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10:00 a.m.
^ F e b r u a r y 22, 1989,
Room 1100, Longworth House Office Building


Good morning, Mr. Chairman and members of the Committee. I am
pleased to testify today concerning the problems of the savings
and loan ("S&L") industry, and the Federal Savings and Loan
Insurance Corporation ("FSLIC").
The Federal Deposit Insurance Corporation ("FDIC") believes
President Bush's "Reform Plan for the Savings and Loan Industry"
("Bush Reform Plan"), announced February 6th, generally is a
sound proposal.
It provides for prompt action to resolve the
S&L situation and proposes structural and regulatory reforms
designed to make the federal deposit insurance system
cost-effective. These changes will help prevent a recurrence of
the factors that led to this most costly problem.
As the insurer of bank depositors, the FDIC has been concerned
that the thrift industry's problems pose a threat to the
profitability — and potentially even the stability — of many
The FDIC has had firsthand experience dealing with many problems
similar to those faced by the thrifts and the FSLIC. These
include high and volatile interest rates, increased competition
from nonbank providers of financial services, a boom-to-bust
economy in the Southwest, and fraud and insider abuse.
These adverse conditions have contributed to the record number
of bank failures over the past several years. In 1988 alone,
the FDIC fund dealt with $80 billion of problem bank assets —
more than the combined total of assets handled during its first
fifty years. As a result, the insurance fund declined from over
$18 billion to approximately $14 billion — our first operating
loss ever.
Concern over the high cost of providing deposit insurance led
the FDIC to undertake a year-long review of ways to improve the
current deposit insurance system. Our recently released study,
Deposit Insurance for the Nineties: Meeting the Challenge,
contains recommendations for reforming the deposit insurance
system and provides an outline for a restructured federal
deposit insurance system. I would like to submit the executive
summary of our study for the record. As part of our review, we
studied the size and estimated cost of the thrift problem, and
analyzed alternative funding sources.
I would like to turn now to the S&L problem.
Size of the problem. In order to estimate fully the budgetary
implications of the thrift problem, ascertaining the size of the
insurance loss is critical. At the beginning of 1988, there
were approximately 500 insolvent thrifts under generally
accepted accounting principles ("GAAP") with assets over $200
billion. During 1988, the Federal Home Loan Bank Board
("FHLBB") took action on more than 200 S&Ls at a reported cost
of over $39 billion on a present value basis. We understand
that the General Accounting Office ("GAO") soon will release a
cost analysis of S&L transactions during 1988.
As of the end of the third quarter of 1988, there were about 220
thrifts that were insolvent under regulatory accounting
principles ("RAP"), not including those thrifts handled by the
FHLBB in 1988, and another 119 GAAP insolvent thrifts. Our
latest estimates suggest that current operating losses at these



RAP and GAAP insolvent S&Ls are about $200 million per month.
That figure will be higher if S&Ls experience deposit outflows,
as they have recently, and must fund with higher cost deposits.
We have stated in the past that reliable cost estimates of
resolving the insolvent S&Ls can be made only through detailed
on-site examinations. We are in the process of making such
estimates pursuant to the joint oversight effort discussed
below. Our best estimates at this time are in the same range as
the Treasury Department's estimated cost of $90 billion.
Bush Reform Plan financing proposal. Regarding the financing
package, the Treasury Department and the Office of Management
and Budget are its architects, and are in the best position to
comment on its efficacy. From our viewpoint, the Plan appears
viable and sound. The Bush Reform Plan provides for an
equitable sharing of the financial burden between the S&L
industry and the Treasury.
Appropriately, banks are not required to pay for the S&L
losses. While the Plan places a heavy burden on the S&L
industry to pay for its problems, the S&L industry should be
required to bear as much of the cost as possible without
jeopordizing their sound institutions.
Ability of banks and S&Ls to pav increased premiums. The Bush
Reform Plan calls for increased insurance premiums for both
banks and S&Ls. The increased premiums for the S&Ls will be
used to partially offset the cost of that industry's problems.
The banks' increased premiums will be used to strengthen the
FDIC insurance fund. Both premium increases will add to general
federal revenues for budgetary purposes.
In our recently released study on deposit insurance, we
concluded that FDIC deposit insurance premiums should be
adjusted for the risk and costs incurred by the insurance fund.
The FDIC spent $7 billion dollars last year, and our fund
declined by about $4 billion, or over 20%. Our fund's reserves
at year-end will be reduced to 83 cents per $100 of insured
deposits, well below desired levels. Without regard to the S&L
industry problems, the FDIC study recommended that bank premium
rates be increased to reflect more accurately recent loss
experience of the FDIC fund.
The Bush Reform Plan calls for such an increase — and we
support this proposal. Raising bank premiums from their current
level of 8.33 basis points to 12 basis points next year, and
then 15 basis points the year after, is reasonable. We estimate
going to 12 basis points will increase premiums about $700
million, and that 15 basis point will bring in almost $600
million more.
The increase in premium expenses translates to about 2.1 percent
and 3.8 percent of pre-tax earnings at 12 and 15 basis points,
respectively. To some extent, this increase probably could be
offset by repricing of services, but the ability to do this is
constrained by today's competitive market place. Assuming that
all the increase resulted in earnings reductions, we estimate
that fewer than 100 institutions out of over 13,000 that are now
profitable would be made unprofitable.

