Saturday, September 13, 2008
Debate shifts to systemic solution: RTC - FT
Rather than address crises in financial institutions as one-off incidents, Trea should build a framework to tackle the broad financial system issue. Resolution Trust Corp like vehicle will be a solution. It will help ringfence banks risky assets and make the clean banks more appealling to investors. Without the framework, the markets will remain gridlocked, leaving more banks like Leh and Wa scrammbling for covers. But this RTC was used to help address S&L crisis for commerical real estates, here a RTC-like framework is needed to address residential estates.... Almost a week after the US Treasury rescued Fannie Mae and Freddie Mac, investors seem far from convinced that the problems facing the US financial system are over. The stock market rally that followed the Treasury's bail-out of the two US mortgage financiers quickly lost steam, with investors experiencing renewed panic over the health of financial institutions less than a day after the rescue. Shares in Lehman Brothers, the investment bank; Washington Mutual, a commercial bank with $310bn of assets; and American International Group, the insurer, all plunged this week on concerns over mounting mortgage losses and difficulties raising fresh capital. Investors appear increasingly fearful that, while the Federal Reserve and the US Treasury have undertaken several increasingly dramatic interventions in financial markets this year - including emergency interest rate cuts, the bail-out of Bear Stearns and the government takeover of Fannie and Freddie - a plan is needed to address the market's problems as a whole. Alan Greenspan, former chairman of the Federal Reserve, argues that a more formal framework is needed to address financial institutions in crisis. In the latest edition of his book, released this week, Mr Greenspan says a high-level panel of financial officials should be given broad authority to determine if an institution's failure is dangerous enough to require taxpayer support. If so, the company would be taken into conservatorship, the equity wiped out, a charge imposed on the debts before they are guaranteed and the assets sold. Mr Greenspan's model is the Resolution Trust Corporation (RTC), created in 1989 to take over failing US savings institutions, sell their assets and then close itself down. The cost to taxpayers would be a concern, says Mr Greenspan, but as with the RTC - on whose board he served - the public cost could be minimised. Richard Bernstein, chief investment strategist at Merrill Lynch, agreed that the government's actions have amounted to attempts to tackle crises at financial institutions as one-off incidents, rather than tackling the broader systemic challenge. "The catalyst for the sustained outperformance of financials is likely to be when the government forms an entity specifically designed to facilitate the consolidation of the financial sector - like the Resolution Trust Corporation during the 1989-1991 period," he said. The debate over whether an RTC-style vehicle is needed - perhaps just to ring-fence troubled mortgage assets - also gained traction among central bankers at the Jackson Hole symposium hosted by the Federal Reserve Bank of Kansas City in August. The US Treasury and Federal Reserve are not working on such a plan, but they have been looking closely at how previous interventions were used to redress systemic market crises. The problem that an RTC vehicle could help to solve is that there are very few buyers for troubled mortgage assets, and few investors now willing to inject fresh capital into the tattered balance sheets of the banks left holding them. As a result, banks such as Lehman and Washington Mutual have struggled to sell their soured mortgage portfolios, and to broker deals for fresh capital. The takeover of Fannie and Freddie, which virtually wiped out preferred equity holders, has also made banks' access to the preferred capital market increasingly difficult. Through a new RTC, the government could provide financial support if needed in return for a share in potential profits once the assets were liquidated. And while the US Treasury's takeover of the two mortgage financiers has helped lower mortgage rates and instil some confidence with holders of the mortgage financiers' debt, the plan is still fraught with uncertainties and will do little to improve the outlook for existing mortgage assets. Bill Chepolis, managing director at DWS Investments, said the sharp move lower in mortgage rates would help the housing market and that there should be a pick up in refinancing applications. Mr Chepolis said the ultimate result of the Treasury's action "is heavily contingent on employment". He said: "If people don't have jobs they are not paying back loans." And while owners of agency debt under two years can now enjoy an explicit government guarantee, prospects for longer-term debt may be less certain as the future of the GSEs, or indeed for any RTC-style solution, will be decided by the next administration. This is crucial - serious thinking about any RTC-type solution, which would require legislation, may not occur until after the US presidential elections. Meanwhile, Michael Cheah, portfolio manager at AIG Sun America Asset Management, said he expects a change in the attitude of Asian central banks, which until recently have been a mainstay of the agency market. "They took a long time to get into this market and they are not going to be adding to their positions. Central bank governors are embarrassed at being caught holding this paper. The over-riding mandate of a central bank is to hold liquid assets and the risk of being unable to sell a large amount of agency paper has become more apparent." The problem is that without buyers for troubled mortgage assets and continued uncertainty for buyers of assets that now hold a temporary guarantee from the US government, the markets will remain gridlocked, leaving banks such as Lehman and Washington Mutual scrambling for cover. Additional reporting by Krishna Guha in Washington Banking crisis could be too complicated for RTC-style liquidation model During the last US banking crisis in the late 1980s and early 1990s, Resolution Trust Corporation was set up to manage impaired assets of banks and savings and loan institutions the government had taken over. RTC, formed in 1989 by an act of Congress, was a US government-owned asset-management company given the task of liquidating the bad assets. Its architect was Richard Breeden, then chairman of the US Securities and Exchange Commission. Between 1989 and mid-1995, RTC closed or otherwise resolved 747 savings and loans associations with total assets of $394bn. In 1995, its duties were transferred to the Federal Deposit Insurance Corporation. A new RTC would also require legislation, which is unlikely to be passed until the next administration. Even then, such a plan could take time to implement. Legislation for the first RTC was passed in February 1989 but the vehicle did not begin its work until August. RTC pioneered use of so-called "equity partnerships" to help liquidate real estate and financial assets which it inherited from insolvent savings institutions. While a number of different structures were used, all the equity partnerships involved a private sector partner acquiring a partial interest in a pool of assets, controlling the management and sale of the assets in the pool, and making distributions to the RTC based on RTC's retained equity interest. Before introducing the equity partnership programme, the RTC also engaged in bulk sales of asset portfolios. The pricing on certain types of assets often proved disappointing but by retaining an interest in asset portfolios through the equity partnerships, RTC was able to participate in the strong returns realised by portfolio investors, thereby minimising the cost to taxpayers. Dan Alpert, managing partner at Westwood Capital, an investment bank, said an RTC model might be more complicated in the current crisis. "RTC was massively successful as a liquidation agent to deal with troubled assets. But the difference between the S&L crisis of the 1990s and today is that rather than liquidating commercial property, the bad assets are mortgages on people's homes, so the exercise is very different."