We enter a discussion of competitiveness and regulations of American banks, as compared with foreign banks:
Q: It's my understanding that bank charters have been readily granted in the USA and until the late 1980s foreign banks were able to open branches anywhere in the country even though domestic banks were prohibited from doing the same thing in Japan. Correct?
A: Japan doesn't allow foreign banks to develop money market instruments or manage mutual or pension funds in its country. The Japanese Ministry of Finance keeps interest rates low and gives Japanese banks their lower cost of capital. David Mulford, Under Secretary of the Treasury for International Affairs, said in early 1990
: Basic deregulation, sweeping change or bold challenges to the way the existing system benefits traditional Japanese financial institutions are hard to find. Full deregulaiton is what is needed. . .The failure by Japan to provide full access to its markets is particularly serious, given Japan's current financial and economic position in the world.
Q: That doesn't seem fair.
A: It gets worse. American laws allow foreign competitors to engage in the most profitable lines of banking business without carrying the same cost burdens of American banks. On top of this, our own commercial banks end up paying premiums that insure the brokered deposits of investment banks who cater to generally the most sophisticated financial consumers.
Q: In addition to the expenses and costly regulations imposed on domestic lenders, foreign lenders have access to cheaper overseas funds.
A: Exactly so. These foreign entities can therefor offer better interest. Is it any wonder they cornered 30 percent of the loans made to American business in 1991.
There's no doubt American banking regulations benefit foreign competition. Thanks to the International Banking Act of 1978, approximately fifteen large foreign banks were exempted from the provision in the 1933 Glass-Steagall Act which prevents American commercial banks from underwriting corporate debt or equity offerings in the United States.
This unfair advantage has contributed to todayÕs situation where only one U.S. bank, Citicorp, can be found in the ranks of the ten largest banks in the world (as far as assets go). Last year a subsidiary of the Union Bank of Switzerland managed debt issues for Borg-Warner Acceptance Corporation, Transamerica Financial Corporation and Allied SignalÑ all in New York. Many foreign banks have been on a spree, buying shares in American investment banking establishments.
Q: That's right. Not long ago Sumitomo Bank of Japan purchased a $500 million share in Goldman Sachs, one of Wall StreetÕs more prestigious firms in order to break into investment banking in this country.
A: To counter the ridiculous situation that allows foreigners to own banks in more than one state while making it illegal for a domestic bank to do so, in 1987 twenty states adopted reciprocal privileges.
Q: "Reciprocal privileges"? What do you mean?
A: Certain states allowed citizens of other states to own banks within its borders as long as the privilege was reciprocated.
Q: Alan Greenspan, Fed chairman, said in April, 1990
A: Well you can see something is being done about geographical diversity.
Q: When are we going to do something about product diversification?
A: Congress has been urged to pass legislation that would overhaul the Glass-Steagall Act and permit banks to engage in underwriting of commercial paper, mortgage-backed securities, revenue bonds and mutual funds.
I remember when now retired Senator William Proxmire, was chairman of the Senate Banking Committee, he wanted to dismantle all or part of the Glass-Steagall Act. He saw it as a legacy he wanted to leave the country.
Q: Why not allow capital-rich companies to affiliate and add their capital base to individual banks?
A: It's the same old territorial scenario. Those that have a good thing going are never anxious for competition.
David Silver, President of the Investment Company Institute, in his article for the April 1987 edition of the Financial Planning News, expressed a fear that Congress might be getting ready to repeat what he referred to as the disastrous 1927 McFadden Act. Mr. Silver suggested to readers that with recent sob stories about bank failures and the inability to compete, the same sensitivities are being appealed to that originally opened the way for the McFadden Act.
Q: I can see where Mr. Silvers might prefer to not have the competition of federally charter banks.
A: I wonder if there is such a thing as an unbiased viewpoint? We cannot escape our backgrounds and we shouldn't deny our legitimate interests.
