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TESTIMONY OF
L. WILLIAM SEIDMAN
CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.
SAVINGS AND LOAN INDUSTRY AND THE FEDERAL SAVINGS
AND LOAN INSURANCE CORPORATION^ ^
C BEFORE THE
__ §
COMMITTEE ON THE BUDGET
UNITED STATES SENATE
10:00 a.m.
March 2, 1989.
Good morning, Mr. Chairman and members of the Committee.
I am pleased to
testify today on the current problems of the savings and loan ("S&L") industry
and the Federal Savings and Loan Insurance Corporation ("FSLIC").
As
requested in the Committee's letter of invitation, our testimony today will
focus on the costs involved in resolving the S&L situation.
The Federal Deposit Insurance Corporation ("FDIC") generally supports
President Bush's Reform Plan for the S&L industry, announced February 6th, and
the recently proposed legislation —
~
to carry out that plan.
that was introduced last week as S. 413
We believe it is a sound, constructive and
farsighted proposal that should be enacted.
S. 413 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.
BACKGROUND
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.
$80 billion of problem bank assets —
handled during its first fifty years.
In 1988 alone, the FDIC fund dealt with
more than the combined total of assets
As a result, the insurance fund
declined from over $18 billion to approximately $14 billion —
operating loss ever.
our first
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2
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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:
Meetinq the Chal1enae. contains recommendations for reforming the deposit
insurance system and provides an outline for a restructured federal deposit
insurance system.
for the record.
I would like to submit the executive summary of our study
As part of our review, we studied the size and estimated cost
of the thrift problem, and analyzed alternative funding sources.
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.
In addition, there would be another 100 insolvent S&Ls under banking
standards —
namely, if goodwill were eliminated.
Our latest estimates
suggest that current operating losses at these RAP and GAAP insolvent S&Ls are
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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
deposi ts.
We have stated in the past that reliable cost estimates of resolving the
insolvent S&Ls should be made by on-site examinations.
We are in the process
of making such estimates pursuant to the joint oversight effort discussed
below.
Once our estimates are completed and GAO has issued its report on the
cost of the FSLIC's S&L transactions in 1988, we will have a more accurate
total estimate of the S&L situation.
Our best estimates at this time are in
the same range as the Treasury Department's estimated costs.
See the attached
Charts A and B.
When discussing cost figures, it is important not to confuse present value
with actual dollars spent over the life of the workout.
provide information on those cost figures.
appropriate figure to focus on —
Charts A and B
The present value is the
it represents the cost in today's dollars.
The actual dollar figure mixes apples and oranges because a dollar spent in
the future is worth less than a dollar today.
For example, consider buying a house that sells for $100,000.
either pay cash or finance it.
One could
If the purchase is financed with, say, a
30-year fixed rate mortgage at 10 percent annual rate, the monthly payment
will be approximately $875.
$316,000.
Over the thirty years, the payments add up to
Even though the person who finances the house outlays, over the
life of the mortgage, more than three times the number of dollars than the
person who pays cash, we do not say that the house costs three time as much
for people who finance.
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The cost estimate which is projected by the President's proposal is based on
today's dollars.
If the rescue plan is financed, the actual dollars outlayed
will be substantially higher than that amount, but the cost will not be.
BUSH REFORM PLAN FINANCING PROPOSAL
The Treasury Department and the Office of Management and Budget are the
architects of the financing provisions of S. 413, and thus are in the best
position to comment on them.
From our viewpoint the financing plan, while
complex, appears viable and sound.
The attached Chart C provides information
on the sources and uses of funds under the proposed financing plan.
Chart D
is a diagram of a more direct financing approach that we developed at the
request of Senator Riegle for the Banking Committee hearing earlier this week.
Ability of banks and S&Ls to pav increased premiums.
In general, we believe
S. 413 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.
The bill would impose 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
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by the insurance fund.
The FDIC spent $7 billion dollars last year, and our
fund declined by about $4 billion, or over 20 percent.
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 —
proposal.
and we support this
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 points 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.
The 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.
6
-
Importantly, the revenues generated from these premiums will go
solely to build the bank insurance fund of the restructured FDIC.
Under S. 413, once the bank 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 date.
