Thrift Crisis: Strategic Plan for Resolution Trust Corporation and Management of FSLIC Deals

Published by the Government Accountability Office on 1990-01-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting   Of&e

For Release         Thrift     Crisis:    Strategic  Plan for Resolution
on Delivery         Trust     Corporation    and Management of FSLIC
Expected at         Deals
10:00 a.m. EST
January 25,

                    Statement of
                    Richard L. Fogel
                    Assistant Comptroller General
                    General Government Programs
                    Before the
                    House Committee on Banking,         Finance   and
                    Urban Affairs
                    House of Representatives

                   (yi-ypj~       /ii ~q~+iAl
                                                                  GAO Form   180(12/87)
                                Thrift  Crisis:  Strategic  Plan
                         for      the Resolution Trust Corporation
                                 and Management of FSLIC Deals
                                    SUMMARYOF STATEMENT BY
                                       RICHARD L. FOGEL
                                ASSISTANT COMPTROLLERGENERAL
                                U.S. GENERAL ACCOUNTING OFFICE
The Financial     Institutions      Reform, Recovery,    and Enforcement         Act
of 1989 requires       the Resolution     Trust Corporation       Oversight    Board
to issue a strategic         plan for RTC resolution     of thrifts       for which
a conservator     or receiver     had been appointed      between January 1,
1989 and August 8, 1992.          The Act also requires       that GAO review
the cost and management of the FSLIC resolutions                that occurred
between January 1, 1988 and FIRREA's enactment.                GAO is
testifying    today to provide       its views on the RTC Strategic           Plan
and on the results        of its work to date on the FSLIC resolutions.
GAO believes    that the               Oversight    Board's Strategic    Plan presents
the Board's policies                 in a reasonably       comprehensive  and
understandable     manner              and that, with the issuance of implementing
procedures    and certain                additions,   it can serve as a roadmap for
RTC operations.      More              information    is needed on:
--   the proposed          method         of acquiring    working      capital:
--   the applicability               of FIRREA provisions            to thrifts       still    in
--   harmonization             of   the    sale   of assets   held     by federal         agencies;
--   RTC's organization    and management processes,     including   its
     method of monitoring    cost exposure,  expenditures,      and conflict
     of interest   abuses: and
--   policies      for     implementing           RTC's menu approach             to sales    of
GAO's preliminary           work on the FSLIC transactions              has borne out
its earlier        concerns that they would be extremely                  difficult      to
manage.      And, it is GAO's general            impression      that FDIC, which was
given responsibility            for managing the assistance              agreements,       has
not given its new responsibility                sufficient      priority.          GAO has
found problems in several              areas so far related          to assistance
agreement management that need to be corrected.                         These include        a
failure     to (1) complete the initial              inventory     audits       of acquired
thrifts,      (2) provide       guidance on appropriate          asset management and
disposition        strategies      and, (3) develop a covered asset tracking
system.       This is troublesome          because the agreements include
provisions       that can be used to limit             their   cost, which are
presently      estimated      by FDIC to be approaching            $40 billion        in
present value terms.
Mr.      Chairman         and Members of the Committee:

We are         pleased       to participate                in your       hearings          on the Resolution
Trust      Corporation              Oversight           Board's      strategic            planning       efforts
and other          aspects          of    the Financial             Institutions            Reform,       Recovery,
and Enforcement               Act of            1989.      My testimony            covers      two areas.
First,         I will       discuss         our    views     on the           Strategic       Plan.       Then,      I
will      provide         some preliminary                 observations            on the quality            of
oversight          of the FSLIC thrift                     resolutions            that     occurred       between
January          1, 1988 and FIRREA's                    enactment.


The Oversight              Board's          Strategic        Plan       for      RTC operations           presents
the      Board's         policies         in a reasonably               comprehensive           and
understandable               manner.             But there        are    still       several      key     areas    of
policy         and procedure              that     need to be addressed                    more fully        in the
Plan      or     in the      implementing               procedures.              Once those      areas       are
addressed          and implementing                 procedures           published,          the Plan        should
serve      as a good roadmap for                        the operation             and oversight           of the

Areas      Requirinq          More Explanation

We are disappointed                      that     the Oversight           Board has not               finalized
its      plans     for     meeting         RTC's working             capital        needs.       Working
capital          is crucial          to an efficient               and economical              case
resolution               and asset          disposition                strategy.             The joint        RTC and
Oversight            Board      letter            dated      January          16,     1990,      to the Chairman                 of
the House Committee                        on Ways and Means,                   says that           three      options
are      still       under      review:             borrowing            through            the Federal        Financing
Bank (FFB);               having      RTC conservatorships                          borrow       additional           funds
from       the      Federal        Home Loan Banks:                     and packaging              brokered          deposits
issued           by thrifts          for     private           placement.

