Yesterday the Fed and Treasury departments proposed massive financial stability measures, including a short-selling ban on financial stocks, a plan to back money market funds for consumers and institutions, and a facility under which financial firms can unload debt they can’t otherwise move to the Fed and Treasury. This last component is a way of government participating until markets can stabilize themselves. Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke, their respective teams and Congress are working on the plan this weekend and it might look something like the Resolution Trust Corporation that was set up in the wake of the S&L crisis to dispose of bad or troubled bank assets.
Below is part of a helpful Q&A from TheStreet.com. Most notable is at the end when they say that Congress might have to regulate credit default swaps, which are a major culprit in this crisis. If you click the Credit Default Swaps tag below, you will see some of our previous coverage on what these are and why they’re such a problem.
What was the Resolution Trust Corporation (RTC)?
The RTC was created following the savings and loan crisis in 1980s. The government inherited thousands of failed small banks and had to dispose of the real estate assets and mortgage-related loans of the thrifts. It originated as part of the Federal Institutions Reform and Recovery Act of 1989. Before the RTC was formed to deal with the mess, the Federal Savings and Loan Insurance Corporation (FSLIC) had closed 294 thrifts.
What did the RTC do?
The RTC provided two functions. It shuttered many of the failing institutions, which wound up totaling 747. The total amount of assets equaled $394 billion. It then liquidated those assets over a period of time until it was folded back into another federal agency — the Federal Deposit Insurance Corporation (FDIC).
How much did the RTC cleanup cost the taxpayer?
According to analysis by the FDIC, the total amount incurred by the taxpayer came to $75.6 billion, while the private sector absorbed just $7.1 billion. The taxpayer covered more than 90% of the cost of the bailout. The FSLIC also accumulated losses. The total tab to the taxpayer as of 1999 came out to $123 billion, or about 81% of the total costs.
How will a “new” RTC differ from the old RTC?
It would likely be very different. So far, only 11 banks have actually failed in the U.S. in 2008, and many of the assets are held by a wide variety of investment institutions. Thus, widespread bank failure hasn’t been the issue, yet.
The crux of the issue comes down to complexity. The securities industry has changed dramatically since the early 1990s. The Commodities and Futures Modernization Act of 2000 led to the widespread use of credit default swaps. The size of the credit default swaps market has been estimated at roughly $45 trillion. Many of the credit swaps involved the use of mortgage-backed securities as collateral for counterparty risk. Some institutions assumed very little risk for the top tranches of those securities, often assuming the safety of a U.S. Treasury. Clearly, that was not the case.
A new RTC would have a very difficult job. Not only would the entity have to decide exactly what paper qualifies, but it may also have to decide the implications to the financial system, considering the size of the credit default swap market. As Paulson commented today, the key would be to ensure stability and recovery in the housing market — the root of the problem. However, Congress may be forced to consider regulating the opaque and unregulated market of credit default swaps.