Q: Anyway I thought some commercial banks were already dealing in securities.
A: Although commercial banks have been allowed to underwrite government guaranteed mortgage-backed securities, such as Ginnie Maes, they haven't been able to touch CMOs, as far as I know.
Q: What's a CMO?
A: Sorry. CMO stands for collateralized mortgage obligations. CMOs are bond-like securities backed by a pool of mortgages whose cash flows are repackaged to obtain securities of mixed maturities. CMOs allow investors and underwriters some protection against prepayments by mortgage holders. If Congress wonÕt let them compete more freely, some banks may simply give up their banking charters so they will be free to diversify into other businesses.
Q: Many of the nationÕs largest banks have applied for an expanded role in the underwriting of securities.
A: Underwriting involves purchasing securities in a block from the issuing corporations and selling them in smaller denominations to a variety of investors.
In contrast to Mr. Silver, Federal Reserve Chairman Alan Greenspan believes commercial banks need more latitude in order to compete against freewheeling foreign institutions and Wall Street firms and therefore hopes Congress will overhaul Glass-Steagall.
Q: I've just got to tell you about a piece I read last summer (8-26-91) in the Wall Street Journal by Alan Murray in which he discussed the antiquated way we handle Treasury auctions in this country. Did you see it by any chance?
A: If I did I don't recall it.
Q: According to Mr. Murray, the government securities market has always put the dealer above the customer. In the past Treasury has entertained fears that it might hold an auction and no one would show up. It was soothing to know the dealers at least, would bid in every auction.
A: You mean someone at the Treasury Department is actually afraid the U. S. government might offer securities for sale and there would be no takers? Give me a break!
Q: That was Mr. Murray's point. Such assurances are absolutely unnecessary in this age of instant global communication. He agreed there is no possibility that the U.S. government would be unable to sell its debt and therefore why do we need and pay for the expensive services of the 40 primary dealers---an outdated luxury that should be phased out. He suggests we examine ways to improve the efficiency of the market, reduce the cost of financing the government's huge deficit so the taxpayer can have some relief.
A: I think I might have read the article, now that you mention it. Didn't it have something to do with the Salomon Brothers scandal?
Q: That incident was supposed to be the catalyst for a rethinking of the auction system controlled by the 40 licensed primary dealers.
A: Actually anyone can place competitive bids, but the bidding process is so cumbersome that few outsiders do it. The common bidders, large mutual and pension funds, route their bids through the primary dealers. This gives these 40 dealers valuable information about how the large institutions are going to bid and is in itself a temptation to abuse, according to Mr. Murray. We take time to fume about underwriting by banks and ignore the manner in which over $2 trillion (figure for 1990 alone!) worth of government securities is auctioned every year.
Q: Let me see if I've got this right. The Glass-Stegall Act prohibits banks from being Òprincipally engagedÓ in underwriting ÒineligibleÓ securities.
A: Right. But to show that they are not principally engaged banks have proposed ceilings to demonstrate that underwriting in no way makes up the principal part of their securities activities.
At the end of 1986 the New York Banking Department, ignoring the old Glass-Steagall arguments that suggested the largest banks, if not severely restricted, could end up controlling industry, decided both J.P. Morgan and Bankers Trust New York could underwrite corporate equity and debt, commercial paper, municipal bonds and other activities formerly the sole province of the investment banker.
Q: I bet investment bankers loved that!
A: They claimed the stateÕs action would result in depressed underwriting profits for everyone and that new investment banking talent would be that much harder to attract.
Q: And more expensive! Do you happen to know what is meant by the term "universal banking"?
A: Universal banking is practiced in European countries, most conspicuously Germany, where banks are allowed to take unlimited equity positions in other companies. Japanese banks are only allowed a five percent equity share. By contrast, American banks are not allowed to engage directly in non-banking activities because their deposits are insured by the federal government and that would give bank-owned enterprises a distinct advantage over independently owned and operated entities. The market would eventually see to it that all businesses in the country were owned by banks.
