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The Massachusetts
Institute of Technology reports that Agency's Proposal To Package S&Ls'
Assets Questioned.
(emphasis mine) [my
comment]
Agency's
Proposal To Package S&Ls' Assets Questioned;
RTC
Securities Aid Investors, Not Taxpayers, Critics Say
By Susan Schmidt, Washington Post Staff Writer
Thu, 12 Nov 92 04:42:06 EST
The federal government is turning increasingly to Wall Street to unload
the enormous loan portfolio it has inherited from failed savings and loans, a
strategy that some experts say looks good now but could
cost taxpayers billions of dollars over the next few years if it backfires [typical
Washington solution]. Instead of selling the loans directly to
investors, the Resolution Trust Corp. is packaging loans
together and selling bond-like securities backed by income from the loans.
The difference is, when the government sells a loan, it usually takes a loss
on the transaction but it also washes its hands of the problem. Under the new
plan, called "securitization," there is a greater
risk that losses could continue to show up years from now.
Albert V. Casey, the RTC's chief executive and a champion of the strategy,
said it is the cheapest, fastest way to dispose of the RTC's $128 billion
stockpile of S&L assets, most of them troubled loans and real estate.
But other RTC officials fear that government guarantees attached to
the securities to make them more attractive to investors will prove far too
generous. [The government response to EVERY banking crisis is to
throw government guarantees at the problem rather than paying the true cost]
The draft of an internal RTC study on sales strategies quotes one agency
official predicting that investors will take advantage of the guarantees to
dump "tens of thousands of loans" back on the government. That
would raise the cost of the S&L cleanup to taxpayers and cause it to drag
on for years more.
By taking hard-to-sell assets to Wall Street, "the RTC takes major
risks," according to the study team, which has prepared its report for
top Treasury and RTC officials.
The investments the RTC is creating are modeled after the securities
sold by institutions such as the Federal National Mortgage Association
(Fannie Mae) [the “securities sold by Fannie Mae” were
created by the government to solve a past banking crises], which are backed
by conventional home mortgages, with the monthly payments providing income to
the investors.
The RTC, however, is taking this approach in an entirely new direction
with its offerings of securities backed by large commercial loans of
varying quality. [Notice this: the government leads the way towards insane
financial innovation. The treasury dealt in OTC derivatives in the 1960s. The
government’s desire to patch up the banking sector has been the leading
force behind securitization. Etc…]
Even riskier are soon-to-be marketed RTC securities backed by problem
loans whose borrowers are not making payments or have defaulted. Dubbed
"Ritzy Maes" by Wall Street because of their resemblance to Fannie
Mae securities, the RTC bonds pay a higher rate of return than U.S. Treasury
securities.
The value appears to far outweigh the risk of loan defaults to investors,
some Wall Street experts say. "It's absolutely a great deal," said
one of New York's most sophisticated securities buyers.
In fact, most of the risk stays with the government [It has
acted FAR more recklessness than EVEN the worst financial institutions].
Buyers point to a number of guarantees, including one on most of the bonds
issued so far stating that the underlying loans from defunct S&Ls were
"proper" and "prudent" when originally made. Because the
RTC has only scant information about many of the loans, it can't know how
many loans were in fact improper or imprudent, and thus it could end up
paying much more to the investors than it expects, according to experts,
including some interviewed by the RTC study team.
If a loan goes into default, for example, investors who can show that the
information about the loan was wrong or incomplete may be able to claim a 100
percent refund from the government, experts said. If a claim against the
guarantees is successful, the government is stuck with the loan loss.
Underlying the debate is an even more fundamental question about the
mission of the RTC, a temporary agency created to clean up the wreckage of
the more than 700 defunct S&Ls.
…
"There will be some liability, but I think when the economy recovers it
will be little liability."
Others see potential hazards in the way the RTC is proceeding.
Deputy Treasury Secretary John Robson said he and members of the RTC's
Cabinet-level oversight board favor exploring new ways of selling the worst
of the agency's assets, including marketing securities on Wall Street. But,
added Robson, the agency's moves into riskier securities "raise some
serious questions that you really want to take a look at."
Some RTC officials, along with critics on Capitol Hill and in the real estate
industry, said the RTC could get as much or more for commercial and
nonperforming loans (those that are not earning interest) by selling them
outright, without the risks of Wall Street sending bad loans back to
taxpayers. [This makes no sense. Loans with government guarantees will
always sell for more.]
An investor who "buys" a security backed by loans assumes the
original role of the lender, using a loan servicing company to collect income
from the borrower.