-3The majority of the banks that would suffer the most significant
decline in profitability from higher assessments are located in
the Southwest and Midwest regions, the two regions that have
experienced the greatest difficulties during this decade.
Given recent FDIC loss experience, the increases are consistent
with our study's conclusions and should not pose an unreasonable
burden to the banking system. Importantly, the revenues
generated from these premiums will go solely to build the FDIC
Under the Bush Reform Plan, once the FDIC insurance fund moves
up from .8 to 1.25 percent of insured deposits, banks can expect
premium rebates. Our preliminary estimate is that rebates could
begin as early as the mid-1990s under the President's plan.
We recently completed an evaluation of the rebates the FDIC paid
from 1950 through the early eighties. We added all rebates from
that period back into our fund and applied the yield we would
have earned on those funds. We discovered that, if no rebates
had been paid during that time, the FDIC today would have
another $26 billion in its insurance fund.
This indicates that the current rate of 8 basis points was more
than sufficient to meet costs if no rebates had been paid.
Thus, a return to lower premiums may be indicated at some future
As to the proposed increased premiums on the thrift industry,
the thrift industry should shoulder as much of the burden of the
industry's problems as possible. Since increased premiums
affect profitability, and potentially even solvency, it is
important to the insurer to levy rates that will leave the S&L
industry viable — and not drive more institutions into the
federal safety net.
Based on the rough estimates we have at this time, increasing
the thrift deposit insurance premiums from 20.833 basis points
to 23 basis points does not appear unreasonable. This increase
of just over 2 basis points will have little additional negative
impact on thrift earnings. The many factors that affect the
future profitability of the thrift industry make a judgment in
this area uncertain, but it appears this increase would not
impose a life-threatening burden on the industry. We are in the
process of conducting further analysis on this subject using
both our resources and industry studies.
The Tax Reform Act of 1986 significantly increased the tax
burden on our nation's commercial banks, especially through
limitations on deducting both bad debt reserves and interest on
debt used to purchase tax-exempt obligations. While certain
provisions in the Technical and Miscellaneous Revenue Act of
1988 ("TAMRA") will benefit the industry as a whole, they are
unlikely to reduce this increased burden to an appreciable
TAMRA. As you, Mr. Chairman, and the members of your Committee
are well aware, TAMRA extended but reduced the tax incentives
provided to FSLIC-assisted transactions. At the same time, it
extended limited tax incentives to FDIC-assisted transactions to
provide parity with FSLIC transactions. We again would like to
express appreciation to you and the Committee for your efforts
in including these much-needed FDIC-related provisions in that