Q: It sounds like a choice between bank-controlled capitalism and stock-controlled capitalism. It also seems like Treasury's plan to allow banks to affiliate with non-banks under a common holding company is a taste of the former.
A: Not at all, because under the administration's plan, the affiliate would not be protected by deposit insurance and fire walls would be erected.
Q: In his Commonwealth speech, did Mr. Rosenberg specify other regulations that he felt were especially anti-competitive?
A: He mentioned regulations that put a cap on the returns banks can make for shareholders and the limits on the kinds of products and services banks can offer consumers. He suggested a repeal of the restrictions on interstate branching and reiterated the need for a recapitalization of the Bank Insurance Fund (BIF) within the Federal Deposit Insurance Corp. (FDIC).
Q: Did he volunteer how he might like to see the recapitalization come about?
A: Nothing really that we didn't already hit on in our discussion. He cautioned against increasing the premiums to such a degree that marginal banks would be unable to pay and healthy banks might find their earnings too severely decreased.
Q: I believe the Bush administration is loathe to decrease the profitability of banks via high insurance premiums and capital requirements. I've read elsewhere that for every dollar a bank pays in premiums to the FDIC, $15 is removed from its lending inventory.
A: I think Mr. Rosenberg mentioned something like that also. He advocated a free market in banking which would, he said, give consumers a wider choice of financial services and products at competitive prices than anything dreamed up by legislators.
Q: Not only that, there's safety in the diversity now prohibited by Glass-Steagall.
A: Absolutely. As we said earlier, there's safety in geographical as well as investment diversity.
Q: According to Randall Pozdena, in a article for the Federal Reserve Bank of San Francisco Newsletter, there is a difference between the way leverage is viewed and used by private corporations and the banking industry. In a corporation, increased leverage (greater debt to equity) raises the expected return (earnings per share) to shareholders which makes those shares more valuable. On the other hand, reliance on debt weakens the private firmÕs ability to survive fluctuations in asset value without default and subsequent bankruptcy.
A: Of course tax policy distorts the picture somewhat since interest payments on debt are deductible against corporate income and dividend distributions whereas retained earnings are not.
Q: I've heard that most U.S. banks are already overcapitalized relative to the risks to which they are exposed.
A: A bank has an incentive to either guarantee all of a loan or to retain the loan and the related exposure. Therefore, while there may be far too much capital in the banking system as a whole, there may be far too little to protect the FDIC from experiencing catastrophic losses in a severe nationwide recession. According to financial consultant Lowell Bryan, having everyone raise more capital is not the answer Ñ specific institutions, not the entire industry, is where the problem lies.
Q: As you yourself have said, Congress has over and over again shown its propensity for blanket legislation rather than targeting needs. The problem is the commercial banks would be risking depositorsÕ money. As legislators see it, the challenge is to restrain the enthusiasm of bankers and see that their greed is tempered with good judgement in order to avoid results similar to those which came from their earlier plunges into real estate, energy and overly optimistic loans to lesser developed countries.
A: The third phase of the Depository Institutions Deregulation Act of 1980, loosening restrictions on banks and savings and loans, was set to take place in 1984. However it was overshadowed by a proposal from the Task Group on Regulation of Financial Services which was headed by then Vice President George Bush.
Q: What proposal?
A: The plan announced in late January 1984 was to replace the comptroller's office with a newly created Federal Banking Agency within the Treasury Department. It would have had jurisdiction over most of the then 1,425 federally chartered banks and their parents.
Q: What do you mean "most"? Are there some banks they wouldn't have controlled?
A: The 50 largest bank holding companies would have continued under the jurisdiction of the Fed which would have also acquired jurisdiction of the 9,000 state-chartered banks then regulated by the Federal Deposit Insurance Corporation. The Fed could have certified individual banks and release them to the jurisdicition of state agencies.
