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May 15, 1991

Federal Reserve Bank of Cleveland

The RTC and the Escalating
Costs of the Thrift Insurance Mess
by Christopher J. Pike and James B. Thomson

jTXlmost daily, the news media report
on the ever-growing cost of resolving the
savings and loan (thrift) insurance crisis.
A year ago, the administration estimated
that the present-value cost of resolving
the insolvency of the now ^defunct Federal Savings and Loan Insurance Corporation (FSLIC) fund was $130 billion.
With the passage of time and the continued deterioration of the troubled portion
of the thrift industry, current estimates of
the final cost of the FSLIC bailout are
half again as high. Taxpayers, who are
paying a substantial portion of this bill,
wonder why the cost continues to increase and why the Resolution Trust Corporation (RTC) appears to be slow in
ending the thrift problem.
Although the RTC is reported to have
resolved many thrifts, it has not done so
quickly or completely. From its inception in August 1989 through February
1991, the RTC has disbursed $ 111.4 billion. Of the $98.3 billion used to resolve
366 thrifts, $64 billion has been invested
in receivership assets and is potentially
recoverable (see tables 1 and 2). However, the RTC has returned to the private
sector less than one-third of the initial
receivership assets of these institutions.
In addition, there may be as many as
510 additional insolvent thrifts that will
eventually have to be resolved. Critics
charge that the sluggishness of the
RTC's salvage operation is partially
responsible for the escalating costs of
resolving the thrift insurance mess.

The purpose of this Economic Commentwy is to describe briefly the structure
of the RTC and the condition of its balance sheet, and then to examine the factors that may be impeding its progress
in closing insolvent thrifts and returning
their assets to the private sector.
• Creating a Public
Salvage Mechanism
In early 1989, the public began to recognize the size and scope of the insolvency
of the FSLIC fund. At that time, the official estimate of the present-value cost of
resolving the FSLIC's insolvency was
approximately $130 billion. As noted in
a previous research paper, this loss,
borne largely by taxpayers, is unprecedented—there are none of even remotely
comparable magnitude in American history. The combined costs of the federal
bailouts of New York City, Lockheed,
Chrysler, and Continental Illinois Bank
did not even reach $9 billion. Thus, the
FSLIC bailout is in a class by itself, a
truly world-class white elephant.3
Handling this white elephant is a colossal and complicated undertaking that has
required new legislation, a new institutional structure, and a new approach.
The signing of the Financial Institutions
Reform, Recovery, and Enforcement Act
(FIRREA) on August 9,1989 marked
the first significant step toward resolving
the thrift insurance mess. The primary
objective of this bill, which provides the
most comprehensive restructuring of

"The long-term challenge facing the
RTC will be properly managing billions of dollars of assets that come
from the resolution of failed thrifts
and disposing of those assets in a
timely and efficient manner."
David C. Cooke,
Executive Director of the RTC'

the thrift industry since the Great Depression, is to resolve troubled thrifts
expeditiously and with minimal detriment to the economy.

$ Billions

FIRREA established an entirely new
regulatory structure for thrifts and
created the RTC to oversee thrift resolutions from January 1,1989 through
August 9,1992.4 It also created the
Resolution Funding Corporation (REFCORP) to provide for off-budget funding of the RTC. The RTC's initial funding consisted of $18.8 billion in direct
Congressional appropriations of taxpayer money, $18 billion of taxpayer
funds allocated by a drafting error in
FIRRE A, $1.2 billion from Federal
Home Loan Banks, and $30 billion from
the proceeds of REFCORP bond sales.
These bonds represent an additional taxpayer liability, because although the interest on this debt is to be paid by thrifts
(through higher deposit insurance premiums and assessments on Federal
Home Loan Banks), the U.S. Treasury is
to repay the principal and is ultimately
responsible for the interest payments.
• The Pace of Insolvent
Thrift Resolutions
Since its inception, the RTC has taken
366 failed savings and loan institutions
into receivership. Unfortunately, in the
majority of these cases the resolutions
cannot be considered complete, because
the RTC has failed to return a large percentage of the resolved thrifts' assets to
the private sector. As of March 1, 1991,
the corporation has been able to dispose
of a mere 31 percent of the initial
receivership assets of resolved thrifts,
with the rest being held in its portfolio
(see figure 1).
The majority of the sales have included
the most-marketable assets, such as cash
and securities. Furthermore, some $13
billion of the reprivatized assets were
sold with an option that allows buyers
to return the assets to the RTC for a full
refund within 90 days of the sale. The
remaining assets held by the RTC, primarily real estate and junk bonds, are of
lower quality and marketability. As seen
in table 2, real estate and delinquent
loans represent about 32 percent of the