-4We want to stress that we will use these tax provisions to
minimize the government's total cost of handling failing
institutions. When the FDIC determines whether the most
cost-effective solution is an assisted transaction or the
liquidation of the problem institution, we will consider both
the direct cost to the FDIC and our best estimate of the tax
expenditure to the federal government.
These provisions will help to handle the massive amounts of
losses that must be absorbed to resolve the S&L and bank
In this regard, the Committee needs to make clear
that these provisions apply to assistance provided through the
Reconstruction Trust Corporation, proposed as part of the Bush
Reform Plan. We also hope the Committee will extend the
applicability of these provisions beyond year-end 1989. If not
extended, the increased cost will be directly reflected in
increased Treasury expenditures for S&L case resolutions under
the Bush Reform Plan.
TAMRA, as it relates to FDIC transactions, is important for two
First, it clarifies the tax treatment of FDIC
assistance transactions.
Prior to the passage of TAMRA, there
was significant confusion concerning the proper tax treatment of
these transactions. The confusion resulted in a double negative
from the standpoint of the federal budget. The FDIC enjoyed no
reduction of its assistance costs because bidders minimized the
value of tax attributes because of the uncertain tax
consequences of such transactions. At the same time, we believe
taxpayers took aggressive reporting positions following these
transactions in a way that resulted in reduced tax revenues.
The clarifications that have been provided through TAMRA go a
long way toward avoiding this double negative result, and
minimize the government's total cost of handling failed
Second, the FDIC now has an opportunity to receive the maximum
benefit from the tax attributes of assistance transactions, and
thereby minimize the government's overall assistance costs.
This will reduce the "on-budget” cost of FDIC-assisted
transactions, and have a positive effect on the deficit in the
current budgetary year. Of course, there also is an offsetting
revenue cost associated with these transactions.
In addition to this tax-related reduction in FDIC assistance
cost, there is another cost savings that we expect to realize as
a consequence of the TAMRA provisions. Specifically, we believe
that we will be able to complete more "whole bank"
In these transactions, the purchasers of failed
banks acquire all or most of the banks' assets, including the
nonperforming or troubled assets. Such transactions differ from
"clean bank" transactions where the purchaser takes only the
good assets. Where we are able to do a whole bank transaction,
as compared with a clean bank transaction, the FDIC's net cost
is less. This savings results from a higher asset realization
through management of the troubled assets by the purchaser,
rather than by the FDIC.
Implementation steps. To ensure that the FDIC and the overall
federal budget realize the maximum savings benefits from the
TAMRA provisions, we have moved as quickly as possible to
implement the tax law changes and educate prospective failed
bank purchasers of their benefits. This effort has taken
several forms.


-5First, we are conducting internal seminars for FDIC employees on
the operation of the provisions. Second, we are working with
the Internal Revenue Service to further clarify the new
provisions so they operate in an efficient manner. Third, we
are sponsoring extensive seminars throughout the country for
potential bidders concerning the nature of the new provisions
and the methods by which the FDIC is implementing them. Fourth,
we are providing notices to potential bidders for failed banks
describing the operation of the tax changes and the impact they
should have on the need for FDIC assistance. Fifth, we are
providing information with respect to each failed bank as part
of the initial bid information that analyzes the impact of the
tax provisions. And sixth, trained tax coordinators will be
present at bid meetings to make sure all tax-related
considerations are understood.
Cost savings. As indicated during my testimony before the
Committee in late January, the FDIC is currently refining its
methods for analyzing the effect of the TAMRA tax provisions on
our transactions, and on the overall cost of government
assistance. We will make a complete report to the Committee as
soon as we have analyzed enough transactions to provide more
reliable information.
Although we may not yet be realizing the maximum benefits from
the changes in the tax law, we believe that the implementation
steps noted above — most significantly the education of bidders
concerning the value of the tax provisions — will result in
increased competition and a maximization of assistance savings
in the near future.
As stated above, we are working closely with the Internal
Revenue Service to clarify certain provisions applicable to
FDIC-assisted transactions. The 1RS recently has confirmed that
individual certification is a statutory requirement necessary
for the purchaser of a failed bank to obtain the various tax
attributes of the acquired bank. We believe this clarification
will give us increased leverage in achieving appropriate savings
by withholding certification if the assuming bank is not
properly valuing the tax benefits.
We will continue to employ these tax provisions in a reasonable
and cost-effective manner, and we respectfully urge the
Committee to extend these provisions into 1990.
I would now like to turn to the interagency oversight effort
underway to deal with the currently RAP insolvent S&Ls.
As part of the Bush Reform Plan, the President recently
requested that the FDIC lead a joint effort to evaluate and
oversee most of the RAP insolvent thrifts. In addition to the
FDIC and the FSLIC, the Federal Home Loan Bank Board, the
Federal Reserve, and the Office of the Comptroller of the
Currency are participating in this interagency initiative.
The purpose of this interagency effort is to limit the growth of
problems in our nation's insolvent thrifts until a comprehensive
reform of the deposit insurance system, and the necessary
funding, are authorized by the Congress.
Insured deposits will
remain fully protected throughout this process.