Q: This is another plan I never heard of.
A: The gang on Capitol Hill kept it from seeing the light of day.
Q: I'm sure to the everlasting gratitude of those who blame deregulation for the massive savings and loan bailout and banking troubles that loom over taxpayers today. What do you think?
A: I'm always for as little regulation as possible and more decentralization of power. But when institutions do a lousy job regulating themselves, government steps in. Regulating is the easy part; everyone loves to tell everyone else how to act. The hard part is deregulation. A lot of people have a stake in maintaining federal and local regulation. Deregulation on the other hand, is like moving a mountain.
Q: John F. Kennedy gave deregulation a try when he was president.
A: But it took the OPEC created inflation of the 1970s to give it any kind of momentum. In the seventies the airlines, trucking and finally financial institutions were deregulated.
Q: I thought Regulation Q was in effect all during the seventies.
A: Regulation Q was a prime example of unhealthy interference by government. If you remember, banks, under Regulation Q, were only permitted by law to pay 5 to 5.25 percent to depositors when the prime (most favorable interest rate) was as high as 21.5 percent! Inflation meant that savers were getting less real dollars back than they put into the banks in the first place. Usury laws kept credit cards at eleven or twelve percent in some cases when borrowing elsewhere cost eighteen to twenty percent.
When deregulation overtook Regulation Q it was way overdue. Restrictive monetary policy had driven interest rates up and depositors had left banks for higher-yielding, unregulated money-market accounts.
Q: When was regulation Q dismantled?
A: The interest rate ceilings imposed by Regulation Q were removed in 1982. Competitive banks immediately began paying depositors interest rates far in excess of what made sense for the risk assumed.
Q: "Risk assumed"? With deposit insurance, there was no risk assumed.
A: That's the point. Government in effect subsidized those interest payments to depositors and allowed the banks to offer overly generous loans to borrowers.
Q: They could do that because technology had allowed them to raise deposits around the world and they were unable to use those deposits for anything beyond the loan business.
A: That's right. The Glass-Steagall Act still keeps the big commercial banks from underwriting corporate securities in this country and competing with the investment bankers. If a transaction is successful the bank is often able to make money from the management fees and also from the profit on the deal itself. The difference between the additional-fee-income and interest-income alone explains why investment banks enjoyed an average return on equity of 26 percent 1983-1985, while commercial banks had to settle for an average return of 14 percent. But these off-balance-sheet deals stretch the bankÕs capital in ways the traditional ratios fail to measure.
Q: No wonder they sought high returns through high-risk lending to Third World countries and to commercial real estate developers.
A: You're right. The discipline of a free market was removed and speculators had a field day.
Q: Most politicians tell it the other way: regulation was removed and speculators had a field day. They still haven't realized that government regulations cannot control market forces. Government regulations just mess things up.
A: The trouble is, when one speaks of market forces in financial matters, one better be prepared for booms, busts and their accompanying panics. The debate should not be whether we rely on regulation or markets---history shows unregulated financial markets self-destruct. Problems arise when we try to use regulation to control market forces that are beyond its control and in the process create flaws that skew the marketplace.
Barney Frank of Massachusetts is, in my opinion, one of the most brilliant men in congress. He showed that he knows darn well what is going on when he reminded fellow members of the banking committee that:
Q: It's only too bad that he has more faith in the ability of inexperienced legislators to calculate risk than he does in experienced bankers and investors. He obviously prefers regulating to market forces. It seems to me that congress, instead of reforming the deposit insurance system, is simply increasing the power of regulators and examiners to determine who gets credit and who doesn't.
A: You're right. When the losses from depressed real estate are tallied it is possible that 40 percent of all deposits will be in undercapitalized institutions. Therefore how these deposits will be lent will be controlled by regulators rather than management and shareholders. Naturally each participant will find ways to exploit the particular rules that apply to him or her.
