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May 15, 1991
6GONOMIG
GOMMeNTORY
Federal Reserve Bank of Cleveland
The RTC and the Escalating
Costs of the Thrift Insurance Mess
by Christopher J. Pike and James B. Thomson
jTXlmost daily, the news media report The purpose of this Economic Commen-
on the ever-growing cost of resolving the twy is to describe briefly the structure
savings and loan (thrift) insurance crisis. of the RTC and the condition of its bal-
"The long-term challenge facing the
A year ago, the administration estimated ance sheet, and then to examine the fac-
RTC will be properly managing bil-
that the present-value cost of resolving tors that may be impeding its progress lions of dollars of assets that come
the insolvency of the now ^defunct Fed- in closing insolvent thrifts and returning from the resolution of failed thrifts
eral Savings and Loan Insurance Corpo- their assets to the private sector. and disposing of those assets in a
ration (FSLIC) fund was $130 billion. timely and efficient manner."
With the passage of time and the contin- • Creating a Public
ued deterioration of the troubled portion Salvage Mechanism David C. Cooke,
of the thrift industry, current estimates of In early 1989, the public began to recog- Executive Director of the RTC'
the final cost of the FSLIC bailout are nize the size and scope of the insolvency
half again as high. Taxpayers, who are of the FSLIC fund. At that time, the offi-
paying a substantial portion of this bill, cial estimate of the present-value cost of
wonder why the cost continues to in- resolving the FSLIC's insolvency was
crease and why the Resolution Trust Cor- approximately $130 billion. As noted in
poration (RTC) appears to be slow in a previous research paper, this loss,
ending the thrift problem. borne largely by taxpayers, is unprece-
dented—there are none of even remotely
Although the RTC is reported to have comparable magnitude in American his-
resolved many thrifts, it has not done so tory. The combined costs of the federal
quickly or completely. From its incep- bailouts of New York City, Lockheed,
tion in August 1989 through February Chrysler, and Continental Illinois Bank
1991, the RTC has disbursed $ 111.4 bil- did not even reach $9 billion. Thus, the
lion. Of the $98.3 billion used to resolve FSLIC bailout is in a class by itself, a
366 thrifts, $64 billion has been invested truly world-class white elephant.3
in receivership assets and is potentially
recoverable (see tables 1 and 2). How- Handling this white elephant is a colos-
ever, the RTC has returned to the private sal and complicated undertaking that has
sector less than one-third of the initial
required new legislation, a new institu-
receivership assets of these institutions.
tional structure, and a new approach.
In addition, there may be as many as
The signing of the Financial Institutions
510 additional insolvent thrifts that will
Reform, Recovery, and Enforcement Act
eventually have to be resolved. Critics
(FIRREA) on August 9,1989 marked
charge that the sluggishness of the
the first significant step toward resolving
RTC's salvage operation is partially
the thrift insurance mess. The primary
responsible for the escalating costs of
objective of this bill, which provides the
resolving the thrift insurance mess.
most comprehensive restructuring of
the thrift industry since the Great De- TABLE 1 SOURCES AND USES OF RTC FUNDS:
pression, is to resolve troubled thrifts INCEPTION THROUGH FEBRUARY 28,1991
expeditiously and with minimal detri-
$ Billions
ment to the economy.
SOURCES
FIRREA established an entirely new Treasury appropriations 18.8
regulatory structure for thrifts and Federal Home Loan Bank contributions 1.2
created the RTC to oversee thrift resolu- Resolution Funding Corporation borrowings 30.1
tions from January 1,1989 through Federal Financing Bank borrowings
August 9,1992.4 It also created the Total external sources 106.0
Resolution Funding Corporation (REF- Repayments from conservatorships 2.0
CORP) to provide for off-budget fund- Repayments/dividends from receiverships _LL6
ing of the RTC. The RTC's initial fund- TOTALSOURCES 119.6
ing consisted of $18.8 billion in direct
USES
Congressional appropriations of tax-
payer money, $18 billion of taxpayer Resolutions and receivership funding 98.3
funds allocated by a drafting error in Advances and other disbursements to conservatorshipsa 11.3
FIRRE A, $1.2 billion from Federal Federal Financing Bank interest _L8_
TOTAL USES 111.4
Home Loan Banks, and $30 billion from
the proceeds of REFCORP bond sales. NET FUNDS AVAILABLE 8.2
These bonds represent an additional tax-
a. Net of conservatorship advances transferred to receiverships.
