D.C. Debate: To Heal or Kill Shaky Banks

Regulators and lawmakers are on a collision course over how to deal with institutions moving toward failure.

Both sides agree quicker government action is needed to deal with the growing number of faltering banks and thrifts. But they are proposing vastly different approaches.

The heads of the Federal Deposit Insurance Corp. and Office of Thrift Supervision are talking up a process dubbed early resolution. The idea is to identify banks or thrifts 18 months to two years away from failure. The FDIC, working with private investors, would bolster an institution with a cash infusion.

The new equity would give a bank the time to turn around, the argument goes, possibly avoiding the costs of a failure.

But legislators, who were burned by the thrift crisis, are not interested in giving regulators more leeway in handling troubled institutions. In fact, they seem determined to force the closing of some undercapitalized but still solvent institutions.

Lawmakers' Version

As part a proposed overhaul of banking law, the House Banking Committee has passed a measure that would require regulators to close a bank within six months if its equity capital falls below 2% of assets. The concept, called early intervention, also has the support of Donald W. Reigle, the Michigan Democrat who is chairman of the Senate Banking Committee.

Early intervention would save money, its supporters claim, because banks would be closed while there is still private capital left to absorb losses and because regulators would be barred from letting insolvent banks limp along indefinitely.

Intervention Is in the Lead

At this point, early intervention seems to have the upper hand, both because legislation seems to have the upper hand, both because legislation supporting it is moving through Congress and because the regulators' proposal faces some political and practical hurdles.

One the one hand, the concept of nursing sick institutions back to health has appeal. "If the FDIC can identify the right institutions, find the right buyers, and strike the right deals, it could save a lot of money" with early resolutions, said Thomas A. Brooks, former FDIC general counsel and partner with Weiner, McCaffrey, Brodsky, Kaplan & Levin in Washington.

But even its architects acknowledge it won't be easy.

Doubt on Effectiveness

"I'm not at all sure we'll ever get an early resolution done," said Harrison Young, director of resolutions at the FDIC.

One of the biggest problems is to get the top managers of a troubled institution to go along with the process, especially since it might end up costing them their jobs.

"I know no bankers approaching insolvency today who two years ago or 18 months ago predicted they would be in this position," said John J. Lyons, principal of Lyons, Zomback & Ostrowski Inc., an investment banking firm in New York. "It's a very worthy concept, but it may be a difficult thing."

Mr. Young acknowledged that a bank's management must have "an impressive degree of realism and responsibility" for early resolution to work.

Another hurdle is enticing shareholders to cooperate and new investors to sink money into a shaky bank. The FDIC would have to offer incentives. For example, it might promise shareholders a piece of the profits if the bank recovers, rather than simply wiping out shareholders when recapitalization occurs.

A Need for Returns

As for attracting investors, money follows return. The FDIC may have to strip out bad assets from a targeted bank to give investors confidence that a rescued bank will make it.

Early resolution also has a public relations problem: It is strikingly similar to the forbearance programs begun by the now-defunct Federal Home Loan Bank Board. Many lawmakers attribute the size of the S&L bailout to the capital breaks the bank board gave thrifts.

Steven M. Roberts, a former regulator and now a principal with KPMG Peat Marwick in Washington, said that while early resolution is a form of forbearance, he said that's not necessarily "a dirty word."

Some Successes Noted

"There have been times when forbearance has been fairly helpful to the regulators," he said. The former aide to Federal Reserve Chairman Paul Volcker said forbearances given in the mid-1980s on nonperforming loans to lesser-developed countries and farmers worked.

"During more normal times, I'm not sure it is the government's role to be choosing winners and losers because it can't do it as efficiently as the marketplace," Mr. Roberts said. "But I don't think we are living in normal times."

Mr. Young admits the policy would put the FDIC in a delicate spot. "We have to strike a balance between being proactive and trying to solve problems rather than letting them fester," Mr. Young explained. "But on the other side, we don't want to try to take over the functions of the marketplace."

The approach being pushed on Capitol Hill has a big problem as well. Slamming the doors shut on a bunch of banks, paying off depositors, and taking over all the bad assets is an expensive way to clean up the banking industry.

Reaction Is Detected

"It's a simplistic reaction to what they believe to be poor judgment in the past by regulators," said Mr. Lyons, the investment banker.

Ronald R. Glancz, a partner with Drinker Biddle & Reath in Washington, agreed, said that early resolution would keep assets in the bank rather than putting them in the government's hands.

"Why just have a body count?" he asked. "Why not try to deal with it and save the good parts."

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