Good Read On The S&L Crisis

SEPTEMBER 25, 2008
What We Learned From Resolution Trust
By L. WILLIAM SEIDMAN and DAVID C. COOKE
As individuals who were intimately involved in the resolution of this country's last financial crisis, we follow with great interest Treasury Secretary Henry Paulson's proposal to acquire distressed real-estate assets from financial institutions.
The current situation threatens our economy more than the savings and loan and banking crisis of the 1980s and early 1990s. The Treasury secretary should be congratulated for moving quickly and decisively.
We would like to offer some thoughts based on our experiences in starting up and operating the government-owned Resolution Trust Corporation, as well as a similar type of operation undertaken by the Federal Deposit Insurance Corporation for dealing with failed banks.
The RTC was charged with resolving nearly 750 failing savings and loan institutions holding $400 billion in assets, and the FDIC had an additional $200 billion from failed banks. Most of these assets were loans to homeowners, builders and developers. Many of the assets, especially construction and development loans, had no established market or "fair value."
The major difference between then and now is that the RTC was, with only a couple of exceptions, dealing with S&Ls closed by their chartering agency. This meant the RTC took over the assets after the institution failed, not before. So the RTC did not have to first negotiate a "fair value purchase price" with a troubled seller. Our experience with past U.S. bank and S&L assistance efforts, as well as those of other countries, leads us to believe that deciding what price to pay -- and which institution to "assist" by buying their assets -- will not be easy.
Guidelines should be established regarding which institutions will be assisted, and how the government will minimize losses, should "fair value" prices prove too high. One option is to not pay all cash upfront. Another method of protecting the taxpayer against overpayment would be for the government to have the right to recover some part of losses suffered on the later sale of assets. Other countries with asset-acquisition programs found themselves conflicted between paying too much to help the bank and trying to avoid losses eventually realized.
Clear guidelines for the management process should be established as promptly as possible for the real-estate loans and/or mortgage-backed securities acquired by Treasury. Like those owned by the RTC, all will require some level of active management.
Buying and managing home mortgages acquired by Treasury will be very challenging. Valuation will be heavily influenced by local real-estate markets and the actions available to the lenders. Restrictions on lender actions or sale prices should be avoided to help maximize recoveries and minimize taxpayers' losses. Restructuring loans often provides an attractive option that avoids foreclosure and keeps families in their homes. But it is important that the lender be allowed to pursue other options when determined to be in the best interest of the taxpayer.
The most difficult loans for the RTC to manage were loans to developers and builders. Our guess is such loans are a looming problem that has not yet been fully recognized. While it is not clear if the proposal currently addresses such loans, it should. Their treatment will impact the property values underlying loans acquired by Treasury.
The RTC started a number of sales initiatives. For the more difficult real-estate loans and properties, we started hiring contractors to manage and sell the assets. But aligning the interests of contractors with the RTC proved very difficult.
The RTC saw that the larger its inventory of distressed assets became, the more the overhang impeded the ability of the markets to determine value and function effectively. We concluded that the only way to stimulate markets as well as avoid conflicting mandates was to quickly move assets into private-sector ownership and expertise, by selling them in bulk in an open and competitive manner.
Here are the most important lessons we learned from our experiences in the late '80s and early '90s:
- Acquired assets require active management. Assets tend to lose value while in government hands, as the government seldom can duplicate a private owner's interest in enhancing value. The RTC employed over 10,000 people in the first year of operation.
- Holding large inventories of assets will lead to depressed prices. No one wants to buy when the market has a large overhang of assets just waiting to be dumped when prices improve.
- To get the market started, assets have to be sold at very low prices. Such sales will attract buyers, with a resulting increase in prices. At the same time, selling at low prices could trigger accusations that the agency is "depressing the market."
- Every government sale or purchase creates winners and losers. This results in intense political and economic pressures to influence the actions of the agency. The RTC's independent governance and operations protected against fraud and political influence.
The Treasury proposal will undoubtedly raise many conflicts similar to those seen by the RTC. In our experience, government ownership and management of assets rarely increases value. Moving assets openly, fairly and promptly to sound private-sector owners is the best way to minimize taxpayers' losses. If the RTC hadn't adopted this approach, it might still be around today.
Mr. Seidman is former FDIC and RTC chairman. Mr. Cooke is former deputy FDIC chairman and RTC executive director.