In the last two weeks a joint task force of regulators, led by
the FDIC, took control of 36 of the insolvent thrifts. We
expect to assume oversight of almost 200 other RAP insolvent
thrifts in the next four to six weeks.
The FSLIC has contracted with the FDIC to take control of these
institutions that are being placed in conservatorship or
receivership. That means the FDIC, with the help of other
regulators, will oversee operations of the insolvent thrifts.
Managements of the various institutions are subject to the
regulators' authority. From the customer's perspective,
however, the only visible difference will be a few more people
in the institution's offices. Day-to-day operations will
continue to preserve basic services to deposit and loan
One of the first priorities of these oversight efforts will be
to evaluate the losses at each institution. Such on-site
examinations are necessary to produce accurate estimates of the
cost of the thriftyproblem. Once our estimates are completed
and GAO has issued its report on the cost of FSLIC's 1988 deals,
the total cost of this problem can be determined.
Another top priority is to identify and stop any abuse, waste,
or fraud that may be present. A further priority will be to
prepare a business plan for the institution and seek cost
reduction through consolidations and more efficient operations.
While in control of these institutions, we will seek to stop any
unsafe or unsound practices. We will limit their growth, and
downsize them through asset liquidations where possible.
However, we will avoid firesales of assets and emphasize the
need to sell at values that reflect current appraised values.
Finally, we will develop longer-term solutions to these
problems. Our staff will recommend different approaches —
liquidating the institutions to selling them to qualified
But our current job is a holding action only.
will not issue notes or enter into income maintenance


The FDIC has established four task groups to address these
responsibilities. These task groups are designed to ensure
stable operations in the insolvent thrifts and to evaluate
options for permanently resolving their insolvency once funding
is approved by Congress.
One of our most important task groups is our new Fraud Squad.
As President Bush has said, "unconscionable risk-taking, fraud
and outright criminality have also been factors [in the thrift
problem].” Investigators assigned to this Fraud Squad will
constitute a mobile unit. Whenever our on-site teams discover
evidence that fraud or insider abuse may have occurred, the
Squad will be sent to conduct a full-scale investigation. This
includes looking for ways to get back misappropriated assets
when possible, and helping send some to jail when appropriate.
Our three other task groups have separate but complementary
Our Oversight and Evaluation task group will examine these
institutions' condition, provide guidance to these institutions,
and take steps to reduce operating costs where possible.


-7Our Planning and Restructuring task group will recommend steps
to restructure and consolidate institutions where appropriate.
And our Transaction and Acguisition task group will begin the
process of seeking out buyers for institutions, real estate and
other assets. We will seek to reach agreements with purchasers
subject to resources being made available to provide assistance.
The FDIC and the FHLBB have agreed that, until the agencies
review the status of the insolvent thrift institutions placed
under joint regulatory oversight, only cash assistance
transactions will be undertaken by the FSLIC.
We also must note that these additional responsibilities in
addressing the S&L situation will place a strain on FDIC
resources. We are dedicated to this new task and will strive
for success, but we do expect to experience growing pains and
recognize our need to climb a learning curve in the process.
Any legislated resolution of the FSLIC problem, in addition to
providing appropriate funding, should reform the system to
protect against recurrence of the problems that led to the
current S&L situation. As mentioned above, detailed
recommendations for improvements to the system are contained in
the recent FDIC study. However, I would like to summarize some
of the most important concepts.
One of the fundamental changes recommended in our study is that
the federal insurer be allowed to operate as much as possible
like an independent private insurer. This principle is central
to improving the system. To maintain adequate resources, the
insurer must have additional controls over revenues, including
the ability to adjust insurance premiums paid by insured
institutions and to require an entrance fee from those newly
obtaining insurance. The insurer also must be able to control
costs. This necessitates the ability to set standards for
insurability for all insured institutions and to promptly
terminate insurance privileges when an institution is operating
in an unsafe manner. The Bush Reform Plan, for the most part,
includes these important changes to the operating structure of
the federal deposit insurance system for S&Ls.
To accomplish private insurer status, the FSLIC and FDIC also
should be as financially, operationally, and organizationally
independent as possible. To ensure political independence, the
insurer should continue to be funded by premiums paid by the
insured institutions.
It should have a budget separate from the
general federal budget and should not be allowed to obligate
general federal revenues. The insurer also should remain
independent from the Congressional appropriations process. The
insurer should remain accountable to Congress on an annual
basis. The insurer's ability to issue notes or like obligations
should be restricted as provided in the Bush Reform Plan.
We believe the Bush Reform Plan is a generally sound proposal,
and hope Congress acts on it promptly. Congressional funding
will be necessary for a cost-effective solution to these
problems. Any legislated resolution of the S&L situation should
improve the federal deposit insurance system to protect against
a recurrence of existing problems.



We appreciate the passage of the recent amendments to the tax
laws concerning FDIC-assisted transactions, and are working to
maximize our savings for the government as a result of those
We would be happy to work with the Committee on any aspect of
the S&L situation where we may be helpful. I would be pleased,
at this time, to answer any questions the Committee may have.