the visible hand

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Resurrecting (Resolution) Trust

Posted by ecoshift on September 17, 2008

Resurrect the Resolution Trust Corp. – WSJ.com
By NICHOLAS F. BRADY, EUGENE A. LUDWIG and PAUL A. VOLCKER
September 17, 2008

We are in the midst of the worst financial turmoil since the Great Depression. Absent bold action, matters could well get worse.

Neither the markets nor the ordinary diet of regulatory orders, bank examinations, rating downgrades and investigations can do the job. Extraordinary emergency actions by the Federal Reserve and the Treasury to date, while necessary, are also insufficient to resolve the crisis.

Fannie Mae and Freddie Mac, the giants in the mortgage market, are overextended and now under new government protection. They are not in sufficiently robust shape to meet all the market’s needs.

The fact is that the financial system needs basic, long-term reform, but right now the system is clogged with enormous amounts of toxic real-estate paper that will not repay according to its terms. This paper, in turn, is unable to support huge quantities of structured financial instruments, levered as much as 30 times.

Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions. This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well.

There is something we can do to resolve the problem. We should move decisively to create a new, temporary resolution mechanism. There are precedents — such as the Resolution Trust Corporation of the late 1980s and early 1990s, as well as the Home Owners Loan Corporation of the 1930s. This new governmental body would be able to buy up the troubled paper at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management.

Such a stabilizing mechanism would accomplish four much-needed tasks:

– First, by buying paper that otherwise is effectively not trading, it would help restore liquidity to the marketplace and help markets to function more fluidly again.

– Second, by warehousing the troubled paper for a longer period than, for instance, the Fed’s discount window typically should or could, it would allow for a more orderly liquidation of this paper, and the chance for much of it to recover a portion of its value.

– Third, by giving the agency the ability to manage mortgages with flexibility to keep people in their homes and businesses running, it should lessen the number of foreclosures. This, in turn, would help moderate the decline in real estate values and the deterioration of neighborhoods, thus supporting house prices that in fact lie at the heart of the crisis.

– Fourth, where necessary, like the RTC of the 1980s, this new mechanism can assist the Federal Deposit Insurance Corporation in resolving sick institutions that are so clogged with the troubled paper they cannot continue as independent entities. However, we would hope that purchasing the mortgage-related paper will minimize the need to provide emergency, short-term assistance to solvent banking institutions…

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2 Responses to “Resurrecting (Resolution) Trust”

  1. SomeDude said

    That’s not a list of nobodies writing that thing–this ship is sinking, but jumping off just mean’s we see Davy Jones’ Locker that much sooner.

  2. ecoshift said

    No fooling. They are bringing people in off the bench because the situation is unprecedented and No One Knows What To Do…

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