Robson agrees with the critics, in part. "It's really not a sale all
the risk is with the RTC," he said. "It's somewhat more
costly than selling whole loans," but that, he said, "will
take you from now till kingdom come."
Casey and his assistants say they can get more for the loans through Ritzy
Mae sales. The RTC averages only about 70 cents on the dollar
selling sound commercial loans outright, but will end up with 85 to 90
cents on the dollar turning those loans into Ritzy Maes, they said. [See?
Rather than bite the bullet and sell loans for 70 cent on the dollar, the
government chose to reduce the cost using government guarantees, at enormous
risk]
"Our experience in selling commercial loans in whole loan form, even
better quality portfolios, was that we we got either no bids or very low
bids," said RTC securities sales chief Michael Jungman. There are
"just not a lot of buyers of commercial loans out there in the world
today."
There is wide disagreement on that point.
The FDIC, which has a much smaller portfolio of loans to sell than does the
RTC, continues to favor direct sales of the loans to investors, rather than
the RTC's approach.
And Casey and other top officials get an argument from some inside RTC.
"The field offices feel capable of selling most assets (directly), and
think that they could maximize recovery values," according to the RTC's
sales strategy study.
"RTC-Washington, on the other hand, has taken
control of most assets and is packaging them to achieve maximum volume of
sales." [Washington wants to quickly deal with the problem with
government guarantees]
…
Bond-rating agencies require the RTC to set aside large cash reserves from
the proceeds of their Ritzy Mae sales, usually 25 percent to 35 percent, to
protect investors against losses if some of the underlying loans go bad.
The RTC's risk is intended to be limited to the amount of those reserves. If
loan losses exceed the reserve amount, the investors are supposed to suffer
the loss.
But the risk can shift back to the federal government because of its
guarantees known as representations and warranties that the information it
provides investors about the condition of the loans is true.
If it's not, the government and ultimately, the taxpayer can be required to
reimburse investors when borrowers stop paying.
These guarantees have helped make the Ritzy Mae securities exceedingly
popular with investors but have conjured up fears of a "black
hole" of potential liability for the RTC.
"A lot of pension funds are buying this stuff because they (the
RTC) will never be able to defend their reps and warranties," said one
large investor.
The RTC staff report quotes one official as saying 10 percent of the
loan pool sold on Wall Street is expected to come back to the agency
through representation and warranty claims.
Investors actually have a perverse incentive to pursue such claims because
the value of their bonds can improve if they are successful in dumping the
bad loans back on the government.
"I'd say it's an open secret. Wall Street [and Washington] knows exactly
what's going on," said one investment banker who believes RTC securities
will come back to haunt taxpayers.
Top RTC officials, however, have denied that they are exposing taxpayers to
huge future liabilities. [this is called lying]
"On the reps and warranties issue, I mean that's like the big lie
floating around," said Lamar Kelly, vice president of the RTC for asset
sales. "And I guarantee the people you're hearing it from are the people
who want to buy on a whole loan basis. And guess what? They want to make
their dime off the government too."
Kelly said investors have made few claims against the RTC based on the
guarantees. But if a wave of claims is indeed coming, it
won't be for a year or two more after the guaranteed loans default and turn
into losses.
CNN reports about
the need to speed up the S&L cleanup.
TIME
TO SPEED UP THE S&L CLEANUP Another crisis looms unless Congress votes
more money for regulators to close down failing thrifts. Delay is costing
taxpayers hundreds of millions.
By Mark D. Fefer REPORTER ASSOCIATE Antony J. Michels
November 16, 1992
(FORTUNE Magazine) – AFTER THE ELECTION, Congress will finally have
to face something it has been avoiding for more than six months: appropriating
the funds to continue cleaning up the savings and loan industry. That
effort has been stalled since April because the House of
Representatives has refused to vote more money for the Resolution Trust Corp.,
the agency charged with mopping up failed thrifts. According to the Treasury
Department, each day of delay adds some $6 million to the final cost of
the cleanup, which means that congressional inaction has cost
taxpayers nearly $1 billion so far.
The irony is that the RTC, after a stumbling start in 1989, is doing good
work, creatively shucking properties, loans, and securities to recover the
money lost when the S&Ls welched on depositors. It can continue selling
off its bloated inventory through 1996, but next September it passes the job
of covering the losses of thrifts that go under to an industry-sponsored
insurance fund called the SAIF (Savings Association Insurance Fund). The SAIF
is also effectively broke and ill equipped to finish the job. Unless these
agencies get the money they need, a climate of crisis could overtake the
S&L industry again.