The January               16 letter          implies           that      a two-dimensional                  approach          to
the working              capital           issue     is under            consideration.                  Borrowing
through           the FFB would              be used to finance                       assets       acquired          from
thrift           resolution          actions         until        such assets                can be sold.             The
other        two options             appear         designed            to reduce            working       capital       needs
through           sale      of assets         while          thrifts          are still          in the
conservatorship                 program,            and,       at the         same time,           reduce      operating
losses           by replacing              high     cost       deposits         with         potentially         lower
cost      ones.

We have said                before         and we continue                   to believe          that      the lowest
cost      source         of cash for               RTC's working               capital         would       be Treasury
borrowing            (either         directly,            or     indirectly            through          the FFB).l
This       is also          in keeping            with     our        view     that         government       activities
should           be fully      reflected             in the budget.                    It     is not apparent               at
this      time       how the other                 two options            would        contribute           to the       least

1Testimony before the House Ways and Means Committee,                                                        October
31, 1989 (GAO/T-GGD-90-7.)
cost      completion            of RTC's mission.                        Such a determination                       cannot          be
made without              specifics            on these          two options               and how they                would        be
integrated             into     RTC's case prioritization                            and resolution

The Plan          includes            some policy          guidance              on the management of
thrifts         in RTC's conservatorship                          program.               However,          it     does not
specify         how FIRREA provisions                       relating             to asset         sales,          affordable
housing,          minority            contracting          and other              matters         will          be applied
to thrifts             in true         conservatorship.

The Strategic                 Plan     sheds      little         light       on how asset                management and
disposition             efforts         will      be coordinated                  and harmonized                  across           the
federal         government.               The RTC and other                      federal       agencies            holding
nonperforming                 loans     and foreclosed               property             must avoid              working           at
cross         purposes.           Other        federal       agencies             that     hold      real         property
are     not     bound by FIRREA's                   anti-dumping                 provisions.              A real          danger
is that         the enormous              amount of real                  estate         assets      in federal
inventories            could          tempt      some federal              agencies         to quickly                 reduce
holdings          in anticipation                 of a growing               surplus        in real              estate
markets         that     may occur             once RTC begins                   to actively             market         its
assets.           Such a development                     could      impair         RTC's ability                  to carry
out     its     mission,          as well         as depress              real     estate         markets
generally.             To avoid           this     outcome,          it      is essential                that      a
coordinated            strategy          for      effectively              managing         and disposing                     of
the     federal        government's               inventory          of assets             be developed.

Because       of the Oversight                      Board's          membership,               it     is in the best
position        to bring             this     about.

The Plan       does not specify                      how RTC is               to be organized                  and managed.
We feel       that         either       the Strategic                     Plan,      its      implementing
procedures,           or other              planning          documents              need to address                     RTC
strategies           for      ensuring             accountability                  structures.               Systems            for
obtaining        and using              management and other                             information,              accounting
systems,       standards              for     personnel              performance,                  and assessments                     of
overall       management capacity                       are         needed.              These systems               and
procedures           are particularly                   important                 in view of           the
decentralized               manner in which                   the RTC apparently                       intends            to
operate.         Decentralized                 decisionmaking                      requires          different              and
more complex               controls          and management                  oversight              structures              than
would       be necessary              for     a centralized                  organization.

The Plan       does not specify                      how RTC is              going          to monitor             its
financial       obligations                  as they          relate         to the obligation                       limitation
in FIRREA.            It      is also         not      clear         how RTC will                  track     its         potential
cost      exposure          from thrifts               that         are     currently              being     managed in
the    conservatorship                  program         and from             those          that     will     fall         within
RTC's control.                 Given         the     financial              magnitude              of RTC's job,                it
must have a good system                        for      monitoring                 its      obligations,
es.timating          the value              of assets          under         its         control,          and evaluating
its    exposure            to thrifts          that      will          likely            require       resolution.
This      information           is      important             for     RTC to adequately                      plan         for        its

financial              needs.        Furthermore,               if     RTC's experience                     resolving
thrifts         and managing                conservatorships                    reveals           that      the estimated
cost       of case resolutions                        exceeds         the     $50 billion                provided         in
FIRREA,         the       agency must be prepared                           to promptly                notify      Congress
of     the     increased          need.

We also         are concerned                with       the Oversight                  Board's           intention         to
allow        potential           acquirers             to bid         on a wide              variety        of resolution
structures.                -As we understand                   this     approach,               potential          acquirers
may bid         on the whole                thrift,        on the           thrift's            liabilities              and
certain         assets,          on individual                 branches,            or on other                 combinations
of the        thrift's           components.