Treasury appropriations
Federal Home Loan Bank contributions
Resolution Funding Corporation borrowings
Federal Financing Bank borrowings
Total external sources
Repayments from conservatorships
Repayments/dividends from receiverships


Resolutions and receivership funding
Advances and other disbursements to conservatorshipsa
Federal Financing Bank interest


a. Net of conservatorship advances transferred to receiverships.
SOURCE: Resolution Trust Corporation, RTC Re\iew, vol. 2, no. 2, February 1991.

$64.0 billion currently held by the RTC
in receivership assets. Junk bonds account for a smaller percentage of the
assets on the RTC's balance sheet —
roughly 9 percent as of April 15,1991.

up any profit..." and "...wipe out value
more quickly than you might imagine.1,,7

The delayed pace at which the RTC is
returning assets to the private sector
can increase the total resolution costs
in two ways. The first is the deterioration of these assets while they remain
in the government's hands. One economist contends that the RTC lacks the
proper incentives to maintain and enhance the value of troubled assets on
its books. Another expert warns, "The
problem assets in insolvent S&Ls are
highly perishable commodities, particularly in the hands of inept or indifferent

There are also indirect costs of the RTC's
warehousing of assets. Capital that could
be used to resolve additional thrift insolvencies is tied up, reducing the speed at
which the RTC can execute more resolutions. Unfortunately, this delay adds to
the final costs of resolving the thrift insurance mess, as operating losses and
deterioration of asset quality at insolvent
thrifts continue to add to the cost of
resolution. This relationship is supported
by a recent study from current and former
Office of Thrift Supervision (OTS) economists, which finds that the most significant determinant of the total cost of
resolving failed thrifts is the number of
months the institutions were insolvent.'g

Second, when the RTC holds assets in
lieu of returning them to the private sector, it incurs carrying costs—the costs
associated with financing and managing
assets. These carrying costs can be a
substantial part of the total resolution
costs. Irvine Sprague, former Federal
Deposit Insurance Corporation chairman, argues that the costs of financing,
staff time, legal fees, appraisals, and advertising are substantial and can "

The cost of delay in closing insolvent
and unprofitable thrifts can also be seen
by looking at the earnings performance
of the thrift industry itself. In 1990,
OTS-supervised thrifts (including those
under RTC control) lost $13.2 billion.
Although roughly 60 percent of all OTS
thrifts were profitable, one report shows
that the industry loss was driven by the
remaining 40 percent of these thrifts,
which lost $17.1 billion. Last year


marked the fourth straight year that aggregate industry losses were driven by losses
at a minority of thrift institutions.
• Obstacles to Efficient
Asset Disposition
Critics of the RTC's performance to date
point out that the corporation's operating
policies have slowed the speed of thrift
resolutions and have resulted in inefficient asset disposition procedures relative
to a private salvage operation. In a recent
study, Professor Edward J. Kane contrasts the RTC's salvage operation with
that of a private salvager. He contends
that while the goal of a private-sector salvager is to maximize recoveries on its assets, a public-sector salvager carries the
additional burden of balancing often conflicting political objectives.10 As a result,
the RTC faces a number of restrictions
on its ability to dispose of assets. In
general, these constraints fall into four
categories: political and legal, administrative, information, and funding.
The magnitude of the current thrift
problem, in terms of both the number
of failed institutions and total losses,
has increased the extent to which political concerns can influence asset disposition by the RTC. With taxpayers footing a substantial part of the estimated
$200 billion in thrift-related losses, the
operation of the RTC is subject to extensive scrutiny by Congress, the administration, and the public. One can
argue, however, that the increased public scrutiny should encourage RTC
managers to conduct the salvage operation in a manner that is consistent with
broader political and social goals.
Unfortunately, legislators, agency officials, and analysts do not always agree
on just how the RTC should resolve
troubled thrifts to serve the public interest in the best way. Individuals with a
short-term outlook want to minimize
the near-term costs associated with
taking losses. In their opinion, the RTC
should spread out the recognition of
losses over time by warehousing assets
and financing them with working capital. Individuals with a long-term outlook are concerned primarily with total
taxpayer liability and therefore want


($ Billions)

