Updated from Thursday, Sept. 18The stock market surged Thursday on reports that regulators may establish a central holding entity for banks' troubled assets, but the proposed fix faces more complex challenges than it did when employed in the savings and loan crisis two decades ago. Thursday evening, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke emerged from a meeting with members of Congress with plans to work through the weekend on a fix for the bank crisis affecting U.S. and world financial markets. In a statement, Treasury spokeswoman Brookly McLaughlin said Paulson, Bernanke and congressional leaders discussed a "comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and markets." McLaughlin didn't disclose details of any proposals. The Wall Street Journal reports the plan would be similar to Resolution Trust Corp., which salved the wounds of the savings and loan crisis in the late 1980s. However, the banking world has changed dramatically since that time and several factors may prevent an RTC redux from being a cure-all for the current malaise. Resolution Trust Corp. was established in 1989 as a repository for the assets of hundreds of banks that failed in the preceding years. Another entity, the Resolution Funding Corp., provided financing for RTC's operations as it oversaw the liquidation of assets in an orderly manner. The notion of an RTC solution for the financial sector today was first mentioned this week by House Financial Services Committee Chairman Barney Frank, D.-Mass. But his Senate counterpart, Chris Dodd, D.-Conn., indicated that such a solution would be a long time coming -- at least until after the November elections. But on Thursday, as the markets wavered back and forth into negative territory, digesting the dramatic events of the past few weeks, CNBC reported that Paulson was formulating an RTC plan already. A call and email message to the Treasury to confirm the report was not immediately returned.
Causes of the current market downturn echo similarities to the S&L crisis two decades earlier: Speculative real-estate investments, shoddy lending standards and insufficient regulation. Creating a giant "bad bank" structure that is overseen by the government could dispose of questionable assets at troubled firms like Lehman Brothers, American International Group ( AIG), Merrill Lynch ( MER) and their counterparts. It would allow for greater transparency about the industry's troubled assets and provide time for the markets to figure out accurate prices. That could help prevent fire-sales of assets that have plunged in value as panic struck buyers and sellers. Furthermore, an RTC solution would remove the uncertainty that is hammering away at banks' share prices and business. Investors and counterparties would no longer have to wonder about which banks are holding a big bag of bad assets, and which ones the government will allow to fail. It might prevent the shotgun marriages that some are speculating may occur between independent brokerages like Goldman Sachs ( GS) and Morgan Stanley ( MS) and their depository counterparts like JPMorgan Chase ( JPM), Wachovia ( WB) or Washington Mutual ( WM). However, such a plan would not be quite as simple as it was in the 1980s. The markets have become far more complex and globally interconnected in the twenty years since. Regulators would undertake the enormous task of sorting out complicated, intertwined assets -- some of whose owners might lie outside their jurisdiction. "Today's global economy spreads troubled assets into institutions not governed by U.S. regulators, both domestically and abroad," notes CreditSights analyst Brian Yelvington.
Still, he notes that the first RTC was "a great success compared to the projected losses and timeline that the government and media originally feared," and that such a solution today would be better than the current "piecemeal approach" the Fed and Treasury have been pursuing so far. In an appearance on CNBC Thursday afternoon, Sen. Charles Schumer, D.-New York, acknowledged that rescuing financial firms on an "ad-hoc basis isn't good enough," but denied that any official RTC proposals have been floated by the Treasury. Schumer, who sits on the Committee of Banking, Housing and Urban Affairs, also took pains to note that taking banks' soured assets off their hands would also not solve the core problem: The soured housing market. Without finding a solution to falling home values and surging foreclosures, Schumer said, a present-day RTC would be inadequate. "If we don't solve the housing problem," he said, "it's going to make it much harder to solve the financial problem."