payer liability, because although the in- SOURCE: Resolution Trust Corporation, RTC Re\iew, vol. 2, no. 2, February 1991.
terest on this debt is to be paid by thrifts
(through higher deposit insurance pre-
miums and assessments on Federal
Home Loan Banks), the U.S. Treasury is $64.0 billion currently held by the RTC up any profit..." and "...wipe out value
to repay the principal and is ultimately in receivership assets. Junk bonds ac- more quickly than you might imagine.1,,7
responsible for the interest payments. count for a smaller percentage of the
assets on the RTC's balance sheet — There are also indirect costs of the RTC's
• The Pace of Insolvent roughly 9 percent as of April 15,1991. warehousing of assets. Capital that could
Thrift Resolutions be used to resolve additional thrift insol-
Since its inception, the RTC has taken The delayed pace at which the RTC is vencies is tied up, reducing the speed at
366 failed savings and loan institutions returning assets to the private sector which the RTC can execute more resolu-
into receivership. Unfortunately, in the can increase the total resolution costs tions. Unfortunately, this delay adds to
majority of these cases the resolutions in two ways. The first is the deteriora- the final costs of resolving the thrift in-
cannot be considered complete, because tion of these assets while they remain surance mess, as operating losses and
the RTC has failed to return a large per- in the government's hands. One econo- deterioration of asset quality at insolvent
centage of the resolved thrifts' assets to mist contends that the RTC lacks the thrifts continue to add to the cost of
the private sector. As of March 1, 1991, proper incentives to maintain and en- resolution. This relationship is supported
the corporation has been able to dispose hance the value of troubled assets on by a recent study from current and former
of a mere 31 percent of the initial its books. Another expert warns, "The Office of Thrift Supervision (OTS) econ-
receivership assets of resolved thrifts, problem assets in insolvent S&Ls are omists, which finds that the most signifi-
with the rest being held in its portfolio highly perishable commodities, particu- cant determinant of the total cost of
(see figure 1). larly in the hands of inept or indifferent resolving failed thrifts is the number of
custodians." months the institutions were insolvent.'g
The majority of the sales have included
the most-marketable assets, such as cash Second, when the RTC holds assets in The cost of delay in closing insolvent
and securities. Furthermore, some $13 lieu of returning them to the private sec- and unprofitable thrifts can also be seen
billion of the reprivatized assets were tor, it incurs carrying costs—the costs by looking at the earnings performance
sold with an option that allows buyers associated with financing and managing of the thrift industry itself. In 1990,
to return the assets to the RTC for a full assets. These carrying costs can be a OTS-supervised thrifts (including those
refund within 90 days of the sale. The substantial part of the total resolution under RTC control) lost $13.2 billion.
remaining assets held by the RTC, pri- costs. Irvine Sprague, former Federal Although roughly 60 percent of all OTS
marily real estate and junk bonds, are of Deposit Insurance Corporation chair- thrifts were profitable, one report shows
lower quality and marketability. As seen man, argues that the costs of financing, that the industry loss was driven by the
in table 2, real estate and delinquent staff time, legal fees, appraisals, and ad- remaining 40 percent of these thrifts,
loans represent about 32 percent of the vertising are substantial and can "...eat which lost $17.1 billion. Last year
marked the fourth straight year that aggre- TABLE 2 RTC RECEIVERSHIP INSTITUTIONS
gate industry losses were driven by losses
at a minority of thrift institutions.