Strong banks will search for "loopholes" in Glass-Steagall and for states that will allow them to do things not allowed by federal law. Non-bank financial firms will continue to sell bank-like products (money market mutual funds, credit cards, home equity loans) with a different set of rules. Instead of making market and economic and competitive forces work better, this narrow reform will distort those forces. It won't be the quality of service that gains market share, but exploitation of rules.
Q: It has recently been suggested that instead of reviving Regulation Q with its inflexible ceiling on interest rates, that maximum interest rates on deposits be raised to the market interest rate on Treasuries. What do you think?
A: As long as legislators are determined to dictate to the market this proposal would at least avoid the drain on banking that occurred under Regulation Q whenever the market rose above the old inflexible mandated rates.
Q: The average citizen has been pretty much brain-washed by media coverage and almost to a man and woman believes deregulation has been the cause of most of our problems and must at least share the blame for the recent instability in the U.S. financial system. They honestly believe that deregulation encouraged banks to venture into risky activities that they often knew little or nothing about.
A: I grant you, the present trend is away from removing regulatory oppressions and toward the imposition of new safeguards aimed at ensuring the safety and soundness of the banking system.
Q: Now who could be against Òensuring the safety and soundness of the banking systemÓ?
A: Exactly! Deregulation is a "chicken or the egg question" Ñ which is the cause and which is the effect?
Q: For you maybe---but as I've said, I think it is settled in the minds of most citizens and deregulation has been awarded the black hat!
A: Did you know that Islam forbids the payment of interest? They have a profit-or-loss system where the borrower and lender make an agreement the delineates the way in which profits or losses are to be shared between the two parties.
Q: Sounds like an equity position where the lender becomes owner of the venture by agreeing to share in losses as well as profits.
A: That's an interesting way to look at it. I like the fact that risk is transferred to the lender, which makes the lender more careful about the endeavors it finances. This emphasizes productive investments.
Q: That makes sense. I would expect lenders to become involved in a venture where they have placed money and to do their best to make it work. They essentially become team players.
A: The banks' balance sheets would show equity positions on the balance side and the liability side would look like a listing of shares in a mutual fund. Instead of depositors, there would be shareholders and their returns would vary with the banks' returns. There would be no need for deposit insurance and no fear of runs on the bank.
Q: It is doubtful that the banks would have so easily lent money to LDCs if the return on the investment depended on the success or failure of the project for which the money was requested.
A: Also if depositors viewed themselves as investors with money at risk, they would shop in order to put their dollars in the bank with the highest profit and least risk. Sound management would be rewarded and encouraged.
Q: And banks would be forced to find the most promising investments in order to attract depositor-investors.
Hey, do you think we've hit on something? Do you think America's commercial banks should forget about earning interest and become equity-based financial institutions?
A: I realize you're joking, but I really think a trend in that direction should be encouraged. An interim suggestion was tendered by Mohammed Alacem, associate professor of economics and Middle East editor of Economic Forum in an article published in the 5-9-91 Wall Street Journal:
Q: That would stifle the entrepreneurial spirit.
A: What do you think tight credit does to the entrepreneurial spirit? Since marginal projects would not be easily financed, there would be fewer failures. A little caution should not be the death knell of the entrepreneur. It could help to ensure a greater percentage of successes, "which ain't all that bad"!
Q: A great theory but------
A: Ok, I admit there are abuses.
Q: Sure, instead of making interest on a car loan, the Islamic bank purchases cars outright and sells them to would-be-borrowers at a profit. If payments are made in installments, this is merely a disguised interest payment.
A: There are no perfect solutions but I think we should be looking for new and better ways to do things. I'm not advocating wholesale adoption, but we can pick and choose from a variety of ideas to upgrade our present system.
Q: I agree that we can't afford to be complacent when in FY1991 the FDIC paid out $66.6 billion and is expected to disburse $100 billion or more in 1992.
