The Great S&L Clearance

During the past decade, the public dialogue surrounding the federal government's regulation of the financial system has been shallow and morally smug and, above all, blind to the emerging realities of deep disorder. Despite the pattern of recurring financial crises, most commentators have clung to the comforting bromides of laissez faire taught by the Reagan era. For each new episode of calamity, they offered evasive explanations that usually blamed the victims -- first the farmers caught in a deflationary collapse of debt, then Texas and the other oil states, next the savings and loan industry, and the largest brokerages of Wall Street itself. Throughout this medley, some of the largest commercial banks have themselves occasionally veered toward the brink.

The presumption of normality still prevails in 1990, though the consequences are now so gross that even the news magazines have noticed that something is wrong. Reporters now compete to see who can report the largest cost estimate for the savings and loan bailout. Is it going to be $250 billion or $300 or $500 billion? One can blame the news media for the lack of honest political debate, but one could also blame the economics profession. While the nation has witnessed the most spectacular financial failures since the Great Depression, academic economists on the whole have been strangely silent on the subject. Perhaps this is because so many of them were the ardent advocates of financial deregulation a decade ago. Many economists are still transfixed by the new technologies of finance, still promising wondrous results in the marketplace of money and credit if only the government will stop meddling.

Government meddling, of course, is all that has saved many famous bankers from total ruin. The deepest hypocrisy of this era is that, despite its laissez-faire pretensions, the federal government is now more deeply engaged in the affairs of private finance -- both as owner and manager and as generous benefactor -- than at any other time in the nation's history. Indeed, the conservatives who control the federal apparatus for financial regulation are acquiring tens of billions of dollars in land and buildings as well as several hundred financial institutions. They have directly bailed out a number of very large commercial banks and sold them at discount to other bankers. They are buying and selling and subsidizing -- and virtually giving away -- financial assets and real property on a scale that would have made New Dealers blink and tremble.

This, I suggest, will eventually become the next large public scandal in finance -- the federal government's own behavior as banker, broker, liquidator. Like the previous episodes, it will take general opinion (and the news media) several years to catch up with the facts and become properly outraged. But the outrages are already occurring. The American public has already lost a lot -- hundreds of billions earmarked for financial bailouts as well as ruined economic prospects for millions of workers and enterprises. But the public is being set up to lose a lot more.

The fundamental explanation, bluntly stated, is that no one in the political community, neither political party, is willing to speak for a larger conception of how the government might deal with these accumulated crises. Republicans in the executive branch, naturally enough, have no interest in fostering a responsible government presence in finance. They look at the S&L crisis as a fire sale -- an opportunity for private investors to pick over the carcasses and clean things up and, of course, make a profit for their efforts. Democrats, having relied for so long on guidance from the now-discredited savings and loan industry, are bereft of ideas. With a few noble exceptions like House Banking Chairman Henry B. Gonzalez, congressional Democrats have no conception of the larger public principles at stake, no sense of how the government might act in a way that protects the general social interest and attempts to minimize the public's future losses.

The most dramatic example is the Resolution Trust Corporation (RTC), created in the 1989 S&L bailout legislation as receiver and liquidator for defaulted properties. The RTC is now caught in a financial dilemma that was apparent from the start. As it acquires the portfolios of failed lending institutions, it becomes owner of vast real estate -- a storehouse that will eventually hold hundreds of billions in office buildings, homes, shopping centers, and other more exotic developments. In order to raise cash so that it can close down more of the several hundred insolvent S&Us, the RTC has a strong incentive to unload these properties as fast as possible. Otherwise, when it runs out of working capital, the RTC has to return to Congress for more money, an awkward political moment that all sides wish to defer as long as possible.

But most of the real assets the government now owns exist in already depressed markets, most notably Texas. Selling these properties rapidly means accepting fire-sale prices far below their book value as well as further depressing the local real estate markets. Why buy an office building from a private developer when the federal government is selling them cheap? Yet, as long as the huge government inventory hangs over the local marketplace, private builders and buyers are haunted by its shadow. Congress, with its usual clarity, instructed the RTC both to dispose of its holdings as quickly as possible and not to dump property in a way that damages local real-estate markets.

The RTC's response to this bind has been to schedule a series of gargantuan auctions, offering properties with 30 percent discounts. It has already accumulated an inventory of $16 billion in assets designated for deeper and deeper write-downs until willing buyers are found. As the RTC sells cheap, the estimates of eventual taxpayer liability will naturally rise. Again, this is only the beginning of what promises to be a long and costly debacle for the American taxpayers.

