid City Bank National Assn.* 10/21/93 87,750 14,190 Los Angeles

31 Bank of San Diego 10/29/93 296,470 61,546 San Diego

32 Century Thrift & Loan 11/05/93 35,363 11,993 Los Angeles

33 Mechanics National Bank 04/01/94 149,643 41,279 Los Angeles

34 Pioneer Bank* 07/08/94 107,611 20,008 Orange

35 Bank of San Pedro 07/15/94 112,109 31,628 Los Angeles

36 Commercebank 07/29/94 119,785 14,732 Orange

37 Western Community Bank* 07/29/94 46,794 6,934 Riverside

38 Bank of Newport 08/12/94 151,026 28,212 Orange

39 Capital Bank 08/26/94 7,546 14,183 Los Angeles

Total $3,371,733 $816,123

Grand Total $3,719,724 $868,220

* Banks chartered between 1980 and 1990.
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

412 History of the EightiesLessons for the Future

66 From 1990 to 1994 the federal funds rate declined from 8.1 to 4.2 percent. This decline significantly increased the U.S.

banking industrys net income (which rose from $16.6 billion to $44.7 billion) and ROA (from 0.50 to 1.15 percent). In addition, over the same period, the number of bank failures declined from 168 to 13.

67 Ten of the failed banks were chartered in 1983, four in 1982, five in 1981, four in 1980, two in 1984, and one each in 1985,

1986, 1987, and 1988.

68 Independence Bank was headquartered in Los Angeles and had total assets of $564 million at the time of failure. Thus, it

was not counted as a community bank. 

69 During this period a total of 466 banks failed nationally, with total assets of approximately $128 billion and resolution costs

of $13.5 billion. 

where.66 The decline in interest rates produced a sharply upward-sloping yield curve, which

increased the value of bank security portfolios and raised net interest margins on new loans.

In California, the gains from lower interest rates absorbed losses caused by the recession

and permitted some institutions to write off problem assets.

The recession had the greatest effect, in terms of failures, on banks chartered during

the 1980s, especially those located in Southern California. Twenty-nine of the 47 failed

banks (62 percent) had been chartered during the 1980s,67 and 39 of the 47 were headquartered in Southern California22 of the failures involved banks headquartered in Los Angeles County, nearly four times the number of failures that occurred in the nine-county San

Francisco Bay area.68 Only 8 failures occurred in Northern California: the 6 that occurred

in the Bay Area, and 2 located in the Central Valley area (table 11.10). 

Nationally, California led the nation in total number of bank failures in 1993 (19) and

1994 (8), replacing Texas, which had the lead from 1986 to 1992. But even so, during the

first five years of the 1990s California bank failures accounted for only approximately 10

percent of the nations failed banks, 2.6 percent of failed assets, and 5.7 percent of resolution costs.69 Furthermore, the 47 California bank failures constituted only a fraction of the

number of failures that had occurred in the Southwest and Northeast. In Texas, for example,

485 banks failed during the 198692 period. In addition, during the second half of the

1980s, nine of the ten largest Texas banking organizations had either been closed or required outside assistance, whereas only one of the four largest California organizations

Security Pacific Bankwas threatened by the recession. In the Northeast crisis, 111 banks

failed during the three years 199092; in 1991 alone there were 52 failures, more than all of

the failures in the California recession. In addition, the largest failure in California had total assets of only $564 million, whereas in the Northeast much larger institutions were

closed in the 199092 period. To this extent, the California banking crisis was indeed different from those in other regions of the nation.
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 413

California Bank Failures and 

Real Estate Investment

What made California banks particularly vulnerable to an economic slowdown were

key investment choices made during the 1980s. In this period California banksratios of total loans and leases to assets substantially exceeded the national averages (and in 1990 went

above 70 percent). (See figure 11.10.)