A: Add on the $70 billion loan to the BIF (Bankers Insurance Fund) and there is a liability of $250 billion in future outlays just to pay off depositors.
Q: That's what I mean. There are no constituents for this item in the budget. Everyone would like to see it fall to zero.
A: Falling real estate values will trigger more failures by thrifts, banks and insurance companies. Depressed real estate values lower the value of loans and securities collateralized by real estate which represent about 30 percent of bank, insurance and other financial institution portfolios.
Q: Not to mention that real estate makes up one third of household net worth and contributes in varying degrees to the net worth of businesses.
A: Don't overlook the fact that commercial real estate is responsible for about 23 percent of all the taxes paid in this country.
Q: More than 70 percent of all local taxes collected.
A: That's right. Real estate values have an enormous impact on every community.
Q: Furthermore, as far as I can tell, every economic recovery in the post war period has begun with real estate. This is serious stuff! How did we let this mess happen?
A: There's no one thing or person to blame, but it's fair to say the 1981 tax cut created excessive incentives which contributed to the overbuilding of commercial real estate.
Q: On the other hand, the 1986 act overshot and knocked the props out of real estate prices by taking risk capital out of the industry.
A: That's right. Then some people claim inadequate regulation was the cause of the over-aggressive lending which led to inflated prices and overcapacity.
Q: Enough with the problems and reasons. What's the cure?
A: We need to stabilize real estate values to prevent the failure of more institutions.
Q: How?
A: To get the industry moving again I believe we need a combination of lower interest rates, regulatory policies that allow sound real estate financing, and a federal tax program aimed at stabilizing and restoring commercial and residential real estate values.
The Fed has been attempting the first step by lowering interest rates but long term rates need to come down further.
Secondly some of the lavish criticism that has been directed at both lenders and regulators needs to be curtailed. The constant blame has led to paralyzing fear. The Fed and regulators should assure lenders they will not be penalized by financing sound real estate investments.
And hardest of all, because next year is an election year and partisan politics will be in full swing, congress should restore some form of passive loss treatment, cut the capital gains tax and expand incentives for low-income housing.
Q: I'd advise some caution there. Existing commercial properties should be favored over new construction---for residential there should be incentives for new construction.
A: Stopping the decline of real estate would restore confidence and health to the capital markets.
Q: The inevitable question----cost?
A: What such a program would cost in foregone taxes would be made up in fewer bail outs.
Shortly after the passage of the 1991 FDIC reform act, Timothy Ryan, head of the RTC (Resolution Trust Corp.) told examiners not to write assets down to liquidation value.
Q: I bet that didn't sit well with Henry Gonzalez, chairman of the 51 member House Banking Committee..
A: You're right about Mr. Gonzalez wanting to counter this "go easy" approach he felt was being urged on bank examiners. After all, congress had just passed rigorous regulations, not geared to help Mr. Bush's re-election, so it is likely that Mr. Gonzalez thought members of congress were kept from the Baltimore meeting of bank examiners, which took place at the end of 1991, for partisan reasons.
Q: I've observed his banking committee in action and it is evident that Mr. Gonzalez wants to see full disclosure of any banking industry problems. He believes the practice of sweeping problems under the rug, is what led to the current Savings and Loan fiasco. He has gone on record as anticipating a banking crisis in the 1990s to mirror the Savings & Loan crisis of the 1980s.
A: That's right. He advocates early intervention and prompt take overs. His zeal can, in my opinion, be dangerous and lead to premature and unneeded bank closings.
Q: You've got to admit there were an inadequate number of regulators in the. Ronald Reagan cut them back and went to off-site monitoring using computers and other technology.
A: Joel McLemore, was an FDIC examiner from 1976 to 1986. He wrote an article published in the Wall Street Journal on 12-5-91. He revealed some of the temptations, and often shady practices, of bank examiners on their way to the top of their profession. Bucking for a promotion led to some over zealous determinations. He suggested that most field offices have at least one hard-nosed examiner who put the burden to prove asset quality on the bank.