Amount Percent of
($ Billions) Gross Assets
• Obstacles to Efficient
Cash and investment securities3 3.1 4.8
Asset Disposition Mortgage-backed securities 1.4 2.2
Critics of the RTC's performance to date
Total performing loans 32.4 50.6
point out that the corporation's operating
1- to 4-family mortgages 14.4 22.5
policies have slowed the speed of thrift
Construction and land 3.1 4.8
resolutions and have resulted in ineffi-
Other mortgages 9.9 15.5
cient asset disposition procedures relative
Other loans 4.9 7.7
to a private salvage operation. In a recent
Total delinquent loans 12.4 19.3
study, Professor Edward J. Kane con- 1- to 4-family mortgages 2.3 3.7
trasts the RTC's salvage operation with Construction and land 2.9 4.6
that of a private salvager. He contends Other mortgages 4.5 7.1
that while the goal of a private-sector sal- Other loans 2.6 4.0
vager is to maximize recoveries on its as- Real estate owned 8.2 12.8
sets, a public-sector salvager carries the Subsidiaries 2.7 4.3
additional burden of balancing often con- Other assets _M
flicting political objectives.10 As a result, Gross assets 64.0 100.0
the RTC faces a number of restrictions
on its ability to dispose of assets. In a. Excludes $5.1 billion in cash and cash equivalents accumulated from receivership collections.
general, these constraints fall into four NOTE: All data are based on preliminary information as of February 28, 1991. Number of institutions: 366.
SOURCE: Resolution Trust Corporation, RTC Review, vol. 2, no. 2, February 1991.
categories: political and legal, adminis-
trative, information, and funding.
The magnitude of the current thrift
problem, in terms of both the number
the RTC to recognize losses quickly investments that must be evaluated by
of failed institutions and total losses,
and dispose of assets promptly, to the RTC and potential acquirers. The
has increased the extent to which politi-
prevent the total cost of the bailout RTC employs more than 1,500 people,
cal concerns can influence asset dispo-
from escalating. but critics contend that its pool of bank
sition by the RTC. With taxpayers foot-
ing a substantial part of the estimated examiners and disposition experts is
$200 billion in thrift-related losses, the Administrative constraints on the sal- too small and inexperienced to keep
operation of the RTC is subject to ex- vage operation arise from two sources. pace with the problem.
tensive scrutiny by Congress, the ad- The first is the additional layer of bu-
ministration, and the public. One can reaucracy that FIRREA imposed with Another obstacle in the evaluation proc-
argue, however, that the increased pub- the establishment of the RTC Oversight ess is the lack of any secondary market
lic scrutiny should encourage RTC Board, which was instituted to ensure in which to trade or to determine a mar-
managers to conduct the salvage opera- that the corporation conducts its opera- ket value for a substantial portion of the
tion in a manner that is consistent with tions in a manner consistent with the seized thrifts' assets. Further complicat-
broader political and social goals. public interest. However, RTC Chair- ing the valuation process is the fact that
man L. William Seidman has stated in credit risk, rather than interest-rate risk,
Congressional testimony that this board is currently the underlying cause of
Unfortunately, legislators, agency offi-
has reduced the RTC's operational flex- losses on thrift balance sheets. Assessing
cials, and analysts do not always agree
ibility and innovation and has conse- the credit risk of each borrower is more
on just how the RTC should resolve
quently hindered the speed and efficien- complex and time-consuming than ad-
troubled thrifts to serve the public inter-
cy with which the corporation can justing assets to account for unrealized
est in the best way. Individuals with a
dispose of assets. gains and losses due to interest-rate fluc-
short-term outlook want to minimize
tuations in a national credit market.
