We’re now over four years into the Great Deleveraging and the market that led us down—housing—is still flatlining. At the same time, lending to small businesses remains anemic with tragic consequences for our unemployed.
What’s to be done? Increasingly, knowledgeable voices are waxing nostalgic for a Resolution Trust Corp. (RTC)-style solution. A careful reader of the reports on TARP will realize that among the program’s three objectives, it accomplished one: It kept the financial system out of the ditch. The other two goals—home retention and expanded bank lending—are out of sight.
Significant structural differences exist between today and the 1990s. The thrift crisis resulted largely from speculative commercial construction and a rapid expansion in thrift charters and their balance sheets. The crux of today’s crisis is the overbuilding and overleveraging of residential real estate.
But the lessons remain. Over the life of the RTC, more than 1,400 institutions were closed. In contrast, since 2008, approximately 350 institutions have closed, but the number of FDIC-insured institutions at the beginning of the RTC (over 16,000) was more than double the number of today’s institutions (7,600).
Many remaining institutions—including a number deemed to be problem banks—deserve to stay open and serve their communities. The plug that prevents many banks from resuming their core banking function of allocating credit to deserving borrowers and projects is the continued overhang of overleveraged loans on real property.
At great direct and indirect cost, we can continue to disrupt communities by closing banks and auctioning off loans at deep discounts and at the significant expense of the FDIC and affected local markets.
Alternatively, we can look to a more creative model powered by Keynes’ “animal spirits” of the private sector.
First, transfer ownership of problem loans, partially or completely, to third-party managers and investors. Second and simultaneously, authorize the FDIC to co-invest in deserving banks through open bank assistance when matched by private investors.
Moving these problem assets out of banks would be matched by a simultaneous capital raise in order to offset losses brought on by discounted asset sales and loan resolutions. As an additional spur to moving problem assets, loans could be transferred at the net carrying value on the books of the transferee bank. Losses would only recognized as third party asset managers resolve the loans or, failing that, foreclosure and liquidation.
Compensation arrangements and incentives would be structured to encourage a reasonable and orderly resolution through the establishment of net present value analyses.
As we enter the next presidential cycle, a mechanism to encourage the cleansing of the banking system becomes politically irresistible. We know the well-worn maxim that small businesses create jobs. We know further truths as well: Community and regional banks lend disproportionately to small businesses.
Lending has shrunk without relief at these banks. This credit paralysis will endure as long as these banks carry the weight of mortgage loans criticized by regulators. The slow jobs recovery will continue unless banks purge themselves and raise capital in order to stoke new lending. The housing malaise will persist as long as these banks lock up years of shadow housing stock.
It may be too late (and probably inappropriate) to resurrect the RTC. A free market solution that moves problem loans into the hands of active managers while preserving worthwhile banking charters provides all the solution with little of the bureaucracy. America needs our community and regional banks healthy and open for business.
Brian Olasov is a Managing Director in the Atlanta and Washington offices of McKenna Long & Aldridge LLP.