These examiners enforce exacting standards that few banks can achieve. While one excessively ambitious examiner in ten might not sound like much of a problem, bear in mind that these examiners seek to do more examinations than others.
Q: When a few large, mostly adequately secured, real estate loans are classified as substandard, even though risk of loss is minimal, the perception of the public and legislators is skewed. Unfortunately individuals, companies, and in this case bankers, simply sit back and "take" it from their government. The feeling of powerlessness against government is becoming all too pervasive in today's society. That's why I like the prescription Mr. McLemore proposed for bankers.
A: What was that?
Q: He said:
A: I want to take a minute to relay an example of what is going on in this regard by referring to an article by Daniel Clemente, a real estate consultant in Virginia, which appeared in the November 4, 1991 issue of the Wall Street Journal. Mr. Clemente told the tale of a real development started in 1986 and aborted in 1990 after the first phase of 318 homes had been completed. Mr. Clemente was a consultant to the bank which acquired the uncompleted portion of the project in the spring of 1990. His firm determined that to maximize the return on the sale of the land, it would be prudent to complete the engineering work. This would enable us to obtain final site plan approval for the subdivision of all land in phases two and three into building lots. . . because the approval process is so lengthy, taking property to final approval adds great value to the property.
The bank was advised to complete construction of the sewer line but before this could be accomplished the RTC took over the institution and decided not to go ahead with any work on the described property. Consequently a year later the RTC (taxpayers) held 213 acres of land with no access to sewer lines which will have to be marketed as acreage rather than lots.
In the meantime the preliminary plan approval granted by the town is about to expire. Since the original preliminary plan was approved, the town has altered its design standards for public facilities. Engineering to meet the new design standards will cost an extra $440,600---money that could have been saved had the RTC finished the job back in 1990.
Mr. Clemente went on to say that eleven neighboring property owners and the town itself had made agreements to shoulder some of the costs of the sewer system but the RTC delay voided these agreements. Instead of costing $768,998 the sewer lines could now cost $3.5 million!
Q: Well I imagine that will drag down the selling price of the property.
A: When foreclosed, the property was carrying $16 million worth of debt so you know it was valued much higher than that. It is predicted to net the RTC somewhere between $3 and $4 million. If it had been managed well and $1.5 million had been invested in engineering and review fees and sewer construction, Mr. Clemente suggests it could "reasonably be expected to yield in excess of $22 million."
Q: It's easy to see that if nothing is done, the downward spiral in the value of real estate will accelerate, precipitating the collapse of commercial banks by undermining the value of property held as collateral and eroding the principal element of every American family's net worth: the equity in their home.
Real estate is a substantial portion of the nation's net worth and it has declined by about 40 percent between 1989 and 1991.
A: It would be helpful if bank regulators stopped forcing banks to write down assets to their artificially low present values when they have real long-term much higher value.
Q: There should be no need to value assets at bargain basement prices as long as the property is showing adequate return.
A: If bankers were left to make their own decisions, I agree with you that they might not need to mark property to "market" as long as it was carrying the loan. Stocks, bonds, property and other fluctuating assets do not lose value unless they are sold. But most legislators know nothing about these things and value their own power above everything else.
Q: Does all the money Congress gives to the RTC go directly to depositors in institutions that have been closed?
A: The RTC doesn't use the money Congress gives it to pay back depositors, It uses the money to purchase the bad assets of insolvent savings and loans.
Q: I've heard William Seidman say an asset looses 20 percent of its value the minute the government takes possession.
A: That is the justification for providing subsides to those who purchase failed institutions and their undesirable assets.
Q: I get it. The lesser subsidy saves the 20 percent that would be immediately lost if the RTC were forced to possess the bad assets instead of selling them with the institution.
A: Lamar Kelly, deputy in charge of asset disposition, said the RTC has sold more than half of the assets seized in 1991 and in the first eleven months had raked in close to $81 billion.
