THE PLANK SEPTEMBER 19, 2008
Clay Risen is managing editor of Democracy: A Journal of Ideas and a contributing editor at World Trade. His first book, A Nation on Fire: America in the Wake of the King Assassination will appear in January.
In recent days, policymakers and financial experts have circled around the idea of creating a government entity--in the model of the Resolution Trust Corporation (RTC)--to buy up failing assets of financial institutions. As former Treasury Secretary Nicholas Brady, former Federal Reserve Chair Paul Volcker, and former Comptroller of the Currency Eugene Ludwig said in a joint statement on September 17, "This new governmental body would be able to buy up the troubled paper [i.e., debt] at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management."
But, er, what was the RTC, and could something like it work this time around?
What Was It?
By 1989, so many savings and loan institutions had gone under that the Federal Savings and Loan Insurance Corporation (FSLIC), created by Franklin Roosevelt to insure S&L deposits, was deemed irreparably insolvent (previous insolvencies, in 1986 and 1987, had been answered by federal recapitalizations).
On February 9, 1989, President George H.W. Bush introduced the Financial Institutions Reform, Recovery, and Enforcement Act. The act was important for a number of reasons--it shut down the FSLIC and created other institutions to shore up the failed system for regulating and insuring S&Ls--but most significantly, it created the RTC.
The RTC was a time-limited (five-year) asset-management agency that would take over the liquidation of all FSLIC-insured entities to go bankrupt between January 1, 1989, and August 9, 1992. The RTC was overseen by the board of directors of the Federal Deposit Insurance Corporation (FDIC), and the bulk of its staff was taken from FDIC rolls.
Did It Work?
Yes. Despite some haggling between the administration and the Democratically controlled Congress, as well as between the administration and the Treasury Department (which wanted to make sure it had significant control over the new agency), the RTC did its job as charged: Between its enactment and the end of its charter, in 1995, the RTC managed the closure of 747 S&Ls, with an asset total of $394 billion, effectively solving the savings-and-loan crisis at a relatively low cost to taxpayers. (I say "relatively low" only in comparison to the alternative, which would've been a massive drain on the economy. As it was, the RTC needed much more money than initially projected, and contributed significantly to the budget deficits in the early 1990s.)
Can a Similar Model Work Today?
Maybe. The idea of a disinterested public agency--one not driven by profit motive or special interest--intervening to resolve Wall Street's mess is attractive on the surface, and the RTC's past success seems to give the idea credence. As Brady, Volcker, and Ludwig wrote, "It is certainly the case that the new institution we are proposing will in the short run require serious money. That will involve a risk to the taxpayer; but the institution, administered by professionals, means that ultimate gains to the taxpayer are also possible."
But there are a few troubling differences. Most notably, while the assets underlying the failing S&Ls were relatively easy to price and sell, the assets in question today--countless types of credit derivatives--are dizzyingly complex. Moreover, while the RTC took over failed S&Ls, the new proposed agency would take over failing assets of existing banks. Those banks will have an incentive to influence the new agency to give them the best deal possible. That would mean a lengthy negotiation process in any case; in dealing with convoluted and hard-to-value assets like "collateralized debt obligations," it could be endless.
Not that the banks would wait until the agency is open for business to get a good deal. The pressure on Congress to shape Wall Street-friendly legislation will be enormous. In 1989, the Bush I administration was just getting going, and was therefore able to spend significant political capital to prevent special interest groups from loading down the legislation with riders or complicating subsidiary tasks.
We face the precise opposite situation today: A president weak by even lame-duck standards, with almost no pull in Congress. Add to that a heated presidential campaign season, and it seems very unlikely that cool-enough heads will prevail.