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Is a relief agency the right answer?

Today's credit crisis is different from the 1980s S&L debacle.

September 19, 2008|Michael A. Hiltzik | Times Staff Writer

Bankers, politicians and economists grasping for ways to address the financial crisis are rallying behind a solution with its roots in the savings and loan debacle of the 1980s -- the creation of a single government agency to buy up billions in bad bank debt and other assets.

The idea, which is gathering steam almost as fast as some of Wall Street's leading institutions have collapsed, is to create a relief agency along the lines of the Resolution Trust Corp. That was the institution created by Congress in 1989 to sell off the assets of failed thrifts.

The proposal's backers include former Federal Reserve Chairman Paul A. Volcker and former Treasury Secretary Nicholas F. Brady. A news report that Treasury Secretary Henry M. Paulson may propose creating such an agency may have contributed to Thursday's powerful rally on Wall Street, on the heels of the big sell-off the day before.

Late Thursday, Paulson and Federal Reserve Chairman Ben S. Bernanke met with congressional leaders to outline the government's options, and a formal plan is expected to be submitted to Congress soon.

Whatever form it takes, there is a growing consensus that the government needs a unified plan to address the credit crisis -- instead of what Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, has branded "a pattern of ad hoc interventions."

This week's bailout of insurance giant American International Group Inc., for example, was crafted at the last minute in an atmosphere of impending catastrophe, as were the earlier rescues of investment bank Bear Stearns Cos. and mortgage giants Fannie Mae and Freddie Mac.

"There's so much bad paper out there that it's clogging the system," Frank said in a televised interview this week. "Somebody has to step in and take it off. . . . If that's the case, is there anybody other than the federal government that can do it? No one that I know of has come up with the answer yet."

Volcker and Brady, along with former Comptroller of the Currency Eugene A. Ludwig, asserted in an opinion piece in the Wall Street Journal on Wednesday that a government agency tasked with buying bad debt would serve several purposes in the current crisis.

It would restore liquidity to the financial system by buying securities that are "effectively not trading," the former regulators said. By holding the paper for longer than could the banks or the Federal Reserve, it could wait for markets to recover and possibly get a better price than the owners would receive in a fire sale today.

Moreover, the authors contended, by taking ownership of mortgage securities at the heart of the credit crisis, the agency would gain the flexibility to work with financially stressed homeowners to avert foreclosures.

Experts caution, however, that the great differences between the S&L crisis and today's financial meltdown make it far from certain whether a single government agency along the lines of the Resolution Trust Corp. can succeed.

Congress created the Resolution Trust Corp. in 1989 to take over $125 billion in assets owned by 296 failed savings and loan associations. Over the next six years it added $394 billion in assets belonging to an additional 747 insolvent thrifts. The RTC's main job was to sell those assets, mostly real estate, at the best price it could get.

In the end, the S&L cleanup cost American taxpayers an estimated $124 billion. The RTC ceased operation in 1996. Despite the price tag of the thrift bailout, many believe the RTC successfully averted even worse consequences and higher costs.

By contrast with the S&L crisis, a large portion of the distressed assets involved in the current Wall Street meltdown is held by investment banks, hedge funds and other institutions that operate outside federal regulation.

"The S&Ls were regulated institutions and were taken over by the government," said Stuart Greenbaum, a business professor at Washington University in St. Louis. "We don't have that now."

Today's troubled securities are much more complex than the S&L assets, with valuations that may not yet have reached bedrock.

"They're very hard to account for and their value is still a moving target," said Michael Greenberger, a law professor at the University of Maryland and a former official at the Commodity Futures Trading Commission. "Creating a bureaucracy that takes paper that has no value and tries to sell it is just going to look like more smoke and mirrors."

Because the assets are not already in government hands, as was the case with the RTC's portfolio, the new agency would have to acquire them from their troubled owners, presumably at a discount price. This would probably force the sellers to record the sale as a loss -- exactly the outcome that many banks and investment houses have tried to avoid. Any overvaluation by the government buyer would mean a potential loss for taxpayers, which would be politically explosive.

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