the near-term costs associated with
taking losses. In their opinion, the RTC A second source of administrative con-
should spread out the recognition of straint is the sheer magnitude of the Uncertainty about conditions in the var-
losses over time by warehousing assets thrift crisis relative to the staff resources ious regional markets also reduces the
and financing them with working capi- available to the RTC. The 556 thrifts RTC's ability to value the assets in its
tal. Individuals with a long-term out- that have experienced government in- control. Coupled with the low market
look are concerned primarily with total tervention as of March 1 represent mil- value of many of the receivership assets,
taxpayer liability and therefore want lions of individual loan contracts and this uncertainty creates incentives for the
RTC to warehouse its assets. Selling FIGURE 1 RTC RESOLUTIONS:
these difficult-to-value assets leaves the INCEPTION THROUGH MONTH-END
RTC open to second-guessing by the
press, taxpayers, and politicians, who As a percentage of total assets
may accuse the corporation of selling 50
the assets too cheaply. Unfortunately,
warehousing assets does not increase the
efficiency of markets, but instead may in- 40
crease the uncertainty concerning the
true value of assets, such as real estate,
when the market is depressed.
30
The lack of adequate funding may also
delay thrift resolutions by the RTC.
The initial $68 billion committed by
20
FIRREA has fallen well short of what
is needed to cover the losses of insol-
vent thrifts. The inability of the RTC to 10
cover losses has limited the number of
thrifts it has been able to resolve, and
the corporation has already drained off
$34.3 billion of its $50 billion of initial Aug., Sept. Oct. Nov. Dec. Jan. Feb.
funding. In fact, without an additional 1990 1991
Percentage of assets returned to private sector
$ 18 billion in funding (by way of legis-
lative error), the RTC salvage operation SOURCE: Resolution Trust Corporation, RTC Review, vol. 2, no. 2, February 1991.
would have ground to a halt last fall. 14
Funding constraints have also reduced
the working capital needed to finance • Removing Some of the Obstacles vent thrifts. First, the corporation will
the temporary holding of assets. A Congress has recently passed legislation increase the markdown to 40 percent
shortage of this capital reduces the to address some of the funding prob- for real estate assets on the market
speed at which the RTC can intervene lems that have threatened to paralyze longer than six months, and to 50 per-
and resolve thrift insolvencies, since it the thrift salvaging operation. The new cent for those held longer than 18
must eventually generate working capi- RTC recapitalization bill allocates $30 months.16 In addition, the RTC also in-
tal through the liquidation of assets. billion of taxpayer funds to absorb tends to offer mortgage-backed securi-
thrift losses and permits the RTC to ties at the rate of $1 billion per month
Much of the RTC's working capital to borrow an additional $48 billion to use once registration is completed with the
date has come from its short-term bor- as working capital. RTC Chairman Securities and Exchange Commission.
rowings from the Federal Financing Seidman recently announced that with
Bank. Of the total $75.3 billion in the newly acquired spending authority, Some analysts have argued that de-
working capital that the RTC has dis- the RTC plans to sell another 215 failed pressed real estate markets have made
tributed through March 1, 1991, ap- thrifts by the end of September 1991. it more expensive for the government
proximately one-fourth has come from to hold on to some real estate than to
Congressional appropriation, while the Although increased funding will merely give it away. Consequently, the
remainder has come from short-term finance the RTC through this period, it RTC expects to give away between
loans. These loans are to be repaid with is unclear whether it will enable the cor- 2,000 and 3,000 of the single-family
the revenue generated from asset sales; poration to resolve all insolvent thrifts. units that it fails to auction to nonprofit
however, the sluggish pace of these Recent statements by the U.S. General groups for use as low-income housing.
sales has reduced the amount of funds Accounting Office suggest that the
available for covering losses and pro- RTC's additional needs to cover losses One other initiative aimed at accelerat-
viding the working capital for addition- could exceed the entire $78 billion of ing asset sales is instituting a new bid
al resolutions. At the end of February recently appropriated funding. 15 option, whereby the RTC will include
1991, only $8.2 billion of cash was an estimate of the value of assets in its
available from the RTC's initial Con- Seidman has also reported that the RTC bid packages. The estimate is the price
gressional appropriation and from its will relax some rules in order to speed that the RTC will pay for these assets at
Federal Financing Bank borrowing the sale of $65 billion in assets (partic- closing and will apply to all institutions
authority to fund additional resolutions. ularly real estate) from those 215 insol- in RTC conservatorship.