Percent of
Gross Assets



Total performing loans
1- to 4-family mortgages
Construction and land
Other mortgages
Other loans
Total delinquent loans
1- to 4-family mortgages
Construction and land
Other mortgages
Other loans
Real estate owned
Other assets



Gross assets


Cash and investment securities3
Mortgage-backed securities


a. Excludes $5.1 billion in cash and cash equivalents accumulated from receivership collections.
NOTE: All data are based on preliminary information as of February 28, 1991. Number of institutions: 366.
SOURCE: Resolution Trust Corporation, RTC Review, vol. 2, no. 2, February 1991.

the RTC to recognize losses quickly
and dispose of assets promptly, to
prevent the total cost of the bailout
from escalating.
Administrative constraints on the salvage operation arise from two sources.
The first is the additional layer of bureaucracy that FIRREA imposed with
the establishment of the RTC Oversight
Board, which was instituted to ensure
that the corporation conducts its operations in a manner consistent with the
public interest. However, RTC Chairman L. William Seidman has stated in
Congressional testimony that this board
has reduced the RTC's operational flexibility and innovation and has consequently hindered the speed and efficiency with which the corporation can
dispose of assets.
A second source of administrative constraint is the sheer magnitude of the
thrift crisis relative to the staff resources
available to the RTC. The 556 thrifts
that have experienced government intervention as of March 1 represent millions of individual loan contracts and

investments that must be evaluated by
the RTC and potential acquirers. The
RTC employs more than 1,500 people,
but critics contend that its pool of bank
examiners and disposition experts is
too small and inexperienced to keep
pace with the problem.
Another obstacle in the evaluation process is the lack of any secondary market
in which to trade or to determine a market value for a substantial portion of the
seized thrifts' assets. Further complicating the valuation process is the fact that
credit risk, rather than interest-rate risk,
is currently the underlying cause of
losses on thrift balance sheets. Assessing
the credit risk of each borrower is more
complex and time-consuming than adjusting assets to account for unrealized
gains and losses due to interest-rate fluctuations in a national credit market.
Uncertainty about conditions in the various regional markets also reduces the
RTC's ability to value the assets in its
control. Coupled with the low market
value of many of the receivership assets,
this uncertainty creates incentives for the

RTC to warehouse its assets. Selling
these difficult-to-value assets leaves the
RTC open to second-guessing by the
press, taxpayers, and politicians, who
may accuse the corporation of selling
the assets too cheaply. Unfortunately,
warehousing assets does not increase the
efficiency of markets, but instead may increase the uncertainty concerning the
true value of assets, such as real estate,
when the market is depressed.
The lack of adequate funding may also
delay thrift resolutions by the RTC.
The initial $68 billion committed by
FIRREA has fallen well short of what
is needed to cover the losses of insolvent thrifts. The inability of the RTC to
cover losses has limited the number of
thrifts it has been able to resolve, and
the corporation has already drained off
$34.3 billion of its $50 billion of initial
funding. In fact, without an additional
$ 18 billion in funding (by way of legislative error), the RTC salvage operation
would have ground to a halt last fall. 14
Funding constraints have also reduced
the working capital needed to finance
the temporary holding of assets. A
shortage of this capital reduces the
speed at which the RTC can intervene
and resolve thrift insolvencies, since it
must eventually generate working capital through the liquidation of assets.
Much of the RTC's working capital to
date has come from its short-term borrowings from the Federal Financing
Bank. Of the total $75.3 billion in
working capital that the RTC has distributed through March 1, 1991, approximately one-fourth has come from
Congressional appropriation, while the
remainder has come from short-term
loans. These loans are to be repaid with
the revenue generated from asset sales;
however, the sluggish pace of these
sales has reduced the amount of funds
available for covering losses and providing the working capital for additional resolutions. At the end of February
1991, only $8.2 billion of cash was
available from the RTC's initial Congressional appropriation and from its
Federal Financing Bank borrowing
authority to fund additional resolutions.

As a percentage of total assets





Aug., Sept. Oct. Nov. Dec. Jan. Feb.
Percentage of assets returned to private sector
SOURCE: Resolution Trust Corporation, RTC Review, vol. 2, no. 2, February 1991.