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 —
net.
and not drive more institutions into the federal safety
In fact, there should be careful consideration of the effect of the
premium level on the industry's viability when coupled with the significantly
increased capital requirements, goodwill write-off and the loss of income from
the FHLB System.
This is a complex question which requires that flexibile
authority be provided to the insurer.
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INTERAGENCY OVERSIGHT EFFORT
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.
Since the program was announced by President Bush on February 6th, a joint
task force of regulators, led by the FDIC, has taken control of 36 of the RAP
insolvent thrifts.
We are going into another 37 today and expect to assume
oversight of the rest of the over 200 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 customers.
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8
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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 thrift problem. As already
noted, 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
more accurately.
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 —
from liquidating the institutions to
selling them to qualified purchasers.
But our current job is a holding action
only.
We will not issue notes or enter into income maintenance agreements.
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.
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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]."
this Fraud Squad will constitute a mobile unit.
Investigators assigned to
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 assignments.
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.
Our Planning and Restructuring task group will recommend steps to restructure
and consolidate institutions where appropriate.
And our Transaction and Acquisition 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.
10
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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.
RECOMMENDED DEPOSIT INSURANCE REFORMS
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.
We would like to highlight, however, two needed
improvements.
Separate budget. One concept contained in the study, within the jurisdiction
of this Committee, is that the FSLIC and FDIC insurance funds should be
separately budgeted and should not be part of the general operational federal
budget.
In essence, the basic purpose and mandate of the funds is to save for
emergencies.
For decades the insurance funds have been depositing their
unspent premium income into the U.S. Treasury.
While the insurance trust
funds receive no taxpayer dollars, these deposits to the Treasury nonetheless
are counted as income to the government rather than savings reserved for
future problems in the industry.
When funds are withdrawn
from the Treasury to deal with a problem institution, that action is treated
as a government expenditure.
money on deposit.
Instead, it should be treated as a payback of
11
As the present system is designed, it creates a disincentive for saving for
future problems.
Moreover, because of the immediate negative impact on the
general budget, the insurer may be hesitant to draw upon funds to deal with
industry problems at an early stage.
For these reasons, we urge the Committee to consider setting up a separate
budget for the deposit insurance funds.
The President's plan does not provide
for such a separate budget.
Independence of the Insurer. Another fundamental change recommended in our
study is that the federal insurer be allowed to operate as much as possible
like an independent private insurer.
Although the President's proposed
legislation provides for progress in the independence of the former FSLIC,
certain provisions of the plan run counter to the principle of establishing an
independent deposit insurer.
In fact, in each of the following instances, the
legislation would make changes to the existing independence of the FDIC that
would limit its independence.
First, the bill would permit the President to appoint and remove, with or
without cause, the Chairman and Vice Chairman of the reconstituted FDIC Board
of Directors.
At present, the Board of the FDIC elects its Chairman.
We
believe such removal authority could compromise significantly the independence
of the FDIC, and recommend that it be deleted.
If a change is needed, we
would suggest that a system similar to the Federal Reserve System —
appointment for a term with the consent of the Senate —
be adopted.
Second, another provision of S. 413 would place limits on the FDIC's borrowing
authority.
We believe it is appropriate to limit the FDIC's ability to issue
12
notes and other debt obligations.
-
However, the proposed limitations are
impractical and overly restrictive and could seriously undermine the safe and
cost-effective operations of the insurer in the near term.
To put the proposed limit in perspective, it would restrict the FDIC's
obligations to $7 billion.
We are almost at the proposed cap already.
Currently the FDIC has about $6 billion in obligations.
In each case the
liability was properly recorded with the appropriate charge taken against net
worth.
The FDIC's $14 billion of net worth represents the unencumbered assets
available in excess of that needed to satisfy all actual and contingent
liabilities.
In other words, the FDIC has not used debt because it does not
have the necessary resources, but because of other valid business reasons.
Examples of such reasons include providing failed bank acquirors additional
flexibility in markets with weak loan demand, avoiding untimely portfolio
sales and even maintaining some additional leverage to ensure buyers hold up
their end of the bargain.
Thus, instead, we recommend a very simple borrowing limit:
No notes can be
issued which will put the agency into a deficit net worth position.
Thus, the
FDIC would be able to obligate neither itself nor the general government
revenues in an amount beyond the limits of the FDIC's resources as determined
by GAO audit.