[Congress Responded By Passing The RTC Completion Act Of 1993, Which Extended
The Receivership Authority Of The Rtc From September 30, 1993 To January 1,
1995, And Provided It With $18.3 Billion To Finish Its Cleanup Operations.
This Additional Funding And The Extension Of The RTC's Receivership Authority
Were Important First Steps In Placing The Saif On Sound Footing. However,
Further Legislation Will Be Required Before Taxpayers Have Any Measure Of
Safety From Failed Thrift Losses.]
It's not hard to see why politicians run from the S&L mess: It's
enragingly expensive and poorly understood by their constituents. The
government pledged $60 billion to shore up the old savings and loan insurance
fund, FSLIC, back in 1988. Since then, the Resolution Trust, which took over
from FSLIC, has spent $84 billion more. Now RTC chief Albert V. Casey wants
another $43 billion from Congress, promising that this is his last request.
But no one has bothered to explain to the voters where all this money
is going and why they should support the process. The public perception
is that the S&Ls are another bailout a la Chrysler, where government gets
involved in propping up a failing private business and rescuing fat-cat
executives. But the truth is that this so-called bailout is nothing more than
making good on the government's promise of deposit insurance. The fat
cats [ie: the politicians which deregulated the industry and let the
problem fester and grow.] already had their free ride in the Eighties,
when lax regulatory oversight allowed them to fritter away depositors' money.
Now the government has to cover those deposits, most of which are fairly
modest -- the average being $9,000.
Here's how the cleanup has been working: The Office of Thrift Supervision,
which regulates the S&Ls, takes over failing institutions and then hands
them to the RTC to sell or liquidate. These sorry thrifts usually have a
negative net worth, meaning the value of their assets (loans, securities,
real estate, and so forth) falls short of their liabilities (chiefly customer
deposits). To dispose of a thrift, the RTC has to make up that difference. Since
the agency's pockets are empty, it has to hang on to and manage the
money losers sent from the Office of Thrift Supervision. They now
number 70 and counting.
…
The agency has shifted its marketing strategy to play to its strength: the
sheer volume of merchandise it has for sale.
It has deemphasized the retail approach of flogging assets piece by piece in
favor of auctions, securitizations, and bulk sales to unload
hundreds of millions of dollars of assets in a single deal.
…
Says Gary R. Horning, a principal with Richland Interests in Houston, which
is bidding for the Great American package: ''It's true that some of these
assets will sell at a discount just because they're in a pool. But some
won't be sold for ten years unless they're pooled.''
Sweeping assets off the books -- fast! -- is Casey's goal. An empty
office building can easily cost the RTC 20% of its book value annually for
maintenance, taxes, and insurance without providing any income in return. Upkeep
on the agency's largest piece of real estate, the 23,250-acre Banning- Lewis
ranch outside Colorado Springs, Colorado, has already run the government $1
million since regulators inherited the property in 1989.
''It's just too expensive to carry this stuff,'' says Casey. ''We've got to
get it off our books.'' But selling real estate today can result in
embarrassing discounts. GE Capital bought those 47 shopping centers for
less than their construction cost. The asking price for the
Banning-Lewis ranch has been cut in half over the past year to $24 million,
10% of the land's book value.
Most experts agree with the Casey approach.
Edward J. Kane, a finance professor at Boston College, has argued from the
beginning that the RTC should not be in the business of buffing up dingy real
estate, hoping for the market to turn around.
''It's important to move these assets into the private sector,'' Kane says.
''The properties need a firm entrepreneurial hand to maximize their long-term
value.''
In fact, Bert Ely, a banking consultant in Alexandria, Virginia, believes
that a turnaround in the real estate market depends on a quick inventory
clearance by the RTC. He says, ''Prices stay depressed as long as you
have that overhang.''
The high-volume approach is also helping get rid of commercial and
residential mortgages, which are roughly half the RTC's remaining assets.
Since June 1991 the agency has sold nearly $30 billion of securities backed
by pools of these mortgages.
Kenneth Bacon, the former Morgan Stanley investment banker who heads up the RTC's
securitization program, says proudly: ''Every month we come to market
with $1. 5 billion to $2. 5 billion in new issues. And we're the gang that
supposedly couldn't shoot straight.'' Known on Wall Street as Ritzy
Maes, these pass-throughs have been absorbed into the more than $1
trillion dollar mortgage-backed securities market with little impact on
prices [not a natural phenonmenon (ie: gold leasing picked up big time)].
