Massive injections of central-bank liquidity and talk of an RTC-like agency to absorb potentially vast quantities of bad assets gave the markets respite, but one wonders for how long. I remember writing about the S&L crisis and the role of the Resolution Trust Corporation nearly 20 years ago. The notion that the RTC is a model or precedent for the kind of action now being contemplated is questionable. The RTC swallowed hundreds of little thrifts whole. It was not primarily a selective buyer of bad assets from huge ongoing entities. And the assets it acquired through this process were much simpler (hence easier to value and dispose of) than the assets in question today. This is to say nothing of the scale. The S&L crisis seemed enormous in scope at the time. It was puny compared to the situation requiring resolution today.
Looking back from this distance, one thinks of the RTC as a success. That may be its principal virtue as a "model": it offers reassurance. At the time, however, the entire episode was a slow-motion mess, and politically fraught throughout. Almost from the beginning, the RTC was underfunded; more than once, its own collapse for lack of resources seemed imminent; and it was the subject of occasionally bitter, invariably partisan bickering for years. Democrats in Congress were usually reluctant to provide the additional funds requested by the Bush (senior) administration.
One thing the episode does underline--and this is far from reassuring--is the inescapably political character of a comprehensive, as opposed to ad hoc, response. Why was it the Fed, and not the Treasury, that quasi-nationalised AIG (not a bank but an insurance company, over which the Fed has no direct oversight responsibility)? Because the Fed has elastically-defined emergency powers that the Treasury does not. Deleveraging an entire financial system under duress is a protracted fiscal operation. In moving from instant-response-to-crisis mode to a comprehensive resolution regime which will have to be in place at huge expense for years, the Fed can no longer be the prime mover. And the Treasury will need legislation--not just whatever might be rushed through Congress next week or the week after, but on a continuing basis right through the next administration--to provide the authority and the cash for its actions.
When you look at the RTC model that way--take the current problem in all its seeming intractability; now give Congress a leading role--it is not so reassuring. But it will have to be that way. There is no alternative.
Weren't early estimates of the cost of the S&L bailout in the $500B range, with the actual cost to the US treasury around $120B, in circa 1990 dollars? Has anyone dared to estimate the potential government liability this time (a moving target with some mutually-reinforcing variables)? Total write-downs are so far put at $500B, but this isn't the government's tab. With $120B being about $200B in today's dollars, and if one scales per GDP, might the hit on taxpayers be about the same? (That said, one wonders whether horrible surprises are in store as the actual positions of these banks/companies are revealed -- accounting chicanery being the unofficial national sport.)
Even if the solution won't look like the RTC, aren't there are still parallels to the S&L collapse, especially the combination of deregulation with government guarantees (if implicit or after-the-fact in this instance)? I couldn't believe my ears last March, right after the Bear Stearns collapse, when John McCain recited Republican boilerplate on deregulation. Why isn't the Obama campaign reminding people of McCain's starring role in the S&L scandal and some of these recent remarks?
Clive,
Is it true you have three testicles?
One thing I don't understand is why the US Government has to buy the toxic mortgage backed securities as opposed to offering some guarantee for them. My understanding is that (1) virtually all of the securities in question are worth less than face value but more than zero, but (2) the absence of willing buyers means that the securities' current market price is below what they ultimately might be worth, and (3) mark to market requirements mean that holders of the secutities (financial institutions) have use the curent market price on their balance sheets, which in turn means (4) their balance sheets suck and no one is willing to extend further credit to them.
So rather than taking ownership of the mortgage backed secutiries, couldn't the government alter the risk profile of hlding them. At present, a buyer faces the possibility of realizing the full loss. But commentators assure us that the full loss (i.e. a 100 per cent loss on the securities, that in fact they are worthless) is very unlikely.
So look at the probability distribution for per cent loss and compare this with current market price and you also get the probability distribution for per cent if you buy and hold the security. Evidently the latter is really ugly at this point. So why not have the government offer a guarantee that cuts of the bottom of the loss distribution, e.g., a guarantee that it compensate for any losses (due to non-payment of the underlying mortgages) up to X or Y percent of the nominal face value of the bond? X or Y would vary with the particular characteristics of the bond. This would create a floor for prices and also increase the expeceted value from buying and holding the bond since it would eliminate the worst case parts of the loss probability distribution?
Obviously difficult to do, but it gets the government out of the ownership business -- which even as a liberal I am pretty sceptical about -- and facilitates markets doing what they are generally pretty good at interms of valuing assets (maybe not the best time to make that argument but ...)
To clarify my question above, I made a mistake and the 1st sentence of the 3rd paragraph should read
So look at the probability distribution for per cent loss and compare this with current market price and you also get the probability distribution for per cent gain if you buy and hold the security until maturity (or the underlying mortgages have been paid off).
Gene,
It seems simpler just to buy the distressed mortgage notes at significant discounts to face -- CNBC is saying maybe 30 cents on the dollar. That would put a floor under prices, and allow banks to take losses but at least get something for these assets and replenish their capital. When the dust settles in 7 years, the federal government might be able to get 50-70 cents on the dollar for these assets and will probably make a profit on the deal.
The bigger political question that Clive doesn't raise is: what are the chances Democrats in Congress will try to kill this legislation, in the hopes of letting everything crater before the election?
Fred
Thanks, but it's not clear to me why buying and holding the distressed bonds is simpler than offering some sort of limited guarantee on them.
We need to buy the assets at prices that represent the distressed value and doesn't include interest calculations, and figure out someway that real estate moguls, developers , and contractors do not profit on the distressed assets as they did with the original RTC
As a tax payer i feel I own all this stuff and I want the money to comeback to me
I heard a national real estate professional suggest that all the little guys and some of those not so little that bought beyond their means be able to get 4.5% or less 30 year fixed mortgages. It sounds like a reasonable idea if the unemployment rate doesn't skyrocket.
In the 70s when i should have bought a house interest rates were 12% plus and I couldnt afford it. I bought my first house at 50
Well worst case scenario, the feds buy all the properties at .30 on the dollar and turn them over to state and local govs for all their affordable housing programs.
At least that saves some taxpayer cost of acquiring new affordable housing for the kagillions of programs that are out there for that purpose.
Robbing from peter to pay paul but what other choice is there?
What is a Resolution Trust Corps?- a socialist solution or lack of creativity and Trust on the part of our governnment to allow private companies to hold distressed assets.... and then have the US govt. insure them- (Our govt. could in fact make money by selling insurance to the holders) and thereby save capitalism- otherwise the psunami hits and it is the end of capitalism as we know it in America.