The Board              expects       that      this      approach            will       provide            RTC with        the
greatest          opportunity               to maximize               the cost          effectiveness                of    its
resolutions.                While      this           approach         could        yield        the highest              return,
it     may be difficult                to assure               that     such a result                    has occurred
because         different            bids      on different                 pieces           of a thrift           may be
very       difficult          to accurately               compare.               This         difficulty           could
result        in delays           in the resolution                     process              while      extensive
costing         and comparisons                  of bids          is done.              It     could        also     result         in
uncertainty              about       whether           the RTC has accepted                          the most cost
effective              resolution.             The complexity                  of      the process               could
confuse         bidders          and bring             about     allegations                  of unfairness.                   It   is
critical          that      RTC bidding                procedures            and case resolution

decisions           be understood                and defensible.                    A broad         menu approach                to
bidding        could         diminish         the       likelihood            of    that      outcome.

At the present                time     we do not                have much information                   on what             is
contemplated               in carrying            out      this       approach            to case resolution.
And,      since      it     has not yet             been implemented,                      there     are no results
to evaluate.                Because this              approach           is new and untested,                          it
should       be used first                 on a limited               basis        and adopted          as a matter
of general           policy         only      after        it     is proven          worthy         of expansion.

As a final           matter,          I want        to emphasize               the        importance         of
protecting           against          conflict           of      interest          and ethical          abuses.              The
RTC will,           according          to the Oversight                     Board's         Strategic         Plan,          rely
heavily       on the private                  sector            to manage and dispose                   of assets
acquired           in case resolutions.                         The Plan           also     notes      the    importance
of   contract             incentive          structures            and protections                  against        conflict
of   interest         and ethical              abuses.             These protections                   must be
carefully          designed           and constantly                  reinforced,             but should           not be
so burdensome               that      they     become a barrier                     to doing         business.

The FDIC has very                   limited         experience              with     use of the private
sector       for     asset         management and disposition.                               We intend            to
carefully          assess          the guidance               and procedures                relating         to
contracting           when they            are      issued.            We also            intend     to devote
considerable               time     to evaluating                 how well          RTC is monitoring
private       sector         compliance             with        the    terms        of the contracts.


FIRREA requires             us to examine             and monitor            insolvent          institution
cases       resolved       by the Federal             Savings        and Loan Insurance
Corporation            (FSLIC)      from January            1, 1988,         through        the date        of      its
enactment,          on August        9, 1989,         and to provide               cost     estimates         for
all     the     transactions.           We are        to report           on this       work by April               30,
1990.         Today I would          like      to discuss           our    approach         to this        work
and offer         some preliminary              observations.

To carry         out our mandate,              we are working              with       the Federal          Deposit
Insurance         Corporation          (FDIC)        and the Office               of Thrift       Supervision
(OTS) to develop              summary data            on assisted            thrift        compliance         with
the     terms     of the agreements              and forbearances.                    We are also
evaluating          the systems         that     FDIC and OTS are developing                          to
oversee         and assure         compliance.          In addition               to a general           review
of    these      systems,        we are examining,              in detail,             5 very      large
transactions             to test     the quality            of FDIC's            and OTS's oversight.

In our        March 11, 1989,           testimony           before        this     Committee        we
indicated         that     the transaction             agreements            would        be extremely
difficult         to administer             because     of their           structure          and complexity
and because          of the long            period     of    time     that        the federal
government          remains        exposed      to risk.2            Our preliminary              work has

2Testimony before the Committee                         on Banking,               Finance      and Urban
Affairs,  (GAO/T-GGD-89-10.)
borne        out     this       concern.             And,      it    is our' general               impression               that
FDIC,        which       now has responsibility                         for      managing          the assistance
agreements              resulting            from     the FSLIC transactions,                           has not given
this       new responsibility                    sufficient             priority.               This      is troublesome
because           the    assistance            agreements             include          provisions              that       can,
if       properly        administered,                limit         the government's                   risk     exposure              on
these        transactions              that      currently            have an estimated                       present         value
cost       approaching              $40 billion.                We have found               problems            in several
areas        so far         that      need to be corrected.

First,        FDIC has no overall                      written          strategy          for      covered            asset
disposition              nor       is there          any formal          guidance           on the criteria                      to
be used for              approving            or disapproving                 various           asset         plans
submitted            by acquirers.                   Without        FDIC guidance                 on the
appropriateness                    of the various               asset      management and disposition
approaches              being       proposed          by the assisted                  thrifts,          there         is
little        assurance             that      the government's                  cost      and risk             exposure            are
being       minimized.                This     lack     of FDIC guidance                    also        diminishes             the
ability           of thrifts           formulating              plans      to determine                what
constitutes              an acceptable                approach          to asset          management.

