02 Oct 2008

The RTC Model

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Stratfor’s George Friedman turns his non-ideological strategic lens on the mortgage crisis, and argues for following the model used in the Savings & Loan crisis of 1989.

Financial meltdowns based on shifts in real estate prices are not new. In the 1970s, regulations on savings and loans (S&Ls) had changed. Previously, S&Ls had been limited to lending in the consumer market, primarily in mortgages for homes. But the regulations shifted, and they became allowed to invest more broadly. The assets of these small banks, of which there were thousands, were attractive in that they were a pool of cash available for investment. The S&Ls subsequently went into commercial real estate, sometimes with their old management, sometimes with new management who had bought them, as their depositors no longer held them.

The infusion of money from the S&Ls drove up the price of commercial real estate, which the institutions regarded as stable and conservative investments, not unlike private homes. They did not take into account that their presence in the market was driving up the price of commercial real estate irrationally, however, or that commercial real estate prices fluctuate dramatically. As commercial real estate values started to fall, the assets of the S&Ls contracted until most failed. An entire sector of the financial system simply imploded, crushing shareholders and threatening a massive liquidity crisis. By the late 1980s, the entire sector had melted down, and in 1989 the federal government intervened.

The federal government intervened in that crisis as it had in several crises large and small since 1929. Using the resources at its disposal, the federal government took over failed S&Ls and their real estate investments, creating the Resolution Trust Corp. (RTC). The amount of assets acquired was about $394 billion dollars in 1989 — or 6.7 percent of gross domestic product (GDP) — making it larger than the $700 billion dollars — or 5 percent of GDP — being discussed now. Rather than flooding the markets with foreclosed commercial property, creating havoc in the market and further destroying assets, the RTC held the commercial properties off the market, maintaining their price artificially. They then sold off the foreclosed properties in a multiyear sequence that recovered much of what had been spent acquiring the properties. More important, it prevented the decline in commercial real estate from accelerating and creating liquidity crises throughout the entire economy.

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