In the movie, "Network," Peter Finch shouted, "I'm as mad as hell, and I'm not going to take this anymore!"
These are sentiments widely held about the government's bailout and mortgage relief programs. This anger is combined with public lack of understanding as to what these programs are intended to do and how much they will ultimately cost. I share these sentiments. Based on my historical perspective from the Resolution Trust Corp. and the Federal Housing Administration, I hope to contribute to a more informed discussion of the issues, as well as to suggest alternative programs.
The current crisis far exceeds what America faced with the savings and loan crisis. We were not in a major recession then, and no banks were "too big to fail."
Founded in 1989, the RTC "resolved" (shut down) S&Ls identified as having too little regulatory capital to lend wisely. Its policies and procedures were comprehensively reviewed, approved, or rejected by the RTC Oversight Board, which had a wider scope of review than the current congressional oversight panel has over the $700 billion Troubled Asset Relief Program.
Note that much of the bailout is not subject to such oversight — the $100 billion and growing American International Group bailout, the $200 billion and growing Fannie Mae and Freddie Mac bailout, and the $275 billion foreclosure mitigation program.
The RTC "seized" (not "purchased") the S&Ls' assets on behalf of the taxpayer, wiped out (versus "bailed out") the shareholders, fired the management, and sold assets with the mission of getting the highest net present value.
Conversely, Tarp attempts to prop up failed banks by purchasing assets or injecting capital. To paraphrase the Nobel laureate Paul Krugman, "the goal is to keep dead (zombie) banks walking." President George H.W. Bush understood that zombie banks should not make loans — unfortunately, that's a truth little understood by his son. The use of Tarp funds to prop up zombie banks, their shareholders, and their managers has not increased lending.
There has recently been a growing drumbeat for an entirely different approach — one based on the lessons leaned from the RTC.
We need only modify the RTC program to be successful. First, an independent agency, like the RTC or the Federal Deposit Insurance Corp., should seize insolvent banks and then run them as operating bridge banks, rather than shutting them down. Careful lending should be continued, and deposits maintained, to preserve the bank's intrinsic value.
Then the following steps should be taken: Replace failed bank managers with competent ones; wipe out shareholders who have little or no equity; seize and sell the bad assets; indict those bankers responsible for this mess; inject sufficient taxpayer capital into the bank to meet risk-based capital standards; and sell the repaired bank in an IPO into the private market to return some taxpayer cash.
As to asset sales, our most innovative idea at the RTC was the securitization of whole commercial mortgages — the beginning of the commercial mortgage-backed securities market. With this program, the RTC saved about $60 billion. How ironic that these instruments to save taxpayers have turned around to bite us.
The required innovation by the new RTC in today's market will be to unravel securitizations to get at the underlying mortgages. This task has been made much more difficult by Wall Street's rocket scientists, who for nearly 20 years have created fortunes for themselves (and the rating agencies) by transforming plain vanilla MBS into nontransparent derivatives and CDOs. Wall Street then peddled these globally, nearly destroying the world's financial system and seriously eroding international confidence in American securities. Laws can be passed to facilitate such unraveling and regulate Wall Street and the rating agencies.
This cleanup of the banking system would be a more effective stimulus if it were accompanied by a mortgage relief plan that was fairer and easier to understand than the proposed one (doesn't discriminate against borrowers who pay their debts); more realistic (doesn't require that home value nearly equal the mortgage amount); broader (not limited to Fannie and Freddie loans); less geared toward special interests (4 points to mortgage originators — shame); and applicable to the financing of new homes, thereby stimulating the industry that started the recessionary chain.
Fair and effective mortgage relief can be accomplished very simply by a universal program of 30-year government borrowings, whose proceeds are passed through to homeowners in the form of 30-year self-amortizing, carefully underwritten mortgages on primary homes.
This program would be available to buyers of all new homes and everyone wishing to refinance — whether or not in default. Borrowers would receive government mortgages at the cost of government 30-year bonds plus 25 basis points for administration. There should be minimal closing costs.
Homebuyers would remain in their houses, because the low interest rates would encourage them to stay, and the value of their houses over time would grow as the long-term, fixed-rate mortgages are paid off. These mortgages would be due on sale, which on average is about seven or eight years.