By the way, did you know there was a drafting error in the legislation authorizing the RTC?
Q: I suppose you'd fall over if I said, sure I knew it all along. Let's just say I'm not surprised.
A: The original legislation in 1989 allowed the RTC to borrow "working capital" totaling more than one and a half times its assets.
Q: You mean there is a perverse incentive to hold on to assets rather than sell them?
A: The more assets the RTC manages the more fees it is allowed to allocate, thanks to the 1989 drafting error. Every time the RTC sell something, that sale reduces the amount of working capital the agency can borrow.
Q: How about putting a cap on the number of assets the RTC can have in conservatorship and on its number of employees?
A: That has been suggested. It's always amazing to me how legislators consistently overlook human nature when drafting laws. It is not shameful and it should be no secret that people act in their own self interest. Why can't our legislators take this fact into consideration?
Q: I would imagine you would have something to say about the law which requires savings and loans to deduct from their capital any direct investment in real estate.
A: What can I say? An amendment to grant temporary exceptions to this legislation and another to decreased the amount of capital a S & L must hold for certain home-construction loans and for high-quality seasoned apartment loans, were deleted by the Senate, after passage by the House and before the final vote on the bail out bill in November 1991.
Q: And speaking of that bailout bill---I understand it was trimmed from the $80 million requested by the RTC to only $25 billion. Correct?
A: That's right. The bill was finally passed on a voice vote in the House and it was the last vote to be recorded in the Senate,(44-33) after many members had left for the 1991 holidays. Since the additional funds are only supposed to hold the RTC until April 1992, more legislation in this area is on the agenda.
Q: Have you heard of bulk sales?
A: Sure. That refers to the practice by the RTC of selling several properties to one purchaser. In these transactions the government typically provides the financing and receives a portion of the cash flow and the proceeds from any subsequent resale. At least 25 percent of the real estate included in such deals is supposed to be unprofitable.
Q: I've heard the practice of combing unprofitable with profitable assets referred to as "bundling".
A: That's what I'm talking about. These "bundles" are sold at a discount and saves the RTC, and ultimately the taxpayers, money. A quick sale is better than incurring the holding costs for managing the bad assets for a long period. In 1992 the RTC hopes to sell $100 billion worth of assets with almost one-third bundled.
Q: But when you offer property for sale, all cash, at bargain basement prices, who do you think you will attract as buyers?
A: I get your point. We're back to that old axiom I learned as a child, "Those who have, get."
Q: You're not kidding! Guess what happens frequently to those deposits we were discussing earlier totaling more than a $100,000?
A: I know what happens. These overly large, and therefore uninsured deposits, are protected as a matter of policy if a bid has been received by the RTC that would be less costly to the insurance fund than a liquidation.
Q: In early 1987, Vernon Savings and Loan in Texas reported $1.35 billion in assets but about $1.7 billion in liabilities. The trouble, according to a report of the Federal Home Loan Bank Board, was ÒImprudent and RiskyÉLending PracticesÓ. Since losses are usually double the amount of a failed institutionÕs negative net worth, in VernonÕs case the loss was estimated at about $700 million.
A: In the summer of 1986 federal bank regulators decided to spend $130 million to salvage the failing Bank of Oklahoma; only the eighth bank to be saved since 1933. First Republic Bank of Dallas, which was formed in 1987 by a merger of Republic Bank and Interfirst, in 1988 turned to the federal government for relief. Reportedly 16 percent of its loan portfolio was ÒbadÓ, leaving bond holders and shareholders at risk.
Q: I remember in 1988, First Republic was the same size as Continental Illinois was at the time of itÕs rescue by the federal government in 1984. But I'm confused. I thought the FDIC only protects the bank's depositors.
A: That's generally true but FDIC protection didnÕt stop depositors from withdrawing $600 million from the bank in the first quarter of 1988.