• Conclusion 3. See James B. Thomson and Walker F. 11. This follows Kane's analysis of the con-
Cleaning up the thrift mess, the goal of Todd, "Rethinking and Living with the straints on the ability of the Federal Deposit
the RTC, is a complex and monumental Limits of Bank Regulation," The Cam Jour- Insurance Corporation to resolve bank insol-
nal, vol. 9, no. 3 (Winter 1990), pp. 579-600. vencies. See Edward J. Kane, "Appearance
undertaking. The RTC's performance to
4. FIRREA transferred the chartering and Reality in Deposit Insurance: The Case
date suggests that it has not met its
authority and supervision responsibilities of for Reform," Journal of Banking and
stated objective of resolving thrift insol- Finance, vol. 10, no. 2 (June 1986), pp.
the former Federal Home Loan Bank Board
vencies quickly and at the lowest cost to 175-88.
to the newly created Office of Thrift Super-
taxpayers. The corporation has resolved
vision. This act also transferred the respon- 12. See L. William Seidman, "Statement on
less than half of the thrifts that will ulti- sibility of thrift deposit insurance from the Predictions and Policy Statements of the
mately be closed, and in those resolu- now-defunct FSLIC to the Federal Deposit Resolution Trust Corporation," in Oversight
tions has failed to return nearly 70 per- Insurance Corporation's Savings Association Hearings on the Resolution Trust Corpora-
cent of the assets to the private sector. Insurance Fund (SAIF). tion, Hearings before the Committee on
5. See Edward J. Kane, "Principal-Agent Banking, Finance, and Urban Affairs of the
Problems in S&L Salvage," Journal of House of Representatives, 101 Cong. 2
The pace at which the RTC has resolved
Finance, vol. 45, no. 3 (July 1990), pp. Sess., January 23-25, 1990 (Government
insolvent thrifts reflects the sheer magni-
755-64. Printing Office, 1990), pp. 87-93.
tude and nature of this unprecedented
6. See Bert Ely, "Statement on Oversight 13. See Paul M. Horvitz, "Statement on the
problem, as well as constraints that reduce
Board's Strategic Plan to Make FIRREA and Strategic Plan for the RTC," in Oversight
the speed, flexibility, and efficiency of Hearings on the Resolution Trust Corpora-
RTC Succeed," in Status and Activities of the
the salvage operation. Unfortunately, tion, January 23-25, 1990, pp. 1165-81; and
RTC and the Oversight Board, Hearings.
the resulting delay continues to add to October4, 19, and November 6, 13, 1989, Irvine Sprague, "Statement on Disposition of
the ultimate resolution costs. Although pp. 92-94. Assets by the Resolution Trust Corporation,"
the recently announced procedures are Hearings, May 4, 1990, pp. 18-19.
7. See Irvine Sprague, "Statement on Dis-
a step toward streamlining operations position of Assets by the Resolution Trust 14. See "Resolution Trust Corporation Fund-
and speeding resolutions, it is clear that Corporation," Hearings before the Subcom- ing Act of 1990," Congressional Record—
. the RTC must further modify its cur- • mittee on Financial Institutions Supervision, Senate, October 27, 1990, pp. S17722-25. •
rent asset disposition policies in order Regulation, and Insurance and the Resolu- 15. See John R. Cranford, "RTC Gets
to resolve the thrift crisis with mini- tion Trust Corporation Task Force of the 'Incomplete' Grade, Urged to Improve
Committee on Banking, Finance, and Urban Records," Congressional Quarterly Weekly
mum taxpayer loss.
Affairs of the House of Representatives, 101 Report, vol. 49, no. 8 (February 23, 1991),
Cong. 2 Sess., May 4, 1990 (Government p. 457.
