RTC could be Rescue Plan Role Model

It is just beginning, but count on the name Resolution Trust Corporation being invoked more and more as the Treasury Department figures out how to approach its mandate to straighten out the economy and spend the billions of dollars Congress has put in its hands.

The Corporation, fondly known as the RTC, was the entity created to resolve the last financial debacle when 1043 savings and loan companies (thrifts), about half the nation's total, failed due to unbridled, ill-advised, and (ahem) unregulated lending practices.

The Federal Savings and Loan Insurance Corporation handled the first 296 failures but then RTC was established in 1989 as the scale of the thrift problems became apparent.  The Corporation was legislated out of existence in 1995 after it had recovered about 85 percent of the value of the assets it had seized.

The Corporation was the butt of a lot of jokes in the early 1990's as it constantly went back to the well for more and more funding, and it was initially so poorly managed that it required restructuring two years after its founding.  But when the carnage was over and what was left of the RTC was folded into the Federal Deposit Insurance Corporation, it appears to have cost the government an estimated $92 billion, well below original estimates and even less than its Congressional appropriations.

The RTC, however, was dealing to a great extent with hard assets taken from the failed thrifts.  There were, to be sure, tons of loans that had to be liquidated as well as junk bonds, art collections, and the like. But the bulk of the value of most thrifts was composed of real estate or real estate secured loans.  The property was not terribly attractive to buyers.  The best of it was the bank buildings and branches and these were generally sold, along with the deposits, to another healthier bank.  RTC liquidators were left with a mixed bag of raw land, partially completed subdivisions and condo projects, and lots of misbegotten "development" projects such as asbestos filled industrial and office buildings where borrowers had never gotten around to the planned rehabs they had convinced the banks to finance.   Still, it was fairly easy to assign a value to the real estate and there was always a market when the price was right.  Then too, the real estate and the real estate loans tended to be commercial.  The big money which was seeking investment opportunities was not interested in owning small properties that would be difficult to manage and costly to market and sell.

Fast forward to the present situation where there is a different set of problems.  Many of the assets that the federal government will be acquiring are so complex that few people understand them (the banks hired math geniuses from MIT to devise some of these products) and there has been an ongoing debate over what the underlying value is.  Individual loans can be bundled and sold to the kinds of bargain hunters that haunted the halls of RTC and FDIC doing pre-auction due diligence.  Many of these assets are foreclosed properties or non-performing loans collateralized with real estate but they are predominately single family residences and, even sold in packages, they present a management nightmare that institutional investors may not be willing to assume.   There will be many unknowns about the packages that will cause investors to heavily discount the prices they are willing to pay.

In spite of the differences and the problems, the RTC is being invoked as a potential model for the government rescue program.

In particular, one of the pioneering inventions of the RTC was the equity partnership.  While these took several different forms, all involved using a private sector partner which acquired a partial interest in a package of assets, handled the management and sale of those assets and paid back the RTC according to whatever ownership of the package the corporation still held.

One of the structures used by the RTC was the Multiple Investor Fund (MIF), limited partnerships established by RTC which then selected a general partner for each fund.  These general partners assumed a number of separate asset pools often on a revolving basis and paid RTC for the partnership; RTC retained a limited partnership interest.  These MIFs were highly leveraged with RTC financing sometimes as high as 79 percent.  After this financing was repaid the remaining profit was shared by RTC and its partner in accordance with their respective interests.

It is this type of profit sharing that is now being talked about in Washington and, according to an article in The Wall Street Journal on Wednesday, dozens of real-estate funds and other investors are dying to participate.

The Journal said that, once the illiquid assets are acquired from the failed or failing firms, they would be sold to these partners in an attempt to get the assets back into the private sector as quickly as possible.  As in the 1990s, the government would finance the partnerships, reducing the equity that investors would have to put out in these credit challenged times. 

If, as the Journal states, there is no shortage of investors hoping to get in on the action, we assume it will be because they see the possibility of highly leveraged transactions, something no longer available from private credit markets, and of course a real chance of big profits.  We hope some of that filters down into the pockets of taxpayers.