The RTC has been among the first to sell securities backed by
commercial loans [lets congratulate the government for its wonderful
contributions to the practice of securitization (sarcasm)], and in the
process found a new group of buyers -- institutions. They wouldn't normally
want mortgages on office buildings today, but they are willing to buy RTC
securities backed partly by them. So are foreign investors, who typically lap
up as much as a third of the offerings. Michael Jungman, vice president for
Capital Markets at the RTC, maintains that, in general, securitization
results in prices 9% higher than could be realized selling the underlying
loans. [it is the government guarantee that adds the value, not
securitization]
…
What's ahead for the cleanup? More institutions need to be shut down.
Timothy Ryan, director of the Office of Thrift Supervision, reckons that 31
S& Ls are now candidates for government takeover in the next two years,
and another 50 are on the edge.
The Congressional Budget Office expects several hundred thrift failures
through 1995. But the Savings Association Insurance Fund currently
has less than $200 million in its kitty in preparation for taking over the
cleanup next September. Norman M. Jones, head of the SAIF's Advisory
Committee, estimates that the fund will require a $32 billion contribution
from taxpayers over the next eight years.
But now that the money must actually be appropriated, the usual political
paralysis has set in. The Bush Administration didn't include a
contribution to the fund in its fiscal 1993 budget.
According to Assistant Treasury Secretary Mary C. Sophos, the
Administration considers it ''more prudent'' to wait until fiscal 1994 to see
''whether taxpayer funds will actually be needed.'' The stage, then, is
set for yet another dismal cycle of political inaction, mounting losses, and,
ultimately, higher tax bills.
Even if Congress finally gives the RTC the money it has asked for, one more
costly chapter in this saga is waiting to be written next September when the
SAIF rattles its tin cup. Don't put your wallet away.
The Baltimore Sun
reports about Tackling the S&L Cleanup.
Tackling
the S&L Cleanup
December 03, 1992
President-elect Clinton has little choice but to tackle the savings and
loan cleanup question early in his administration: Every day's delay costs
the U.S. treasury $6 million-and prolongs the political and fiscal headaches
for the new administration in coming to grips with this nightmare.
This isn't a popular issue. In fact, Congress would just as
soon never vote again on another bailout bill. But the harsh reality is that
between $25 billion and $50 billion are still needed to close insolvent
savings and loans and pay off all the depositors. Anywhere from 50 to
400 more floundering financial institutions may have to be closed before it's
over. That's an enormous burden which will only add to the mammoth
federal deficit, but the sooner Mr. Clinton disposes of this problem, the
better for everyone.
My reaction:
Consider the situation in the early 1990s:
1) Through the
government guarantees attached to RTC securities, the US was liable for
BILLIONS if the economy slipped into recession.
2) Recession
would force the closure of another 50 to 400 floundering thrifts, costing
billions.
3) Recession and
a worsening of the financial crisis would further depress the housing market,
causing defaults on government backed mortgages to spike and costing
billions.
4) Major
commercial banks were ALSO bankrupt (because of the LDC debt crisis, more on
this in a later entry) and their failure would bring down the most of the
banking system, costing hundreds of billion.
Together, these
factors risked feeding on each other, leaving taxpayers on the hook for close
to a trillion and triggered a dollar crisis. The recession of 1990-91 would
have turned into a great depression as decades of rot worked their way out of
the system.
This didn’t happen of course
 
A conveniently timed drastic drop in interest rates miraculously saved the day.
The
drain on the public purse continued into 1993. But market fundamentals in the
form of the interest rate environment, and the bottoming out of
regional economies and real estate markets, were beginning to turn up again
for S&L asset portfolios. From 1993 to 1995 the industry
began to stabilise, and the portions of the industry that had survived the
great S&L crisis moved steadily back towards profit over the next few
years.
With short term
interest rates having dropped far below mortgage interest rates, insolvent
thrifts were able to survive. Low interest rates also mean low defaults, and
the government didn’t have to make good on all its guarantees.
...and, instead of a great depression, the US economy started heading
towards something much worse.
The government
used the proceed gold leasing (ie: the sale of central bank gold) to lower
interest rates (gold is sold and RTC’s securities are bought) and temporarily
propping up the insolvent financial system, setting the US down the road
towards complete economic collapse two decades later (today).
(blue line represents Federal Reserve lending to insolvent institutions and
the red line represents the gold leasing rate (how much gold is being sold))
Eric de Carbonnel
Market Skeptics
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