RTC Shouldn't Try to Sell Credit Risk, Since Nobody Wants It
Congress should authorize the Resolution Trust Corp. to guarantee all but the first 5% of any performing loan that falls into its clutches. I estimate that this could save taxpayers $5 billion or more. Here's why:
When the RTC takes over an S&L, it effectively assumes all of the risks in the S&L's assets, both credit risks !nd interest rate risks.
When it sells those assets, it wants to divest itself of the risks. The problem is that, for perfectly rational reasons, the market doesn't want to accept the credit risk on commercial loans.
As a consequence, there are few participants in the market for loans made by failed S&Ls, and those few participants are willing to buy only at prices that very liberally cover the credit risks involved.
As a part of this phenomenon, the RTC is unable to induce buyers of deposits to take on a high percentage of the associated assets, and the government then ends up having to manage them and eventually to sell them separately. As everyone knows, if you want to sell ski parkas in summer, you have to offer a big discount.
The solution is for the RTC not to try to divest itself of the credit risk. By guaranteeing the assets, the RTC can:
* Sell the assets based on their interest rate characteristics alone; that is, sell them off the Treasury curve, which should increase prices of most loans by 5% to 20%, depending on type.
* Significantly enlarge the pool of potential buyers, creating a more competitive market.
* Force or induce buyers of liabilities to acquire assets as well.
* Thereby reduce the amount of assets on its books.
* Reduce the RTC's funding needs.
* Permit the RTC's personnel to focus on selling the assets that truly are difficult to sell.
Of the RTC's present inventory of $164 billion of assets, $73 billion are performing loans that could be sold quickly if credit risk were taken out of the equation. And most of the assets of S&Ls that fail in the next couple of years also could be disposed of quickly, thereby speeding up the whole process.
My proposal calls for the buyer to assume the first 5% of the risk because I assume that the buyers will be the servicers and therefore should have a real incentive to manage the loans vigorously. Other formulations to enforce vigorous loan management are possible, or course.
My proposal also would limit the RTC's guarantee to 10 years. Again, that is a pure judgment call. The contingent liabilities of the agency should have a sunset date; and 10 years is long enough for loan purchasers, since few long-term loans default after 10 years, and those that do usually have been amortized sufficiently so that the lender comes out whole.
Of course, this is not a perfect solution. Attackers will say that the guarantee will cost an indeterminate amount of money that the government will not have reserved for. They will say that we will just be postponing recognition of this part of the S&L problem.
These observations will be correct. But the cost of the guarantee will be lower than the cost of inducing the market to take credit risk that it doesn't want.
Mr. Lowy, counsel to the law firm of Rosenman & Colin, New York, has been vice chairman of Dollar Dry Dock Bank and is the author of "High Rollers: Inside the Savings & Loan Debacle," which will be published in the fall.