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November 1, 1993
eCONOMIC
COMMeNTORY
Federal Reserve Bank of Cleveland
Making the SAIF Safe for Taxpayers
by William P. Osterberg and James B. Thomson
A he first concrete step toward resolving
the decade-long thrift debacle was taken
by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA), which overhauled the federal savings and loan regulatory apparatus. A principal goal of FIRREA was to
separate the cost of resolving the already
insolvent thrifts ("zombies") from the
operations of the industry's new deposit
insurance fund. Because the Federal Savings and Loan Insurance Corporation
was bankrupt, Congress created the
Resolution Trust Corporation to dispose
of the zombies. This receivership agency
was to be funded primarily by taxpayers,
while any costs related to federal insurance of deposits at healthy thrifts would
be paid for by the thrift industry itself
through the Federal Deposit Insurance
Corporation's Savings Association Insurance Fund (SAIF).
To help ensure that the costs of resolving the zombies were kept separate
from the costs of dealing with future
failures, FIRREA set up a transition period between its enactment and the
start-up of the SAIF. During this time,
the Resolution Trust Corporation (RTC)
was charged with selling, merging, or
liquidating (generically, "resolving")
the third of the industry that was insolvent. At the same time, the SAIF was
to be capitalized through deposit insurance assessments on federally insured
savings associations.
On October 1 of this year, the SAIF officially began operations and the RTC's
statutory authority to accept new receivership cases expired. Unfortunately,
because of insufficient funding during
ISSN 0428-1276
its tenure, the RTC's work was not finished. A number of insolvent thrifts remained to be closed by the Office of
Thrift Supervision and were left for the
SAIF to resolve. Not only was this
situation contrary to Congress' intent, but
if left uncorrected, the SAIF was likely to
be an inadequate backstop for the S&L
industry.
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.
This article traces the evolution of the
current regulatory quagmire and takes
a look at the policy options facing Congress. Assessing these options requires
an understanding of three trends in the
financial services industry. First, regulatory changes have largely removed the
rationale for separate regulatory structures for banks and thrifts. Second, thrifts
are becoming more like banks and in
some cases are even changing their charters. And third, as banks become healthier and a portion of the thrift industry continues to falter, the premiums necessary
to fund the SAIF will put thrifts at a competitive disadvantage.
As the Savings Association Insurance
Fund (SAIF) begins its operations, its
financial stability is being questioned
in many quarters. Here, the authors
argue that Congress needs to reassess
the condition of the fund and weigh
the options for recapitalizing it. One
option that merits particular consideration is merging the SAIF into the
Federal Deposit Insurance Corporation's Bank Insurance Fund.
• The SAIF May Be Hazardous
to Savings Associations
The SAIF begins its operations with a
fund of only $441 million (up from
$279 million at the end of 1992). Earlier this year, the Congressional Budget
Office (CBO) estimated that the cost of
closing troubled thrifts would exceed the
SAIF's projected premium income by
$43 billion through fiscal year 1998.2
Although this figure did not factor in
the RTC's receivership authority being
extended, it did assume that the remaining zombie thrifts would be handled by
the RTC, not the SAIF. Even though the
savings industry has improved since
then and the cost of thrift closings
should be lower than the CBO estimate,
the size of the shortfall in the SAIF is
still likely to be significant.
Unfortunately, even after the thrift mess
is resolved, the SAIF will not be out of
the woods because the cost of SAIF insurance will continue to increase relative to the cost of Bank Insurance Fund
(BIF) coverage.3 Currently, thrifts and
banks pay approximately 26 basis points
(0.26 percent) per $100 of insured deposits to recapitalize the SAIF and BIF,
respectively. Soon, however, the SAIF
will require an increase in thrifts' premiums to cover the $772 million in annual interest due on the almost $ 11 billion of Financing Corporation (FICO)
bonds issued as part of the S&L bailout
between 1987 and 1989 4
Worse yet, S&Ls will be at a disadvantage even without the FICO charges.
