Mere talk of a possible government solution to the credit crisis weighing down the U.S. and global markets provided enough hope to investors to support a mammoth rally in the U.S. stock market this week. When the first reports of a federally funded bailout for the sector leaked Thursday afternoon, the market rallied large in the last hour of trading. The market expanded that rally Friday with gains large enough to effectively wipe out the week's earlier losses. As Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke work with members of Congress over the weekend to hammer out specific details of the bailout plan, market player are already speculating about what the plan could look like and if it could really provide an effective solution to the financial crisis. Essentially, the goal is for the government to take the bad debts that are weighing on these banks and liquidate these illiquid assets in an orderly fashion. And that has people who were around in the 1980s reminiscing about the so-called savings and loan, or S&L, crisis of that era and the aggressive way in which the government bailed out the that mess -- specifically, Resolution Trust Corporation, or RTC. So here's a simple FAQ on the '80s-era RTC and some thoughts on what a similar program could mean some 20 years later. What was the Resolution Trust Corporation (RTC)? The RTC was created following the savings and loan crisis in 1980s. The government inherited thousands of failed small banks and had to dispose of the real estate assets and mortgage-related loans of the thrifts. It originated as part of the Federal Institutions Reform and Recovery Act of 1989. Before the RTC was formed to deal with the mess, the Federal Savings and Loan Insurance Corporation (FSLIC) had closed 294 thrifts. What did the RTC do? The RTC provided two functions. It shuttered many of the failing institutions, which wound up totaling 747. The total amount of assets equaled $394 billion. It then liquidated those assets over a period of time until it was folded back into another federal agency -- the Federal Deposit Insurance Corporation (FDIC).
How much did the RTC cleanup cost the taxpayer? According to analysis by the FDIC, the total amount incurred by the taxpayer came to $75.6 billion, while the private sector absorbed just $7.1 billion. The taxpayer covered more than 90% of the cost of the bailout. The FSLIC also accumulated losses. The total tab to the taxpayer as of 1999 came out to $123 billion, or about 81% of the total costs. How will a "new" RTC differ from the old RTC? It would likely be very different. So far, only 11 banks have actually failed in the U.S. in 2008, and many of the assets are held by a wide variety of investment institutions. Thus, widespread bank failure hasn't been the issue, yet. The crux of the issue comes down to complexity. The securities industry has changed dramatically since the early 1990s. The Commodities and Futures Modernization Act of 2000 led to the widespread use of credit default swaps. The size of the credit default swaps market has been estimated at roughly $45 trillion. Many of the credit swaps involved the use of mortgage-backed securities as collateral for counterparty risk. Some institutions assumed very little risk for the top tranches of those securities, often assuming the safety of a U.S. Treasury. Clearly, that was not the case. A new RTC would have a very difficult job. Not only would the entity have to decide exactly what paper qualifies, but it may also have to decide the implications to the financial system, considering the size of the credit default swap market. As Paulson commented today, the key would be to ensure stability and recovery in the housing market -- the root of the problem. However, Congress may be forced to consider regulating the opaque and unregulated market of credit default swaps.