New Attack Plan: Bring Back RTC on a Grand Scale

Brady, Ludwig, Volcker. Three pretty smart guys who have seen a lot in their careers and dealt with mind-boggling turmoil in the markets. Kind of like the turmoil we have today. They penned an editorial in today's Wall Street Journal that essentially brings back the Good Bank/Bad Bank concept in a systematic way, not in the one-off, herky-jerky manner that has characterized Treasury Secretary Paulson's handling of affairs.

The crux of their arguments are similar to those I've made recently, with the creation of optionality through liquidity as the centerpiece of their plan. Further, the plan keeps us away from the moral hazard of pushing investment banks into commercial bank's arms, leaving the FDIC to pick up the pieces of broken asset portfolios that were the making of their more lightly-regulated brethren. That is not supposed to be the way it works.

Four key reasons Brady/Ludwig/Volcker raise for bringing back the Resolution Trust Corporation [RTC] model are:

- First, by buying paper that otherwise is effectively not trading, it would help restore liquidity to the marketplace and help markets to function more fluidly again.

- Second, by warehousing the troubled paper for a longer period than, for instance, the Fed's discount window typically should or could, it would allow for a more orderly liquidation of this paper, and the chance for much of it to recover a portion of its value.

- Third, by giving the agency the ability to manage mortgages with flexibility to keep people in their homes and businesses running, it should lessen the number of foreclosures. This, in turn, would help moderate the decline in real estate values and the deterioration of neighborhoods, thus supporting house prices that in fact lie at the heart of the crisis.

- Fourth, where necessary, like the RTC of the 1980s, this new mechanism can assist the Federal Deposit Insurance Corporation in resolving sick institutions that are so clogged with the troubled paper they cannot continue as independent entities. However, we would hope that purchasing the mortgage-related paper will minimize the need to provide emergency, short-term assistance to solvent banking institutions.

Private markets Good Bank/Bad Bank deals can happen when there is sufficient time to segregate the troubled assets, raise the capital necessary to support the Bad Bank and to implement the plan. This was the path Lehman was heading down before Dick Fuld's stubbornness around valuation caused time to run out. Good Bank/Bad Bank was foisted upon them through the bankruptcy process.

The thousands of regional and local banks that are in trouble due to both bad loans and bad investments will neither have the time nor the scale to implement private Good Bank/Bad Bank solutions. And even if their financial assets are poor, they generally have valuable core deposit bases and customer lists on which to build healthy, re-capitalized institutions or to become attractive sale candidates. It is these firms, as well as large banks, investment banks and insurance companies that find themselves in a liquidity crisis, that will sell troubled assets into the RTC pool. It is the RTC that will serve to mute the impact of massive asset liquidations in the short-run, while protecting value through the liquidity option for the U.S. taxpayer in the long run.

Will trillions of dollars be needed to properly capitalize the RTC in order for it to do all that it must? Yes. Will this burden fall squarely upon the shoulders of the U.S. taxpayer? Yes. But is it a better outcome than Treasury Secretary Paulson dealing with problems in onesies and twosies without a clear plan or strategy? Absolutely. Force transparency. Cement the fiduciary responsibilities of those running the RTC, whose sole purpose is operating the entity that protects and maximizes the interests of the U.S. taxpayer.

Like Messrs. Brady, Ludwig and Volcker, I don't see another way. Things have gone too far. Private Good Bank/Bad Bank deals are no longer a possibility in today's highly uncertain environment. It is time to act quickly, decisively and in a transparent manner. Otherwise, the bottom of this crisis will keep moving farther and farther away.

Comments

[surgcare:]

Hasn't the taxpayer done enough . What gaurante does the taxpayer have that they'll get their money back .Let people like Buffet , Strisand , Redford and others put up the money .

2008 Sep 17 05:00 PM

[RedRiver:]

I believe that good research will show that the RTC actually made money for the US Taxpayers as bizarre and unbelievable as that may seem.

There is only one way out of this mess and that's to spend our way out regardless of inflationary woes. Not that I am for any of this but when we allow ourselves through our representatives to get boxed into a corner, it is what it is. Spend a couple of Trillion on creating a new RTC or, on an infrastructure improvement plan........ either way its going to really really hurt. We got exactly what we deserved. The "Big Brain" concept highlighted by Greenspan and Ben has always been a joke. This economy is just too complicated for anyone person to understand, plan and guide.

Hope the Chinese, Japanese and the Saudi's keep buying our paper because if they stop, its over.

As for the really rich,there is nothing preventing them from dumping their citizenship to protect their assets from us poor suckers.

2008 Sep 17 06:47 PM

[huangjin:]

If the taxpayer will be burdened to pay off Japanese and Chinese bondholders, wouldn't it be easier to move yourself and your business to China or Japan and also profit off the backs of U.S. taxpayers?

2008 Sep 17 07:45 PM

[Outtanames999:]

The utter stupidity of the idea, and from three heavy-weights no less, though certainly blindflolded by myopia, is so immense it defies description.

You are a pussy if you think that the market has to suck at the government tit when times get tough. Get over your oral fixation, stop being a cry baby, and buck up and be a man.

Where is the vaunted private capital? Let it step in, take out the bad paper, and take the high risk it celebrates and champions. You don't need to give it to a government wet-nurse first. Just sell it to the highest bidder. Let a third party assess the value first if you want if you think the water is so full of sharks that you won't get a fair price.

Where is the free market? Let it work as claimed to sell anything and everything to anyone and everyone, and let the market dictate what the market will bear. I don't remember the government bailout being a part of the free market.

Where are the regulators to set a level playing field for all participants so that there can be a free market? Why are there different rules for different participants? Where are the protective measures that address the well known vulnerabilities of unbridled market particpant self-interest and greed?

You can't have unregulated or weakly regulated markets dominated by theives, cheats, frauds and con men and then expect the government to save the day when the con men run out of victims and start conning each other. No what the government must do is arrest the con men and put them in jail or line them in front of a firing squad.

You can't have ratings firms that put a defective feedback loop into algorithms that look around see what kind of effect their own ratings are having on the market and then factor that back into the ratings with no governor to prevent a death spiral.

The dotcom crash killed off the CEO.
Aug. 2007 was the death of the quants.
Aug. 2008 was the death of the shorts though their sentence has not yet been imposed.

Sept. 2008 is the death of investment banking and it will also prove to be the death of the CFO who utilized all the exotic instruments that brought down Wall St.

The CFO is now as weak and pathetic in boardroom politics as the CTO. Some idiots are trying to put the risk managers into the batting box next, but don't worry we're up to their tricks and will have none of it.

Live by the market. Die by the market. Live by the trade. Die by the trade.

2008 Sep 17 07:45 PM

[illinoisguy:]

There is no such thing as a free market. Never has been, never will be.

2008 Sep 17 08:29 PM