FIRREA mandated that both the BIF
and SAIF maintain a coverage ratio of
125 basis points per $ 100 of insured deposits. Currently, deposit insurance premiums consist of a "normal" premium
and a recapitalization premium. The
normal premium is the amount that
would be assessed to cover the funds'
ordinary and ongoing operating expenses and their expected losses from
depository institution failures. The recapitalization premium is in essence a
surcharge aimed at gradually rebuilding the funds to their minimum fund-toinsured-deposits ratios. Once each fund
reaches 125 basis points per $100 of insured deposits, the recapitalization assessment may be decreased. However,
because its loss reserves are higher
than the SAIF's, the BIF will be able to
lower its premiums sooner. Current estimates show that BIF premiums will
fall to about 11 basis points by 1998.
Bert Ely, a noted bank and thrift analyst, estimates that SAIF premiums
could exceed BIF premiums by 20 basis points as early as 1996.
As is often the case in economics, policies can have unintended, secondary effects that dominate the intended effects.
In this instance, the intended effect of
creating the SAIF was to preserve a
separate housing finance industry. Unfortunately (and ironically), the cost
disadvantage faced by SAIF-insured
firms relative to BIF-insured firms
seems likely to accelerate the decline
of the savings industry.
competitive advantage over other potential mortgage lenders.
• The Historic Rationale for
Separate Regulatory Structures
Since regulatory policy clearly plays a
key role in the predicament threatening
the SAIF, it is important to understand
the historic rationale for the current
structure. The creation of separate regulatory systems for banks and thrifts was
a consequence of federal banking legislation enacted between 1932 and 1934,
which led to the compartmentalization
of the financial services sector. Banks
were forced to divest themselves of
their investment banking operations
and were prohibited from underwriting
securities. On the other hand, they
were given the exclusive franchise for
issuing demand (checkable) deposits.
Although thrifts were effectively limited
to long-term mortgage loans, access to
subsidized FSLIC deposit guarantees
made it profitable for them to fund themselves with short-term deposits when the
yield curve sloped upward. As a result,
the industry was extremely sensitive to
sudden increases in interest rates that
raised the cost of funds above the return earned on long-term mortgage
portfolios. By the end of the 1970s, this
Achilles' heel spelled the beginning of
the end for the FHLBB, the FSLIC, and
a large part of the S&L industry. The
high interest rates in 1980 and 1981
had a devastating impact on thrifts and
rendered a huge portion of the industry
insolvent. This massive insolvency
bankrupted the FSLIC fund, which by
some estimates was $100 billion in the
red by 1982. It took nearly a decade for
Congress and the Executive Branch to
face up to the magnitude of the losses
and the size of the FSLIC shortfall.
S&Ls were the vehicle through which
the federal government promoted the
housing industry, and this function provided the rationale for separate regulatory structures. The Federal Home
Loan Bank Act of 1932 established the
Federal Home Loan Bank Board
(FHLBB), an independent agency, to
charter and regulate federal S&Ls. It
also set up the FHLB System, a network of banks intended to provide
funding and liquidity to these institutions.
The Federal Savings and Loan Insurance Corporation (FSLIC), a specialindustry deposit insurer, was established under the National Housing Act
of 1934, one year after the Banking Act
of 1933 (the Glass-Steagall Act) established the Federal Deposit Insurance
Corporation (FDIC) for banks.
As part of a regulatory structure designed to promote the S&L industry—
and thereby home ownership — the
FSLIC was placed under the auspices
of the FHLBB. This regulatory system
included investment restrictions such
as the qualified thrift lender test, which
effectively limited thrifts to making
mortgage loans.6 Access to FHLB advances (loans originally tied to mortgage lending) at below-market interest
rates, coupled with fixed-rate deposit
insurance, gave FSLIC-insured thrifts a
FIRREA was the vehicle for resolving
the thrift debacle. In addition to creating
and partially funding the RTC salvage
operation, the Act radically changed the
structure of the thrift regulatory agencies.7
The independent FHLBB was replaced
by the Office of Thrift Supervision,
which, like the Office of the Comptroller of the Currency, is an agency of
the U.S. Treasury Department. Moreover, the FDIC administers both the
BIF and the SAIF, and membership in
the FHLB System is no longer restricted to savings associations.8 Gone
with the FHLBB and the FSLIC was
the notion that the S&L regulator
should actively promote the industry it
regulates, and hence, gone was the special treatment given the nation's thrifts.