• Removing Some of the Obstacles
Congress has recently passed legislation
to address some of the funding problems that have threatened to paralyze
the thrift salvaging operation. The new
RTC recapitalization bill allocates $30
billion of taxpayer funds to absorb
thrift losses and permits the RTC to
borrow an additional $48 billion to use
as working capital. RTC Chairman
Seidman recently announced that with
the newly acquired spending authority,
the RTC plans to sell another 215 failed
thrifts by the end of September 1991.
Although increased funding will
finance the RTC through this period, it
is unclear whether it will enable the corporation to resolve all insolvent thrifts.
Recent statements by the U.S. General
Accounting Office suggest that the
RTC's additional needs to cover losses
could exceed the entire $78 billion of
recently appropriated funding. 15
Seidman has also reported that the RTC
will relax some rules in order to speed
the sale of $65 billion in assets (particularly real estate) from those 215 insol-

vent thrifts. First, the corporation will
increase the markdown to 40 percent
for real estate assets on the market
longer than six months, and to 50 percent for those held longer than 18
months.16 In addition, the RTC also intends to offer mortgage-backed securities at the rate of $1 billion per month
once registration is completed with the
Securities and Exchange Commission.
Some analysts have argued that depressed real estate markets have made
it more expensive for the government
to hold on to some real estate than to
merely give it away. Consequently, the
RTC expects to give away between
2,000 and 3,000 of the single-family
units that it fails to auction to nonprofit
groups for use as low-income housing.
One other initiative aimed at accelerating asset sales is instituting a new bid
option, whereby the RTC will include
an estimate of the value of assets in its
bid packages. The estimate is the price
that the RTC will pay for these assets at
closing and will apply to all institutions
in RTC conservatorship.



Cleaning up the thrift mess, the goal of
the RTC, is a complex and monumental
undertaking. The RTC's performance to
date suggests that it has not met its
stated objective of resolving thrift insolvencies quickly and at the lowest cost to
taxpayers. The corporation has resolved
less than half of the thrifts that will ultimately be closed, and in those resolutions has failed to return nearly 70 percent of the assets to the private sector.
The pace at which the RTC has resolved
insolvent thrifts reflects the sheer magnitude and nature of this unprecedented
problem, as well as constraints that reduce
the speed, flexibility, and efficiency of
the salvage operation. Unfortunately,
the resulting delay continues to add to
the ultimate resolution costs. Although
the recently announced procedures are
a step toward streamlining operations
and speeding resolutions, it is clear that
. the RTC must further modify its current asset disposition policies in order
to resolve the thrift crisis with minimum taxpayer loss.
• Footnotes
1. See David C. Cooke, "Status of the Resolution Trust Corporation: Testimony before
the RTC Oversight Task Force," in Status
and Activities of the RTC and the Oversight
Board, Hearings before the Subcommittee on
Financial Institutions Supenision. Regulation, and Insurance and the Resolution Trust
Corporation Task Force of the Committee on
Banking, Finance, and Urban Affairs of the
House of Representatives, 101 Cong. 1
Sess., October 4, 19, and November 6, 13,
1989 (Government Printing Office, 1989),
pp. 290-326.
2. At the end of February 1991, 190 thrifts
were operating in RTC conservatorship, and
another 320 thrifts supervised by the Office of
Thrift Supervision were considered marginal.
We define a thrift as marginal if it is not in
RTC conservatorship (as of February 28,
1991) and has a total net worth of less than 3
percent of assets on December 31,1990.

3. See James B. Thomson and Walker F.
Todd, "Rethinking and Living with the
Limits of Bank Regulation," The Cam Journal, vol. 9, no. 3 (Winter 1990), pp. 579-600.
4. FIRREA transferred the chartering
authority and supervision responsibilities of
the former Federal Home Loan Bank Board
to the newly created Office of Thrift Supervision. This act also transferred the responsibility of thrift deposit insurance from the
now-defunct FSLIC to the Federal Deposit
Insurance Corporation's Savings Association
Insurance Fund (SAIF).
5. See Edward J. Kane, "Principal-Agent
Problems in S&L Salvage," Journal of
Finance, vol. 45, no. 3 (July 1990), pp.
6. See Bert Ely, "Statement on Oversight
Board's Strategic Plan to Make FIRREA and
RTC Succeed," in Status and Activities of the
RTC and the Oversight Board, Hearings.
October4, 19, and November 6, 13, 1989,
pp. 92-94.
7. See Irvine Sprague, "Statement on Disposition of Assets by the Resolution Trust
Corporation," Hearings before the Subcom• mittee on Financial Institutions Supervision,
Regulation, and Insurance and the Resolution Trust Corporation Task Force of the
Committee on Banking, Finance, and Urban
Affairs of the House of Representatives, 101
Cong. 2 Sess., May 4, 1990 (Government
Printing Office, 1990), pp. 18-19.
8. See James R. Barth, Philip F. Bartholomew, and Michael G. Bradley, "Determinants of Thrift Institution Resolution Costs."
Journal of Finance, vol. 45, no. 3 (July
1990), pp. 731-54.
9. The S&L Quarterly Performance: Ratings
and Analysis, Austin, Texas: Sheshunoff Information Services, 1991.
10. Kane states that"... unlike a private salvor, the RTC is saddled with the additional
objective of slowing down official recognition of the full size of FSLIC's losses." See
Kane, "Principal-Agent Problems."

