Blog cafe : New agency, bad idea

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A new Resolution Trust Company to hold bad assets would perform far worse than the old RTC that was used in the Savings and Loan crisis. To understand why, consider how assets are put into each outfit. In the old RTC, the assets of failed savings and loans (S&Ls) were put into RTC. If there was a question about the quality of an asset, the decision was made by government regulators as they evaluated the capital of the S&L. The S&Ls themselves didn’t have any say about what went into RTC. If the regulators thought the total assets of the S&L were not worth much, then everything went into RTC. One of the reasons that RTC didn’t cost as much as we once feared was that regulators were very conservative. They closed down some institutions that could have survived. The regulators put too low a valuation on many thrift institution assets.

The new RTC will work differently. Banks and other financial companies will decide which assets they want to push into RTC. They can pick and choose from their own portfolio holdings. That element of choice was absent from the old RTC. The companies participating in the new bailout will have every reason to place too high a valuation on the assets they sell to new RTC. Nobody would bother selling great assets. Instead, they’ll take something worth 10 cents on the dollar and tell RTC that it’s a great buy at 30 cents on the dollar.

We must expect the new RTC to cost more than initial projections, just the opposite of the old RTC.