(Freddie Mac), the Federal National
Mortgage Association (Fannie Mae), the
Farmers Home Administration (FHA),
and private mortgage pools. Advances in
communications and information technology have increased the ability of markets
to bundle up mortgages and issue securities against them. This market innovation
has essentially made thrifts' mortgage
specialization obsolete.
FIGURE 1 MORTGAGE DEBT OUTSTANDING
Billions of dollars, end of period
4,500
_
•
All other
MnllLMIIl1 ptmN Dl MU--I
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
IIQ
SOURCE: Board of Governors of the Federal Reserve System, Flow of Funds Accounts.
TABLE 1
MORTGAGE HOLDINGS AS OF 1992:IVQ
(millions of dollars)
Type of Mortgage Loan
Commercial Banks
Savings Institutions
One- to four-family
Multifamily
Commercial
Farm
511,976
38,011
324,681
19,822
489,622
69,791
68,235
324
Total
894,490
627,972
SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin, August 1993, table
1.54, p. A38.
• The Evolving Generic
Depository Institution
The remaining regulatory distinctions between banks and thrifts no longer serve
to define the S&L industry as the unique,
or even leading, housing lender. As seen
in figure 1, despite being restricted by the
qualified thrift lender test, savings institutions are no longer the predominant holders of mortgages. Moreover, thrifts'
total mortgage holdings and their share
of outstanding mortgages have been falling since 1988 and 1984, respectively. Total mortgages on banks' balance sheets
have exceeded thrift holdings since 1990.
Table 1 gives a breakdown of bank and
thrift mortgage portfolios. At the end
of 1992, banks held over $22 billion
more in home mortgage loans (classified as one- to four-family mortgages
in the table) than did thrifts, and almost
$267 billion more in total mortgages.
However, mortgage holdings by banks
and thrifts measure only one aspect of
the increased competition in mortgage
markets. Primary home mortgages held
by secondary-market mortgage pools
totaled $ 1,380 billion at the end of
1992, $378 billion more than the combined holdings of one- to four-family
mortgages held by banks and thrifts.
The secondary-market pools include
the Government National Mortgage
Association (Ginnie Mae), the Federal
Home Loan Mortgage Corporation
The remaining regulatory distinctions
seem only to impede an ongoing process of integration of the markets formerly served by banks or thrifts. For
example, the Garn-St Germain Act of
1982 allows thrifts to invest no more
than 10 percent of their assets in consumer and commercial/industrial loans.
Nonetheless, these institutions have
made inroads into the small-business
lending market. The 1988-89 National
Survey of Small Business Finance
found that 14.1 percent of the small and
medium-sized business respondents
used financial services from thrift institutions, although only 6.3 percent listed
thrifts as their primary source of services. ' In spite of the relatively small
share of firms using thrifts for their
banking needs, the numbers suggest
that these institutions have begun to
penetrate a market that is still largely
considered the domain of banks.
Thrifts have also made inroads into consumer lending, despite being constrained
by the asset restrictions of the GarnSt Germain Act. They held nearly 6 percent of outstanding consumer installment
credit balances at the end of 1992, while
banks held about 44 percent.'' However,
measures of consumer installment credit
generally understate the importance of
savings institutions as consumer lenders
because they ignore home equity lines of
credit. Finally, since 1981, differences
between depository institutions no longer
derive from the types of liabilities they
can issue.
Three other developments point to the
fact that banks and thrifts are becoming
more alike. First is the continuing trend
of exit from the savings industry. The
decline in the number of S&Ls during
the 1980s and into 1991 was primarily
due to failures. Increasingly, however,
attrition from the industry's ranks can
be traced to the conversion of existing
institutions from federal S&L charters
to state bank charters. Of the 117 thrifts
that exited the industry during the first
half of 1993, only five were closed by
the Office of Thrift Supervision and
turned over to the RTC, while 61 converted to state bank charters. '
Second, consolidation of the depository
institutions sector is occurring both
within and across industry lines. Banks
and their parent holding companies are
increasingly using the acquisition of
S&Ls to enter new markets and to increase their presence in the banking
markets they already serve. Mergers
and Acquisitions reports that 59 deals
from 1992:IIQ through 1993:IQ involved the acquisition of thrifts or
thrift branches by commercial banks
and bank holding companies.
