Son of RTC at Last

by Don Hoyte

Have we finally realized the role that the Resolution Trust Corporation (RTC) played in stabilizing the Savings and Loan crisis in the 1980s? And more important have we finally realized how much we need that role today?

What did the RTC do? It took control of real estate properties and, after things settled down a little, sold them. Doesn’t sound like much of a help does it?

But what the RTC really did was to establish the bottom in the 1980s real estate market. No longer would properties sit on savings and loans (S&L) balance sheets dropping from 80 to 60 to 40 percent of their book value, and dragging the S&L’s value down with them. The RTC would, in essence, purchase the property and then hold it for orderly sale.

That really is a function that the market itself should perform. Investors should be able to recognize undervalued assets, purchase them and then re-sell them at a profit. Except in the majority of real estate markets today, no one knows where the bottom is.

If you ran an investment fund and bought real estate at 60 cents on the dollar and then resold it at 75 cents on the dollar you’d be a financial genius. If you bought it at 60 cents on the dollar and it fell to 40 cents on the dollar, you might not be seen as very bright.

Defining the bottom in declining markets is crucial to the normal working of the financial system. That is really what the RTC did in the late 1980s, and they were still disposing of properties in 1995. How many private sector investment firms do you think would be able to operate on that kind of time schedule given that they report their profits quarterly?

Short sellers, those investors that bet the price of something is going to go down, really hate to lose money, but they know that things are good when there is no bottom in a market. It doesn’t matter if the price of real estate has dropped by 50 percent, if you are a short-seller, you’ll make a killing if it drops by yet another 40 percent. And given human nature, lacking any outside influence, in fearful markets that can easily happen, be it a market for houses or tulip bulbs.

What the RTC did in setting the bottom to the real estate market of the 1980s was to decimate short sellers, meaning they could no longer bet that the value of real estate would continue to drop and benefit from that bet.

In truth, short-sellers really didn’t know how long the RTC would have to hold some of the properties it controlled before it would be able to sell them. Neither did the RTC, and the RTC ended up owning a bunch of golf courses built in order to sell lots for new houses.

But what the speculators did know was that the RTC had deep pockets---deeper pockets than they did. And that scared bejeezus out of short-sellers.

So with the latest proposals by Lawrence Summers, Paul Volker, Alan Greenspan and Barney Frank sounding at long last like Son of RTC, someone ought to be applauding their efforts to address the underlying cause of the current financial turmoil. Someone is stepping in, setting the bottom to the real estate market, and saying to the short sellers, we can outlast you.

Short-sellers are not bad people, they are, after all is said and done, like the rest of us---greedy. What do we all want? MORE, of whatever.

But they are also smart, when they see that 40 cents on the dollar is the bottom that’s what they’ll bid knowing they can make a bundle by selling at 50 cents on the dollar.
Is this really all that different from past financial problems? In a way, not really.

The country learned after 1929 that unbridled enthusiasm has its downside. Mr. Greenspan most recently termed this irrational exuberance. When markets get going too good (the irrational part) a lot of folks stand to get hurt, and that’s not good for the larger economy.

So the Federal Reserve tries to moderate those peaks of activity by raising the interest rates or the margin rates making it more expensive to be exuberant. When exuberance gets expensive, you do get less of it.

What we have now is irrational anxiety. Do you get less anxiety by raising interest rates? No, you’d most likely get more since the flow of money isn’t really the problem. Fear is the problem. How do you get less fear? You can get some big guy named Vito or Bubba to stand next to you. In the 1980s, Vito and Bubba went by the name of RTC.

The cry of don’t mess with the market from short-sellers who have been profiting from fearful markets dropping more and more every day sounds oddly like the cry of don’t mess with the market from investors who trash the Federal Reserve for upping interest rates and taking the punchbowl away from the party during periods of irrational exuberance.

Will it work? Ask yourself how long do you think the market will allow a house to sell for $145,000 that cost $200,000 to build? If without any training in economics, you say not long then you understand how Son of RTC will work.

Why haven’t we tried this before now? Well, it requires that you accept that government as an institution can play a direct and effective role in stabilizing fearful financial markets.

This isn’t about just setting interest rates or offering loans to financial institutions but is actually buying stuff in order to set the bottom in the marketplace. I don’t think I’ve heard that sort of rhetoric coming from the administration any time in the last---oh---at least seven years.

Or maybe it brings up some other issues some folks would like to see remain buried. Like the Lincoln Savings disaster that hastened the S&L crisis that lead to the formation of the RTC in the first place.

Lincoln Savings led to the Keating Five scandal in which five U.S. Senators were implicated in influence-peddling. Charles Keating, head of Lincoln Savings, made $300,000 in political contributions to Sen. Alan Cranston, Sen. Don Reigle, Sen. Dennis DeConcini, Sen. John Glenn, and Sen. John McCain.

The first three were voted out of office, and Glenn and McCain were rebuked by the Senate Ethics Committee for exercising poor judgment in dealing with this financial debacle.

Think about it. We’ve got a presidential candidate found by his peers as exercising poor financial judgment in the last national financial crisis. Now he wants to be president during one of the most financially challenging times we have faced in the last 80 years.

Whatever the reason for not acting before now, we’ve needed Son of RTC for at least 18 months. What we don't need in the next 18 months is a president in charge of Son of RTC who at best has a poor grasp of why we need it and at worst actually contributed to the country needing the original RTC.