This Crisis Makes S&L Bailout Look Easy

The Bush Administration's $700 billion financial rescue plan bears little resemblance to the government’s handling of the savings-and-loan-crisis almost two decades ago—and may not be as successful, experts say.


The plan, which is still being hammered out with Congress, raises a number of red flags. First and foremost, unlike the process then, there’s no accompanying re-regulation of the financial services industry.

  • Rescue Plan Goes to Congress
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  • "We educated ourselves enough — we were able to build a competent structure,” says Donald Riegle, who chaired the Senate’s Banking Committee at the time. "We built a legislative package that worked quite well. Firrea (Financial Institutions Reform, Recovery and Enforcement Act) included creation of a regulator as well as the RTC.”

    Though history shows the S&L crisis was resolved successfully, there was considerable skepticism about the FIRREA law, the new regulator it created, the Office of Thrift Supervision, and the bailout entity, the Resolution Trust Corp., at the time of their creation.

    It also wound up costing less than many expected.

    In the current rescue plan, the absence of regulatory reform is no small matter, given the size of the problem and the complexity of investment instruments today.

    For Investors

    “It isn't just a question of the clean up,” says Riegle, now chairman of APCO Worldwide's government relations team. “You have to figure out how this happened and how you keep it from happening again. What are the standards for the future?"

    The regulatory and oversight shortcomings also illustrate the federal government’s patchwork approach to the problem prior to the more draconian bailout package. The Bear Stearns, Lehman Brothers, Fannie Mae-Freddie-Mac, AIGcases were also handled differently.

    Former S&L regulator and White House economist Lawrence White says that in the current environment if federal money is going to be at risk then the government needs regulatory tools to limit exposure, what he calls a safety-and-soundness regime for investment banks.

    “Minimal capital requirements, limitations on activities that may be too risky, managerial competency requirements, and clear powers of receivership for an insolvent institution,” says White, now a professor at NYU's Stern School of Business.

    In the S&L crisis, the government had those powers, before and after the bailout legislation, and are considered a key part of the success.

    Failing S&Ls were seized, depositors' money protected and assets then sold off with the institution ultimately being shut down.


    Another key difference is the size and complexity of the problem and the proposed solution— an initial $700 billion versus the estimated $145 billion price tag for the S&L rescue.

    Riegle says the problem and solution “dwarf the RTC” and are “a lot less plain vanilla.”

    “We're not talking bricks and mortar, we're talking about financial instruments, “ says Tom McMillen, a key player in the House of Representatives during the S&L saga.

    Banking analyst Bert Ely adds that the RTC “dealt with both good and bad assets."

    Dealing with the assets—from pricing to disposal—will be tricky business, whether the government holds them or sells them, say S&L veterans.

    One of the keys to the success of the S&L unwinding was an “orderly liquidation,” says McMillen, now chairman and CEO of Homeland Security Capital.

    Otherwise, it’s “like taking a whole block of houses and selling at once, which is not a way to get the best price.”

    The private asset managers controlling funds under the plan would presumably be competing to sell assets, which happen to be the same assets that no one wants to touch now.

    A Dumping Danger

    Robert Glauber, a top Treasury official who played a key role in the S&L unwinding, says the government will “be under pressure to buy and hold the assets because the argument will be that rapid dumping will crater the market for mortgage-based securities. Worse it will establish prices against which other institutions holding similar assets will have to take marks that will impair their capital.”

    Glauber says there was criticism of the RTC at the time that it “damaged the market by dumping assets," even though it did a good job.

    “The RTC decided it had to sell real estate assets at whatever prices would clear the markets so that prices would bottom and start to recover,” says Glauber, now with Harvard University's John F. Kennedy School of Government.

    That seems to be both the challenge and the goal this time around, but this market includes both conventional debt items, such as mortgages, and complex derivatives. ( What should investors do? See video)

    In the S&L bailout, White notes that the government “had the benefit of an asset disposal unit already up and running at the FDIC."

    “I think we're into a world nobody understands yet,” says Riegle.“What is the asset mix?”

    White says for that reason and others pricing of troubled or undesirable assets won’t be easy. “Because they are stinky, they're probably one of a kind,” he says.

    The administration’s plan to have private firms manage the funds may also be problematic, even if — as the Treasury says — it will have "full discretion over the management of the assets as well as the exercise of any rights received in connection with the purchase of the assets" and it can hold them as long as it likes.

    Similar proposals to subcontract some of the work at the time of the S&L rescue drew criticism on Capitol Hill.

    There were also major concerns about potential fraud and other wrongdoing given the size of the undertaking, which, to the surprise of many, never materialized.

    In the end, the government wound up using private sector contractors for asset disposals, which McMillen called “very helpful.” But they were also working in more of a local-market basis, not a national, never mind global one.

    In this case, critics could say the idea is like tipping the person you’re bailing out for a job poorly done.

    “You're asking the public to write a giant check, you obviously want an elite public interest team working the problem, says Riegle, who adds the government could and probably should hire “people from that sector and work in a public situation.”

    For all their criticism, Riegle and others agree that the current crisis has emergency situation qualities that the S&L bailout did not, so swift action — like it or not — is wise and necessary.

    Riegle says under normal circumstances, public hearings would be a necessity because something of this scale “cannot be done behind closed doors.”

    There may not be that luxury of time, even if better — or different — crisis management might have provided that. The Organization for Economic Cooperation and Development, for instance, proposed a somewhat similar approach in April.

    “I think speed is really important.” Says McMillen