Finally, consolidation of savings institution and bank trade associations is under way, especially among associations
representing smaller institutions. In
fact, the Independent Bankers Association of America recently amended its
charter to allow thrifts to join. ' 5 At the
very least, this trend toward generic
depository-institution trade groups
represents a recognition by banks and
thrifts of common interests as well as
common problems. It also suggests that
both types of institutions increasingly
view their competition as being depositories of all types, not just firms with
the same kind of charter.
• The Policy Options
In order to resolve the current threat to
the SAIF, policymakers must address
more than just the costs associated with
the zombies. A more farsighted option
would be to acknowledge the blurring of
the distinctions between banks and thrifts.
The need for a separately chartered industry devoted to housing finance was
questioned in a recent report to the
President and Congress.16 One policy
option is simply to facilitate the merger
of the two industries by removing all
regulatory distinctions. An argument in
favor of this course is that maintaining
separate regulatory systems could accelerate the decline of the nation's S&Ls,
leaving no specialized housing lenders.
Moreover, to the extent that regulatory
barriers inhibit the evolution and consolidation of the depository institutions industry, retaining separate insurance funds
will hinder economic efficiency.
A second option is to maintain the
status quo (as embodied in the RTC
Completion Act), with separate industries and separate industry insurance
funds, but with no new appropriation
of funds for the SAIF. This option is
also likely to speed the decline of SAIFinsured depositories. As discussed above,
thrifts face intense competition from
banks in both mortgage and deposit
markets. Taxing the operations of SAIF
members to cover the interest on FICO
bonds will reduce their earnings because competition from banks, which
do not face the tax, will prevent them
from passing the added costs on to their
customers. This in turn will hasten the
failure of a number of thrifts and further
reduce the size of the S&L industry.
The SAIF may be destabilized because
as the industry shrinks, the fund's premium income will drop just as the increased failures are boosting its costs.
One possible alternative to this catch22 scenario for funding the SAIF —
congressional appropriation of recapitalization funds — is especially contentious because of the continuing political
fallout from the FSLIC debacle. FIRREA
was conceived not as a bailout of thrift
depositors, but rather as a way to honor
the government's commitment to them
while ensuring that taxpayers would
never again be called upon to rescue a
federal deposit insurance fund. This
sentiment was echoed by President Bush
at the August 9, 1989 signing ceremony
for the bill, where he proclaimed, "We
will keep the federal deposit insurance
system solvent and help serve those
millions of small savers who make
America great..." while "...ensuring
the taxpayers' interests will always
come first....17 Consequently, there
seems to be some reluctance in Congress to bail out a federal deposit insurance fund, particularly one established
on the ashes of the now-defunct FSLIC.
A middle ground between maintaining
or obliterating all regulatory distinctions between banks and thrifts is to
consolidate the FDIC's two funds. To
implement the merger, depository institutions currently insured by the SAIF
would be allowed to transfer to the BIF
between January 1 and December 31 of
1994, and to do so without paying an
exit fee. However, to qualify for BIF insurance, the depository would have to
be adequately capitalized, as defined
by bank regulators in their implementation of the prompt corrective action
provisions of the FDIC Improvement
Act of 1991 (FDICIA). Furthermore,
before joining the BIF, SAIF-insured
institutions would be subject to a fullscope on-site examination. This would
be conducted jointly by the Office of
Thrift Supervision and the Office of
the Comptroller of the Currency for
federally chartered thrifts and by the
FDIC for state-chartered institutions.
In other words, to qualify for BIF insurance, an SAIF-insured institution's capital would have to meet or exceed the
minimum capital guidelines required by
the Bank of International Settlements
(BIS), have an examination rating of one
or two (on a scale of one to five, with one
being the best), and not be under any
written supervisory agreement.