• Footnotes Printing Office, 1990), pp. 18-19. 16. Under current rules, the RTC marks
1. See David C. Cooke, "Status of the Reso-
8. See James R. Barth, Philip F. Bartholo- down property by 5 to 10 percent initially, by
lution Trust Corporation: Testimony before
mew, and Michael G. Bradley, "Determi- 15 percent after six months, and by 20 per-
the RTC Oversight Task Force," in Status
nants of Thrift Institution Resolution Costs." cent after nine months.
and Activities of the RTC and the Oversight
Journal of Finance, vol. 45, no. 3 (July
Board, Hearings before the Subcommittee on
1990), pp. 731-54.
Financial Institutions Supenision. Regula-
tion, and Insurance and the Resolution Trust 9. The S&L Quarterly Performance: Ratings
Christopher J. Pike is a senior research assis-
Corporation Task Force of the Committee on and Analysis, Austin, Texas: Sheshunoff In-
tant and James B. Thomson is an assistant
Banking, Finance, and Urban Affairs of the formation Services, 1991.
vice president and economist at the Federal
House of Representatives, 101 Cong. 1 10. Kane states that"... unlike a private sal- Resen'e Bank of Cleveland.
Sess., October 4, 19, and November 6, 13, vor, the RTC is saddled with the additional
1989 (Government Printing Office, 1989), objective of slowing down official recogni- The views staled herein are those of the
pp. 290-326. tion of the full size of FSLIC's losses." See authors and not necessarily those of the
Kane, "Principal-Agent Problems." Federal Resen'e Bank of Cleveland or of the
2. At the end of February 1991, 190 thrifts
Board of Governors of the Federal Reserve
were operating in RTC conservatorship, and System.
another 320 thrifts supervised by the Office of
Thrift Supervision were considered marginal.
We define a thrift as marginal if it is not in
RTC conservatorship (as of February 28,
1991) and has a total net worth of less than 3
percent of assets on December 31,1990.
Annual Report 1990 Now Available
Essay Examines How Banks
Are Weakened by Overprotection
According to the essay in the Federal "Unfortunately," explains the essay, Regulations could be gradually elimi-
Reserve Bank of Cleveland's Annual "the common view of bank failures, nated, suggests the essay, so that banks
Report 1990, regulation—rather than which is rooted in the financial collapse are subject to the same market forces
market forces—has guided the devel- of the 1930s, is misleading. It over- as are unregulated, unprotected finan-
opment of the U.S. banking system and emphasizes the likelihood and effects cial firms. "The result," says the essay,
has ultimately reduced its efficiency, of financial fragility and has been used "would be a more efficient, competi-
stability, and competitiveness. "Since to justify restrictions, regulations, and a tive, and stable financial system that
all industries exist in a constantly safety net to protect the banking indus- will not need to rely on taxpayer subsi-
changing environment," states the try and the public. A closer look at the dies to compete, or even survive, in the
essay, "this 'protection' actually creates forces that led to the Great Depression financial marketplace."
vulnerability and increases the costs of and other, earlier panics seems to indi-
bank failures." cate that poor monetary policy decisions Annual Report 1990 is available from
and a lack of timely, reliable informa- the Public Affairs and Bank Relations
The essay, entitled "The Banking In- tion caused the crises, not an inherent Department of the Federal Reserve
dustry: Withering Under the Umbrella weakness of banks." Bank of Cleveland at 216/579-3079.
of Protection," indicates that U.S. bank-
ing regulations and guarantees "have The essay documents the decline in the
been shaped by a belief that banking is relative importance of banks in the
'special.' This belief is based on the financial services market. Other firms,
fear that the economy is especially vul- such as finance companies, insurance
nerable to banking failures, panics, and companies, and brokerage houses, now
other malfunctions in banking markets. provide the same services as banks—
without special regulations and guaran-
tees. Consequently, treating banks as
separate, unique firms is unnecessary.
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