In addition to maintaining relatively high loans-to-assets levels, the California banks

also altered the risk orientation of their lending programs by originating increasing proportions of real estate loans as a percentage of total assets. In 1989 these types of loans

amounted to more than 30 percent, significantly above the level held at the end of 1980 (see

figure 11.11). Exposure continued to increase through the early part of the recession before

leveling off in 1991 at just above 40 percent of total assets. Although this trend toward

greater real estate lending was occurring nationally, the proportion of real estate loans to total assets was significantly higher for California banks than for the U.S. banking industry.

The higher levels of real estate lending for California banks were reflected primarily in the

holdings of commercial real estate loans, which from 1980 to year-end 1989 increased from

approximately 8 percent to almost 20 percent of total assets. This trend continued into the

recession, with commercial real estate loans leveling off in 1991 at approximately 25 percent of total assets (see figure 11.12).

The switch to real estate lending was partly a function of the loss of market share of

commercial and industrial loans to the capital markets and to other competitors, a trend that

had been occurring nationally in the U.S. banking industry for some time (see figure 11.13).

In California between 1984 and year-end 1989, the median commercial and industrial loans

dropped from more than 20 percent of total bank assets to approximately 16 percent. These

types of loans continued to decline in importance in California bank loan portfolios, averaging between 10 and 15 percent in 1994. Another reason for the switch to real estate lending was that the surge in population growth in the state during the 1980s created new

investment opportunities for such activity. As mentioned above, California attracted 6 million new residents during the decade, accounting for nearly 25 percent of the national population increase. In dollar values, between 1980 and year-end 1989 annual real estate

lending by California banks rose from only $47 billion to approximately $105 billion.

The high proportion of real estate loans in California bank loan portfolios during this

period accounted for a substantial percentage of nonperforming assets as the recession hit

in the early 1990s. This fact was reflected in the rising median volume of nonperforming assets and median net charge-offs on loans and leases (see figures 11.14 and 11.15). The high

levels of nonperforming loans and charge-offs significantly affected the earnings performance of California banks during these same years (table 11.9). 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

414 History of the EightiesLessons for the Future

Southern

California

Banks

Banks in the

Rest of California

U.S.

Banks

Figure 11.10

Median Total Loans and Leases,

Southern California versus the Rest of California

and U.S., 1980–1994

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

1980 1982 1984 1986 1988 1990 1992 1994

50

55

60

65

70

75

Percent of Assets

Southern

California

Banks

Banks in the

Rest of California

U.S. Banks

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

1980 1982 1984 1986 1988 1990 1992 1994

10

20

30

40

Percent of Assets

Figure 11.11

Median Total Real Estate Loans,

Southern California versus the Rest of California

and U.S., 1980–1994
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 415

Southern

California

Banks

Banks in the

Rest of California

U.S. Banks

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

Figure 11.13

Median Total Commercial and Industrial Loans,

Southern California versus the Rest of California

and U.S., 1980–1994

Percent of Assets

1980 1982 1984 1986 1988 1990 1992 1994

5

10

15

20

25

Southern

California

Banks

Banks in the

Rest of California

U.S.

Banks

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

Figure 11.12

Median Total Commercial Real Estate Loans,

Southern California versus the Rest of California

and U.S., 1980–1994

1980 1982 1984 1986 1988 1990 1992 1994

0

10

20

30

Percent of Assets
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

416 History of the EightiesLessons for the Future

Southern

California Banks

Banks in

the Rest of

California

U.S. Banks

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

Figure 11.14

Median Nonperforming Assets,

Southern California versus the Rest of California

and U.S., 1982–1994

Percent of Assets

1982 1984 1986 1988 1990 1992 1994

1

2

3

4

5

6

Southern

California

Banks

Banks in

the Rest of

California

U.S. Banks

Note: Southern California consists of Los Angeles, Orange, Riverside,

San Bernardino, San Diego, and Ventura Counties.