A strong case can be made for adopting
this compromise approach. First, many
questions regarding the viability of the
SAIF will remain even after the RTC
finishes mopping up the remaining
FSLIC red-ink spill. Second, the historic rationale for separate regulatory
systems for banks and thrifts no longer
seems valid, particularly given the in18
tense competition between the two.
Third, adequate safeguards are in place
to ensure that the zombie problem is resolved and not simply passed on to BIF
members. And finally, the majority of
savings associations already qualify for
BIF insurance, so implementing
19 this
option would be fairly simple.
• The Transition: A None vent
for Most SAIF Members
As of March 31, 1993, 1,733 thrifts (96
percent of the private-sector institutions)
with $689 billion in assets (93 percent of
private-sector thrift assets) would have
met the minimum capital threshold for
BIF membership under the merger option. Furthermore, a total of 1,301 institutions (72.9 percent) with $482 billion in
assets (65 percent of private-sector thrift
assets) would have met the second condition to qualify for BIF insurance. Thus,
more than two-thirds of the S&L industry
would immediately qualify for BIF insurance, and transferring funds would be a
nonevent.
The remaining institutions that are viable but that do not meet the conditions
for BIF insurance on January 1, 1994
would have a year to either comply,
seek a merger partner, be acquired by a
BIF-insured depository, or voluntarily
liquidate. Any SAIF-insured institution
failing to meet these conditions by the
end of 1994 would be placed into an
FDIC-managed conservatorship. These
depositories would be allowed to operate in conservatorship for up to one
year pending an acquirer being found,
or until they qualified for BIF insurance. At the end of 1995, any S&Ls
still in conservatorship would be liquidated, and any losses associated with
their closing would be charged first
against the SAIF and second against any
surplus RTC funds. Any remaining balance in the SAIF and surplus RTC funds
would be transferred to the BIF, and
the SAIF and RTC would cease to exist.
• Conclusion
Increased integration of financial markets, coupled with recent legislative
changes in the federal regulatory structure for depository institutions, calls
into question the rationale for maintaining separate bank and thrift insurance
funds. Given the trend toward merging
of the two industries, maintaining the
current regulatory distinctions may
only serve to hasten the demise of the
nation's thrifts.
While the RTC Completion Act of
1993 segregates the costs of the FSLIC
debacle from those associated with future thrift insolvencies, it is only a partial solution to the SAIF's funding
problems. This suggests that Congress
should reassess its current SAIF policy
and reexamine its options. A farsighted
policy would recognize the current
trend toward consolidation. An obvious
policy response would be to obliterate
all regulatory differences between
banks and thrifts. However, it is not
clear that Congress wishes to do away
with the separate housing finance industry that was the original rationale
for the two regulatory structures.
One appealing compromise would be to
merge the two deposit insurance funds.
This would reduce administrative costs,
since the FDIC would not have to keep
two sets of books and two separate pools
of receivership assets. Consolidation of
the SAIF and BIF would also eliminate
the projected future difference in the
deposit insurance premiums between
SAIF- and BIF-insured institutions,
thereby removing the latters' competitive advantage.
Finally, dismantling the great wall between the FDIC's insurance funds would
facilitate the current trend toward industry consolidation by reducing the transaction costs associated with acquiring a depository institution (or its branches) with
a different charter type.
• Footnotes
1. FIRREA established the Office of Thrift
Supervision as an agency of the Treasury to
supervise savings associations.
2. See Congressional Budget Office, Resolving the Thrift Crisis, Washington, D.C.:
CBO, April 1993, pp. 56-59.
3. In the RTC Completion Act, Congress
authorized the SAIF to spend up to $8 billion
between 1994 and 1998 to cover the losses
associated with thrift closings. This spending
authorization does not, however, fully address the funding needs of the SAIF or the
implications of the projected future gap between SAIF and BIF premiums. In addition,
there are a number of conditions that the
SAIF must satisfy before it can spend this
money. The Federal Deposit Insurance Corporation must certify that 1) the funds are
needed to cover SAIF losses, 2) thrift deposit
insurance premiums cannot be raised to
cover these losses without hurting the industry, and 3) higher assessment rates on SAIF
members to cover these losses are likely to
increase the government's losses in the future. The legislation also provides for the use
of any surplus RTC funds to cover thrift
losses from January 1, 1996 to December 31,
1997. The terms and conditions for spending
the RTC surplus (if one indeed exists) include those listed above for spending the $8
billion funding backstop.
