Bailout 101: From the RTC to TARP

The Emergency Economic Stabilization Act of 2008 (EESA) moved through Congress in near record time. To celebrate, the legislative branch, similar to Ferris Bueller, is taking the rest of the year off, leaving the Treasury to make the bailout work. While we wait for the Treasury to fully establish the institutions and contracts needed to spend $700 billion, a historical review of the Resolution Trust Corporation (RTC) and its activities may provide some insight regarding what to expect.

Comparisons have already been made between the Troubled Assets Relief Program (TARP) under EESA and its spiritual ancestor the RTC. The RTC was created by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). FIRREA was passed by congress on August 9, 1989, to address the Savings & Loan crisis which was threatening the financial system.

For deeper insight, look to Show Me the Money: TARP, RTC & How Their Mechanics Drive Profits a companion piece that’s part of this series.

And in the immortal words of Ben Stein, "In 1989, the U.S. Congress, in an effort to alleviate the effects of the Savings and Loan crisis enacted the...Anyone?...Anyone?"

The Transactions
From 1989 to 1995, the RTC resolved 747 insolvent thrifts and recovered $395 billion of the $456 billion in its charge. In its six years of existence, the RTC handled failed thrifts in three ways:

  1. Merger, Consolidation, or Reorganization. The entire thrift, including all its assets and liabilities, were purchased or merged into an existing thrift.
  2. Liquidation of the S&L's assets. The RTC would sell all the thrift’s assets and then use the proceeds to pay depositors of the insolvent institution up to the amount of their FSLIC-insured deposits.
  3. Sale or total dismantling of the thrift entity. RTC would sell all deposits to other S&Ls or banks rather than liquidate. Those assets would then be marketed and sold.
We have already seen the government encourage mergers such as Bank of America and Merrill Lynch. However, the latter two mechanisms involving asset sales are more relevant to the current crisis.

Once the thrift was placed in conservatorship or receivership, the RTC acquired and assumed control over all of the thrift's assets. The RTC then looked for guidance from FIRREA, which directed the RTC to maximize the return from the sale and disposition of these assets, both securities and real estate holdings. This raised issues around asset valuation and market making (among others), a situation which is likely to be repeated with TARP.

The Vehicles
Because the RTC encountered extreme difficulty in appraising assets for bulk sales, equity partnerships were formed as a means to effectively execute the government’s liquidation strategy. The equity partnerships enabled the RTC to benefit from the management and liquidation expertise of their private sector partners with the structure helping to assure an alignment of incentives superior to that which typically exists in a principal/contractor relationship. By retaining an interest in asset portfolios, the RTC was able to benefit from the extremely strong returns being realized by portfolio investors. TARP includes provisions for the hiring of asset managers to provide similar private sector expertise in appraising assets.

The Funding
To finance the operation, FIRREA installed and authorized the Resolution Funding Corporation (REFCORP) to issue $50 billion in long-term securities. The RTC used these funds to pay insured depositors at failed thrifts. FIRREA also authorized the RTC to borrow funds from the United States Treasury and issue notes to obtain its working capital.

REFCORP operated as a Treasury agency under the direction of the RTC Oversight Board, whose chairman was the U.S. Treasury Secretary. In theory, REFCORP bonds were attractive to investors because they were modeled more like Treasury securities than agency securities. REFCORP bonds were sold through an auction process virtually identical to Treasury auctions.

By early 1991, REFCORP had brought to market two 40-year bond issues (totaling $10.5 billion) and four 30-year bond issues (totaling $19.5 billion). Those bonds were eligible to be stripped and reconstituted to the same extent as Treasury bonds.

The TARP has certain funding mechanisms spelled out as well. The first is the Troubles Assets Insurance Financing Fund. Premiums charged to financial institutions participating in the TARP will be used to guarantee those troubled assets originated or issued prior to March 14, 2008. The legislation also calls for funding through the general borrowing authority granted to the Treasury Department.

Some background that highlights a major difference between the legislation that created the RTC and the legislation creating TARP. In addition to forming the RTC, FIRREA aggressively reorganized the regulatory structure by:
  • Abolishing the Federal Savings and Loan Insurance Corporation (FSLIC) and the Federal Home Loan Bank Board (FHLBB);
  • Creating the Office of Thrift Supervision (OTS) and RTC to get its hands filthy with the nitty-gritty bailout details;
  • Establishing the Federal Housing Finance Board (FHFB) as an independent agency to oversee the 12 Federal Home Loan Banks (also called “district banks”);
  • Replacing FSLIC by creating the Savings Association Insurance Fund (SAIF), which is administered by the FDIC, as an ongoing insurance fund for thrift institutions (like the FDIC, the FSLIC was a permanent corporation that insured savings and loan accounts up to $100,000);
  • Adding more responsibilities to Freddie Mac and Fannie Mae to support mortgages for low-and moderate-income families.
EESA is much more modest and establishes an office within the Treasury to run the bailout.

The Players
Under FIRREA, Congress granted the RTC the same powers and rights to carry out its duties as the Federal Deposit Insurance Corporation (FDIC) had received in 12 U.S.C. § 1821-1823 (1989). The FDIC, and the RTC, had three main responsibilities: (1) to act as an insurer; (2) to act as a supervisor; and (3) to act as a receiver.

Congress also empowered the RTC and FDIC to issue administrative subpoenas to accomplish its mandate. Congress specifically provided that the FDIC and the RTC “shall have the power... to issue, revoke, quash, or modify subpoenas and subpoenas duces tecum...” 12 U.S.C. § 1818(n). Note the broad language and minimal use of restrictions. In essence, Congress wrote a "blank check" to these regulators to aggressively enforce the new bailout regime. As years under the RTC progressed, many companies found their livelihood at the whim of the regulatory duo. Remarkably, the sole statutory restriction on the RTC's and the FDIC's power to issue subpoenas was that the subpoenas be issued “for purposes of carrying out any power, authority, or duty with respect to an insured depository institution.” 12 U.S.C. § 1818(n), 1821(d)(2)(I)(1989).

The Post Script
The final cost to American taxpayers for the S&L crisis proved to be much less than originally estimated, totaling $132 billion rather than figures of $500 Billion that had been floated. TARP’s administrators would do well to learn the lessons of the RTC – both successes and failures – to see that the dual benefits of rejuvenated financial systems and minimized taxpayer burdens are met.

The Business Law Research group has assembled the RTC Overview, a comprehensive report on the RTC, its actions and impacts. To access this report and other related securities filings, please call (800) 669-1154 or email gsi.info@thomson.com.

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