For example,                certain          asset     management             plans       propose             the sale         of
covered           assets       with        financing          from      the     assisted           thrifts.             Under
the       terms      of most of the agreements,                            the      new financing                itself
will       become a covered                   asset     and therefore                  the assisted              thrift           can
continue            to receive             the guaranteed               yield       as well         as capital                loss

coverage           on its        book value.                 While          the     agreements            with        the
assisted           thrifts          allow         for     the possibility                   of such transactions,
there       is no FDIC guidance                          on whether              these      types       of transactions
should      be approved                 or disapproved                    even though              they     can expose              the
government            to continued                 risk      and cost              long     after       the covered
assets      have been placed                       with      new owners.

FDIC's      lack        of guidance                for     approving               assisted          thrifts'          asset
management            plans         is surprising                  since         the RTC, which                 is managed by
the FDIC Board of Directors,                                 has developed                  fairly        extensive
guidance           and policies               in its         Strategic              Plan      on this           and other
issues      concerning                 how assets            are         to be managed and sold.                            We have
discussed           this        problem           with     the          responsible           FDIC officials,                  who
told      us that          policy        guidance            would          be developed.                 We intend            to
follow      up with             the FDIC to ensure                        that      this      is done promptly.

In addition            to a lack              of policy             guidance,              there      is no management
information            system           for       tracking          either          the     amount of covered
assets      in assisted                 thrifts           or progress              made in meeting                    the goals
outlined           in the various                  asset         management            plan        submissions.               FDIC
cannot      tell       usI       for     example,            the         current       amount of covered
assets,      which           had totaled                 about      $60 billion               at the        time      of the
resolutions.                 FDIC told             us that          they         have an asset             tracking
system      which          is    in the process                   of being           implemented,               but
officials          do not know when it                           will      be fully          operational.                   The

development               of this          system         needs to be accorded                            a higher
priority           than      it      has received             to date.

Our other               concern       relates           to the          initial           inventory            audits           of   the
thrifts           sold     by FSLIC.               FDIC needs to expedite                             the completion                   of
these       audits         because          they        are critical                    to effective            management of
the       FSLIC Thrift             Resolution              Agreements.                    The purpose               of these
audits           is to account              for     all      the assets                  and liabilities                  of each
failed         thrift       and to determine                      its         negative            net worth           at the         time

of     sale.         These audits                 are     the basis               for     final       determinations                   of
both       the     amount of the negative                          net worth               assistance               payment          and
the       universe         of covered              assets.              Until           the audits           are finalized
by FDIC,           the quarterly                  payments         to the assisted                        thrifts         for
interest           on negative             net worth              notes           and for          yield       maintenance                on
covered          assets       will      continue             to be based on estimates                                that        may
prove       incorrect.

These       inventory             audits       were to have been completed                                     180 days after
the     date      of each of the transactions,                                     or,     for      the most part,                   by
mid 1989.               We found        that        only      9 of         the          152 required            audits           have
been finalized                so far.              Review         and approval                   of the rest              is way
behind         schedule.             Divided            responsibility                    for     the audits              within
the     Federal           Home Loan Bank Board                          and,       then,         within       FDIC
contributed               in the past              to the delays.                        Continued           delays         are,
according           to FDIC officials                      that         are     now responsible                     for     the
audits,          due to a lack              of resources.

The results                 of the      9 finalized              audits,            which     were for         relatively
small       thrifts            and cannot           be generalized,                   show that          the negative
net worth              of     the acquired             thrifts          was about            13 percent         higher
than       estimated            at the         time      FSLIC entered                into     the transactions.
An increase                 of an estimated                  $13.8      million         in negative            net worth
assistance              will        be provided              to the acquirers                 of 7 of the 9
thrifts,           while        there        will      be a decrease                 of an estimated              $1.4
million          for        the other          two thrifts.

While       only        9 of the         152 audits              have been finalized,                     the
preliminary                 draft     reports          on another             105 have been submitted                       by
the     firms          doing        the audits           and are            being     reviewed      by FDIC.              We
intend          to incorporate                 the results              of the        finalized          and
preliminary                 draft     audits          into     our      report        on the cost          of the
FSLIC transactions.                          Our report              will     also     present      an estimate              of
the     total          cost     to the         federal         government             and a comparison               of
current          estimates            with      the administration's                         estimates         of cash
flows       prepared            during         the deliberations                     on FIRREA.

That       concludes            my prepared              statement.                 My colleagues          and I would
be pleased              to answer            questions.