A few years hence, however, the injury will become even more enraging. Taxpayers will discover, too late, that fabulous fortunes have been made at their expense. The scavengers who bought in cheap in 1990 will eventually be rewarded with vast profits as the properties and financial institutions they acquired appreciate dramatically in value. This is why so many big-league investors and major Wall Street firms are circling around the bailout process, buying choice carcasses at concessionary prices. They understand that a huge payoff awaits the patient owner who is willing to take the long view of the marketplace.

Texas is the easiest example to understand. When oil prices collapsed in 1985, the deflationary ripples ruined thousands of supporting enterprises, emptied office buildings, and led to wholesale foreclosures in suburban subdivisions. The Texas economy is still limply recovering from that tidal wave of debt defaults. But Texas will not remain depressed forever. In fact, Texas will boom for sure whenever world oil markets tighten sufficiently to drive oil prices from the present $18-20 range to another spectacular run-up like the oil shocks of the 1970s. When will this occur? Some predict by the mid-1990s, some think it will take longer. Whenever it occurs, the value of both real properties and financial institutions in the oil states will multiply fabulously as the oil-based economies flourish again. At that moment, taxpayers will discover that their government bought in at the peak and sold at the bottom.

The only reliable way to avoid this eventuality is to alter the basic assumptions on which the federal government is addressing this mess. Like it or not, for better or worse, the government is now enmeshed as the major player in the tattered sectors of the financial system. Instead of pretending otherwise and opting for quick remedies, the government ought to accept that reality and operate with a long-term view of economic prospects and social obligations. In other words, the Resolution Trust Corporation should be reconstituted as an operating agency, committed to managing both financial institutions and real estate properties until they can be gradually phased back into private ownership. That commitment would be stabilizing for local markets if it was genuine. Both the feds and local developers would have the same stake in the future health of local economies. The short-term costs of managing rental properties instead of dumping them would be more than offset by the eventual return. That trade-off, after all, is what motivates the private buyers. Conservatives might argue that the properties will inevitably lose value if the government manages them. But if not for ideological biases, the government could hold the buildings and subdivisions and even have private management firms operate them, until the markets recover.



At the very least, the taxpayers should be held harmless against windfall profits by the scavengers. Every sales contract, whether it is for a bank or an S&L or a vacant office building, should require an agreement to share the future appreciation with the seller, that is, the government. Naturally, this requirement would dampen the enthusiasm of the scavengers who have been so skillful at negotiating favorable terms for themselves. That is why the government agents must be prepared to hold onto the properties indefinitely -- to walk away from the fire sale and declare that the public interest requires a longterm commitment as owner and manager. No one can say how long that might last for it depends largely on economic conditions, but the clean-up will probably require at least a decade of patient stewardship -- that is, assuming no additional financial debacles contribute further to the public liability.

As it happens, there is an outstanding precedent for this approach in recent history -- the government's rescue of the Penn Central Railroad. When Penn Central was bankrupted in 1970, the government effectively nationalized its freight system and operated it as Conrail. This required billions in subsidies, to be sure, but the economic alternatives were worse -- leaving the industrial Northeast and Middle Atlantic regions with a failed rail system. In time, under good management, Conrail returned to profitability. In the early 1980s, it was sold to private shareholders as a free-standing corporation for $1.6 billion dollars.

A similar approach for governing the financial mess will not prevent huge losses to the taxpayers; those are already an inescapable reality But at least the public would be protected against the outrageous damage yet to come. And local economies would be less vulnerable to the cash-flow problems of federal bookkeeping. In time, the federal government could withdraw from both managing and owning financial institutions and real properties, just as it did with Conrail. But the timing would be gauged in the public's interest -- so the taxpayers will not have to take another bath.

The question of cleaning up this particular financial disaster is, of course, only one of many related questions where the larger public interest is not being addressed. If Congress had the courage to think in these terms about the savings and loan bailout, then it might also find the courage to face the much larger issue of financial re-regulation -- reinventing legal limits on the behavior of private financial institutions, both to restore stability and to serve the broad public objectives so damaged by irresponsible finance in the 1980s. Neither reform is in prospect at present. More likely, the public is going to get gouged again and again before anyone in political power has the nerve to speak for it.