By imposing the limit that we recommend, the insurer could not
issue debt if it does not have its own resources to repay that debt and, thus,
could nst obligate taxpayer funds.
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Third, S. 413 would require the FDIC to submit quarterly reports to both the
Secretary of the Treasury and the Director of the Office of Management and
Budget on the FDIC's financial operating plans and forecasts.
We believe it
should be sufficient to file such reports with the Administration through the
Treasury and that the reports should be those prepared by the FDIC in the
ordinary course of its business.
CONCLUSION
In conclusion, while we know this Committee is acutely aware of the need for
expeditious legislative action, we want to stress that point.
Nothing of
major substance can be accomplished to correct this problem until the Congress
acts to provide funding and guidance.
We believe S. 413 is a sound bill, and hope Congress acts on it promptly.
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.
Attachments
Ifliü l
Liab.
Annual
Income
L ilx
NIL.
Total
Assets
Cost
S&L Group
C o s t ¿El
To Assets
Cost../E2
To . A s s n t s
Handled by FSLIC
in 1988
208
$103.2
$120.1
$-10.2
$38.9
.38
$42.9
.42
RAP - Insolvent
& Unprofitable
217
$56.9
$65.6
$-5.3
$22.8
.40
$25.0
.44
RAP - Insolvent
& Profitable
Si
$2x5
$2x5
10.0
$0x4
x l6
0x5
x24
430
$162.6
$188.2
$-15.5
$62.1
.38
$67.9
.42
RAP Solvent but
GAAP - insolvent &
unprofitable
72
$24.2
$23.7
$-0.3
$3.6
.15
$4.8
.20
RAP - Solvent but
GAAP - insolvent &
profitable
45
$12x1
$11x2
$0x3
$1x5
xU
$2x2
xl5
547
$198.9
$223.6
$-15.5
$67.3
.34
$74.9
.38
RAP & GAAP - solvent
but tangible
insolvent and
unprofitable
69
$55.1
$53.2
$-0.5
$8.3
.15
$10.9
.20
RAP & GAAP
solvent but
tangible - insolvent
and profitable
52
$55x4
163.5
$0x2
$5x5
xlO
110.9
xl5
668
$320.4$
$340.3
$-15.8
$82.4
.26
$96.7
.30
154
$101.1
97.6
$-0.7
$9.6
.09
$14.9
.15
882
$421.5
$437.9
$-16.5
$92.00
.22
$111.6
.26
Lslx
COS-L.
Other:
SUBTOTAL
SUBTOTAL
SUBTOTAL
Marginally solvent
but unprofitable
TOTAL
1
2
Estimated Cost #1 rFailed-■bank cost formula with zero loss assigned to residential mortgages and passthrough securities.
Estimated Cost #2 '.Failed -bank cost formula with 10% loss assigned to residential mortgages and
mortgage pass-through securities.
CHART A
3rd QUARTER SUMMARY SHEET OATA OM FINANCIAL TROUBLED S&Ls ($BILLIONS)
CHART B
A DM IKIS 7RA 7 1 OK ’S FINANCING PROPOSAL*
(in billions of dollars)
Tine to Maturity
10 years
-N9
C 9
20 years
30 years
1 0 0 -1 2 5
1 1 5 -1 ^ 0
1 2 5 -1 5 0
li%
1 1 5 -1 *0
1 3 5 -1 6 5
1 60 -2 0 0
6%
1 2 5 -1 6 0
1 6 0 -2 0 0
2 0 0 -2 5 0
$%
1 ^ 0 -1 7 0
1 90 -2 3 0
2 5 0 -3 0 0
1 0 %
1 5 0 -1 8 0
2 1 5 -2 6 5
1
1
3 00 -3 5 0
•Cash flows represent actual dollars spent if net present value
cost of $90-il0 billion is financed over different tine periods
at interest rates shown in chart.
CHART C
ADMINISTRATION’S FINANCING PROPOSAL
SOURCES
OF FUNDS
USES
OF FUNDS
SOURCES
OF FUNDS
CHART D
ALTERNATIVE FINANCING PROPOSAL
SOURCES
OF FUNDS
USES
OF FUNDS
ISS O
filili« i n '
@FedFRASER