11. This follows Kane's analysis of the constraints on the ability of the Federal Deposit
Insurance Corporation to resolve bank insolvencies. See Edward J. Kane, "Appearance
and Reality in Deposit Insurance: The Case
for Reform," Journal of Banking and
Finance, vol. 10, no. 2 (June 1986), pp.
12. See L. William Seidman, "Statement on
Predictions and Policy Statements of the
Resolution Trust Corporation," in Oversight
Hearings on the Resolution Trust Corporation, Hearings before the Committee on
Banking, Finance, and Urban Affairs of the
House of Representatives, 101 Cong. 2
Sess., January 23-25, 1990 (Government
Printing Office, 1990), pp. 87-93.
13. See Paul M. Horvitz, "Statement on the
Strategic Plan for the RTC," in Oversight
Hearings on the Resolution Trust Corporation, January 23-25, 1990, pp. 1165-81; and
Irvine Sprague, "Statement on Disposition of
Assets by the Resolution Trust Corporation,"
Hearings, May 4, 1990, pp. 18-19.
14. See "Resolution Trust Corporation Funding Act of 1990," Congressional Record—
Senate, October 27, 1990, pp. S17722-25. •
15. See John R. Cranford, "RTC Gets
'Incomplete' Grade, Urged to Improve
Records," Congressional Quarterly Weekly
Report, vol. 49, no. 8 (February 23, 1991),
p. 457.
16. Under current rules, the RTC marks
down property by 5 to 10 percent initially, by
15 percent after six months, and by 20 percent after nine months.

Christopher J. Pike is a senior research assistant and James B. Thomson is an assistant
vice president and economist at the Federal
Resen'e Bank of Cleveland.
The views staled herein are those of the
authors and not necessarily those of the
Federal Resen'e Bank of Cleveland or of the
Board of Governors of the Federal Reserve

Annual Report 1990 Now Available

Essay Examines How Banks
Are Weakened by Overprotection
According to the essay in the Federal
Reserve Bank of Cleveland's Annual
Report 1990, regulation—rather than
market forces—has guided the development of the U.S. banking system and
has ultimately reduced its efficiency,
stability, and competitiveness. "Since
all industries exist in a constantly
changing environment," states the
essay, "this 'protection' actually creates
vulnerability and increases the costs of
bank failures."
The essay, entitled "The Banking Industry: Withering Under the Umbrella
of Protection," indicates that U.S. banking regulations and guarantees "have
been shaped by a belief that banking is
'special.' This belief is based on the
fear that the economy is especially vulnerable to banking failures, panics, and
other malfunctions in banking markets.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Address Correction Requested:
Please send corrected mailing label to
the above address.

Material may be reprinted provided that
the source is credited. Please send copies
of reprinted materials to the editor.

"Unfortunately," explains the essay,
"the common view of bank failures,
which is rooted in the financial collapse
of the 1930s, is misleading. It overemphasizes the likelihood and effects
of financial fragility and has been used
to justify restrictions, regulations, and a
safety net to protect the banking industry and the public. A closer look at the
forces that led to the Great Depression
and other, earlier panics seems to indicate that poor monetary policy decisions
and a lack of timely, reliable information caused the crises, not an inherent
weakness of banks."

Regulations could be gradually eliminated, suggests the essay, so that banks
are subject to the same market forces
as are unregulated, unprotected financial firms. "The result," says the essay,
"would be a more efficient, competitive, and stable financial system that
will not need to rely on taxpayer subsidies to compete, or even survive, in the
financial marketplace."
Annual Report 1990 is available from
the Public Affairs and Bank Relations
Department of the Federal Reserve
Bank of Cleveland at 216/579-3079.

The essay documents the decline in the
relative importance of banks in the
financial services market. Other firms,
such as finance companies, insurance
companies, and brokerage houses, now
provide the same services as banks—
without special regulations and guarantees. Consequently, treating banks as
separate, unique firms is unnecessary.

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