To the Editor:

Brian Olasov's Comment of May 20, "Conservatorship Does More Harm Than Good," raises important questions about the resolution of failed thrifts. But it badly misrepresents Congressional Budget Office analysis and the congressional debate.

Mr. Olasov charges that major banking legislation in 1989 and 1991 was the "result of congressional demagoguery" and that the Budget Office's research on the cost of forbearance during the thrift crisis "was flawed on a fundamental count." He is mistaken.

The Budget Office analyzed the apparent cost to the government of regulatory delay in closing and resolving failed institutions - that is, the cost of forbearance. Mr. Olasov claims that "in measuring the thrift's value at the point of insolvency, the (Budget Office) study assumes that the book value was an accurate indicator of the thrift's value in liquidation."

Calculating Costs

He claims incorrectly that the office calculated the cost of forbearance by subtracting the book value of thrifts when they first became insolvent from their actual cost when they eventually were resolved by the regulators.

That is not what the analysis did. In fact, page 5 of the staff memorandum clearly states that making such a calculation "would misstate the losses incurred after an institution became insolvent on a book-value basis."

The analysis looked at 1,130 thrifts that either were resolved during the period 1980 through 1990 or projected in early 1991 to be resolved that year. The estimated cost of resolving those thrifts was $127 billion in 1990 dollars.

Most were resolved many months after they first reported insolvency - some as long as 10 years later. On average, they were book-value insolvent, on tangible basis, for 38 months before being resolved by the government.

The Model Used

The Budget Office estimated what it would have cost had those thrifts been resolved when they first became tangibly insolvent. The estimate was based on a model that took into account the market value of assets and liabilities at the time the institution became insolvent as well as the government's administrative expenses for resolving them.

In making these estimates, the econometric analysis of the determinants of resolution cost explicitly attempted to account for the unbooked, embedded losses in thrifts when they became insolvent.

Had the thrifts been resolved on a more timely basis, the estimated cost of resolution was $61 billion in 1990 dollars. The difference between that amount and the reported $127 billion actual cost is the $66 billion cost of forbearance.

Return from Insolvency

Finally, the analysis recognized and reported that some thrifts recovered after becoming tangibly insolvent. About 345 operating in 1991 and tangibly solvent on a book-value basis were technically insolvent at some time during the 1980s.

At the time the study was written, the Budget Office projected that 70% of them would ultimately fail and require action by the Resolution Trust Corp.

Adjusting initial estimates of the cost of forbearance to account for the possible continued recovery of the surviving institutions lowered the estimate by only $1.5 billion.

Mr. Olasov is correct in pointing out that "similarities between book value of equity and market value can be little more than coincidental." That is why the Budget Office has consistently estimated the cost of the thrift crisis by estimating market values first.

This avoids the kind of mistake Mr. Olasov makes when he says that government-controlled liquidations impose losses of 40% of the value of assets but later notes that these figures are measured as a percentage of book values.

Mr. Olasov fails to demonstrate that, as he put it, "forbearance works." In general, leaving failed institutions in the hands of owners is not a least-cost solution.

Although there are occasional exceptions, research by the Budget Office and most academics has shown that leaving under-capitalized institutions under private-sector management will increase the cost to taxpayers.

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