Figure 11.15

Median Net Charge-Offs on Loans and Leases,

Southern California versus the Rest of California

and U.S., 1980–1994

Percent of Assets

1980 1982 1984 1986 1988 1990 1992 1994

0

0.2

0.4

0.6

0.8

1
Chapter 11 Banking Problems in California

History of the EightiesLessons for the Future 417

Within the individual banking groups, although all three groups increased their real

estate lending during the 198089 period, their portfolio choices and risk strategies differed. The Big Four organizations were less aggressive lenders in commercial real estate

than community banks and banks chartered in the 1980s. (Commercial real estate lending

includes construction and land development loans, loans secured by multifamily residential

properties, and loans secured by nonfarm nonresidential properties.) Median commercial

real estate loans as a percentage of total assets at the Big Four amounted to approximately

13 percent at the end of 1989, up from only approximately 7 percent in 1980 (see figure

11.16). For California community banks, however, median commercial real estate loans increased significantly between 1980 and year-end 1989, rising from only approximately 9

percent of total assets to approximately 20 percent. A similar pattern was observed for

banks chartered during the 1980s: between 1980 and 1989, median commercial real estate

loans as a percentage of total assets increased by almost 21 points, going from less than 1

percent to approximately 22 percent. For community banks and banks chartered during the

1980s, this type of lending continued to increase during the recession years of the early

1990s (figure 11.16). When the recession was at its fullest, the relatively high proportion of

Banks Chartered

in the 1980s

Figure 11.16

Median Commercial Real Estate Loans,

California Banking Groups versus the U.S.,

1980–1994

Percent of Assets

1980 1982 1984 1986 1988 1990 1992 1994

0

5

10

15

20

25

30

U.S. Banks

Big Four

Community

Banks
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

418 History of the EightiesLessons for the Future

commercial real estate lending played a leading role in the majority of failures of both community banks and banks chartered in the 1980s.70

Conclusion

The series of regional recessions during the 1980s and early 1990s reached California

last. However, in sharp contrast to the recessions in the Southwest and Northeast, where large

numbers of banks failed and huge insurance losses were recorded, California experienced relatively few bank failures and relatively low losses. This was the situation despite the recession that was the deepest the state had experienced since the 1930s. Some reasons for this

comparative mildness include, first, the fact that short-term interest rates declined during the

early 1990s, allowing banking industry profits to increase. Second, the most serious consequences of the recession were localized in Southern California, so that bank failures were primarily restricted to banks in this geographic area. Most banks headquartered outside of

Southern California were not seriously challenged by the recession. Third, most failures occurred among relatively smaller community banks and/or banks that had been chartered in

the 1980s, so that losses to the insurer were limited. Fourth, primarily because of the geographic portfolio diversification (both inside and outside California) of the four statewide organizations, the loan losses these organizations experienced in Southern California were

mostly offset or reduced by gains from units in other regions. Thus, the effect of the recession

was not as pronounced on the large organizations as on banks whose loan portfolios were restricted to local markets. This result also differentiates the California bank crisis from the

other regional crises: in California no large banking organization failed.71

However, although there were several differences between the California recession

and the other regional recessions, there were also certain shared elements. These included a

boom psychology that spurred development and inflated real estate prices; a shift by commercial banks into real estate lending, particularly high-risk commercial and construction

lending; and the vulnerability of banks chartered during the 1980s. At least in these three respects, the California experience essentially paralleled the experiences in the Southwest and

the Northeast.

70 The correlation between commercial real estate lending and deterioration in the asset quality of California community bank

portfolios between 1990 and 1994 has been documented. See two articles by Gary C. Zimmerman: Californias Community Banks in the 1990s, FRBSF Weekly Letter (January 26, 1996), and Factors Influencing Community Bank Performance in California, Federal Reserve Bank of San Francisco Economic Review, no. 1 (1996): 3436. For a more general

discussion of the issue, see Lynn E. Brown and Karl E. Case, How the Commercial Real Estate Boom Undid the Banks,

in Real Estate and the Credit Crunch, ed. Lynn E. Brown and Eric Rosengren (1992), 5797. 71 Because Security Pacific Bank was purchased by Bank of America without any assistance from the FDIC, it was not

counted as a bank failure.