Is Everything Old, New Again?

Anyone remember the S&L crisis of the late ’80s? All of the sudden, a lot of folks remember the last financial crisis (1975u20131981) and also that your faithful publisher was the first chairman of the Resolution Trust Committee (RTC), so here are some of the questions coming my way due to my previous job and the current financial problems.

The usual first question: Is this financial mess like the one in the late ’80s? Yes, in the fact that the problem stems from bad loans (last time, commercial loans; this time, housing). But outside of that being a common factor to all banking problems, the current situation is drastically different. This time the loans (subprime and Alt-A) largely were packaged and sold in tranched, credit-rated securitization, thus the majority of the subprime defaults are in securitizations sold all over the world. The securitizations are often sliced and diced, so the value of the individual holder’s piece of the securitization is difficult to determine. Plus, when there is a default of a securitized mortgage, there is usually no servicer readily available to deal with the problem of renegotiations to avoid foreclosure.

Second, today’s problem should cause you to wonder about this: Though over a thousand deposit-insured institutions failed in the last crisis, there were no long or short lines of depositors waiting in bank lobbies for their right to get cash for their deposits. This definitely helped the financial system to avoid near panic the last time. Pictures of long lines of depositors waiting for their money from the failed IndyMac Federal Bank are all over the news, so something has changed.

The reason for the change is at least partially the result of a change to the laws governing the FDIC enacted in the FDIC Improvement Act (1991) just after I left my job as chairman of the RTC and the FDIC. The amendment enacted (over my protest, but my term was ending and I was, as they say, history) required the FDIC to reduce the payments of all depositors with uninsured deposits over $100,000, stating that this was the lowest cost means for the FDIC to meet its insurance obligations. However, this amendment took away most of the FDIC’s ability to handle a failure in the way it deemed best for the insurer, the fund, and the banking system.

Since the FDIC is charged with resolving failed insured financial institutions, this 1991 amendment was, in fact, an ill-conceived effort by those who were out to prevent the FDIC from protecting all deposits in a “too big to fail” scenario through a bridge bank or other vehicle.

In today’s environment, where Lehman Brothers, Bear Stearns, Fannie, Freddie, AIG, etc. are obviously not too big to fail and to leave creditors out to dry, only banks appear subject to this restriction.

One thing we learned from the failure of more than 1,000 banks and S&Ls was that their most important saleable asset was their deposit base. Their lowest cost funding is the basic requirement for banking successfully. We also learned covering all depositors usually got us the quickest and best sale. And we came to realize that the longer an institution is in government hands, the more it tends to lose value. Since these lessons were learned over time, the FDIC knows how to handle failures without lines of depositors in the bank lobby and how to do so at minimum cost.

What the FDIC needs is flexibility in handling failures. This worked very well during the last financial crisis. Time is short. If this isn’t done promptly-especially as more banks fail with each passing week-pictures of depositors in lines to withdraw their deposits will be very unsettling to the financial system. Further, if the FDIC has to pay off depositors in cash rather than transferring their accounts to new institutional buyers, the FDIC will soon be short of cash.

It must be noted that recent, smaller failures appear to have been handled without reducing deposit guarantees. FDIC veterans Bovenzi, Glassman, et al. seem to have found a way to deal with the problem for the moment.

Finally, there are some knowledgeable gentlemen, such as Brady, Ludwig, and Volcker, who have asked whether the current situation calls for an RTC-type government bailout vehicle. The answer is the FDIC, which handles all reserved deposit claims of banks and S&Ls, development banks, etc., can really do anything a new entity could do with bank assets. The RTC was created by Congress because the insurance fund of the S&L industry was bankrupt and needed a solvent organization. Whether we need a new RTC or not, of one thing I am sure: It’s not my turn. I’ll just be one of those who will sit on the sidelines and give the new chairman free advice as he struggles with this very tough situation!