Keating Five

The Keating Five were a group of five United States Senators caught in a major political scandal in the late 1980s. The scandal centered on their relationship with Charles Keating, the chairman of the Lincoln Savings and Loan Association. Keating had made over $1.3 million in campaign contributions to the senators, who then intervened on his behalf with federal regulators from the Federal Home Loan Bank Board (FHLBB). These regulators were investigating Lincoln for its risky investment practices, which were a hallmark of the wider Savings and Loan Crisis. When Lincoln ultimately collapsed in 1989 at a cost of over $3 billion to U.S. taxpayers, the senators' actions came under intense scrutiny. The scandal became a textbook example of the corrupting influence of money in politics and the dangerous intersection of powerful businesses and their regulators, offering timeless lessons for investors about the importance of management integrity.

The five U.S. Senators at the heart of the controversy were a bipartisan group:

• Alan Cranston (Democrat of California)
• Dennis DeConcini (Democrat of Arizona)
• John Glenn (Democrat of Ohio)
• John McCain (Republican of Arizona)
• Donald W. Riegle Jr. (Democrat of Michigan)

Charles Keating was a high-flying financier who ran Lincoln Savings and Loan. Instead of sticking to the traditional, boring business of home mortgages, Keating turned Lincoln into his personal casino, gambling depositor funds (insured by the government, of course) on speculative real estate projects and junk bonds. When federal regulators began to scrutinize Lincoln's shaky finances and unorthodox activities, Keating went on the offensive. He used his financial clout to buy political influence, hoping the senators he funded would persuade the regulators to back off.

The senators held two meetings in 1987 with the regulators. In these meetings, they questioned the regulators' treatment of Lincoln, effectively pressuring them to ease up on Keating's company. For a time, it worked—the investigation was delayed. However, you can't defy financial gravity forever. In 1989, Lincoln Savings and Loan collapsed, becoming one of the largest financial failures in U.S. history. The resulting public outrage led to an investigation by the Senate Ethics Committee. While the committee concluded that no laws were broken, it found the senators' actions gave an “appearance of impropriety.” Senator Cranston received a formal reprimand for his conduct, while the other four received lesser criticisms. The scandal tarnished their careers and served as a stark public lesson on the dangers of “crony capitalism.”

This slice of political history might seem distant, but it’s packed with crucial lessons for any investor, especially those following a Value investing philosophy.

The single most important lesson from the Keating Five affair is about the character of the people running a company. Warren Buffett famously says he looks for three things in a manager: intelligence, energy, and integrity. He warns that if they don't have the last one, the first two will kill you. Charles Keating was intelligent and energetic, but his lack of integrity was catastrophic. He used Lincoln as his personal piggy bank and was willing to bend any rule and court any politician to keep the game going. As an investor, you must investigate the track record and reputation of a company's leadership. Are they transparent? Do they treat shareholders as true partners? Or do they have a history of self-dealing, poor corporate governance, and ethical shortcuts? A brilliant-but-shady CEO is a massive red flag.

Lincoln’s business model was fundamentally dependent on outmaneuvering regulators. This is a classic example of regulatory risk. Some companies thrive in gray areas, using lobbyists and political connections to fend off oversight. This can work for a while, but it's an incredibly fragile foundation for a business. A new political administration, a determined regulator, or a shift in public opinion can cause the entire structure to collapse overnight. When analyzing a company, ask yourself: Does its success depend on favorable regulations or a lack of oversight? If the answer is yes, you are investing in a company that is one election or one scandal away from disaster.

The Savings & Loan industry was supposed to be simple. But Keating transformed Lincoln into a complex beast filled with opaque real estate deals and risky bonds. This complexity made it nearly impossible for outsiders—and even some insiders—to grasp the true level of risk. The legendary investor Peter Lynch championed the idea of investing in what you know. If you can't explain what a company does and how it makes money in a few simple sentences, you should probably avoid investing in it. The Lincoln S&L collapse is a perfect illustration of this principle. Complexity often serves to hide weakness, fraud, and excessive risk.