4. The Competitive Equality Banking Act of
1987 (CEB A) authorized the sale of $ 10.8 billion of these bonds as a token recapitalization
of the old Federal Savings and Loan Insurance
Corporation (FSLIC) fund. Under CEBA,
FSLIC-insured thrifts and the Federal Home
Loan Banks are responsible for repaying the
principal and interest on FICO bonds.
5. Ely's estimate accounts for both the differences in BIF and SAIF reserves and the
FICO interest charges. See Robyn Meredith's
article, "RTC Bill Passes: Thrift Resolutions
to Resume," American Banker, November
24, 1993, p. 3.
6. The qualified thrift lender test requires an
S&L, as a condition of its charter, to hold at
least 65 percent of its portfolio in housingrelated assets, such as mortgages and mortgagebacked securities.
7. See Christopher J. Pike and James B.
Thomson, "The RTC and the Escalating
Costs of the Thrift Insurance Mess," Federal
Reserve Bank of Cleveland, Economic Commentary, May 15, 1991.
8. At the end of 1992, the FHLB System
had a total membership of 3,622 institutions,
of which 35 percent, or 1,260, were commercial banks (with $311 billion in assets). See
Congressional Budget Office, Federal Home
Loan Banks in the Housing Finance System,
Washington, D.C.: CBO, July 1993, table 2.
9. See Board of Governors of the Federal
Reserve System, Federal Reserve Bulletin,
August 1993, table 1.54, p. A38.
15. See Robert M. Garrson, "IBAA Votes to
Admit Thrifts as Full Members," American
Banker, October 13, 1993, p. 2.
10. Thrift institutions in the survey include
savings institutions and credit unions. For
more information, see Gregory E. Elliehausen and John D. Wolken, "Banking Markets and the Use of Financial Services by
Small and Medium-Sized Business," Federal
Reserve Bulletin, October 1990, pp. 801-17.
16. See National Commission on Financial
Institution Reform, Recovery, and Enforcement, "Origins and Causes of the S&L Debacle: A Blueprint for Reform," Report to the
President and Congress of the United States,
Washington, D.C.: U.S. Government Printing
Office, July 1993.
11. See Board of Governors of the Federal
Reserve System, Federal Reserve Bulletin,
August 1993, table 1.55, p. A39.
17. See "Bush Remarks: 'First Critical Test'
Has Been Passed," American Banker, August
10, 1989, p. 4.
12. At the end of 1992, thrifts held $12.6 billion in home equity loans, about 1.2 percent
of assets. Banks, by contrast, held $73.2 billion, about 1.2 percent of assets. Data on
home equity lines of credit are taken from
the December 31, 1992 issue of the Federal
Financial Institutions Examination Council's
Quarterly Reports on Income and Condition
("call reports") and the December 31, 1992
issue of the Office of Thrift Supervision's
Thrift Financial Report.
18. Proposals to consolidate the federal bank
and thrift regulatory agencies have been introduced in both houses of Congress, and the
Clinton administration is likely to submit
similar legislation in January.
13. See Robyn Meredith, "Rapid Flight
from Thrift Charters May Leave OTS High
and Dry," American Banker, September 20,
1993, p. 2.
William P. Osterberg is an economist and
James B. Thomson is an assistant vice president and economist at the Federal ReseiTe
Bank of Cleveland. The authors thank Mark
Sniderman and Walker Toddfor helpful comments and suggestions.
The views stated herein are those of the
authors and not necessarily those of the Federal Resene Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.
19. The issue of who should pay the FICO interest would not be resolved by such a merger.
Logically, FICO expenses should be part of the
taxpayer-funded resolution of the FSLIC insolvency. However, even if current SAIF members were still assessed separately for FICO,
they would be better off under this option.
20. See Office of Thrift Supervision, NEWS,
OTS 93-47, June 17, 1993.
14. See Mergers and Acquisitions, various
issues, 1992-93.
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