Failed Thrifts: Resolution Trust Corporation and 1988 Bank Board Resolution Actions

Published by the Government Accountability Office on 1990-04-02.

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

                  United   States General   Accounting   Office

For Release         Failed Thrifts:  Resolution    Trust Corporation
on Delivery         and 1988 Bank Board Resolution     Actions
Expected at
2:00 p.m. EST
April   2, 1990

                    Statement   of
                    Richard   L. Fogel
                    Assistant   Comptroller General
                    General Government Programs

                    Before the
                    Committee on Banking,            Finance      and Urban   Affairs
                    House of Representatives

GAO/T-GGD-90-29                                                          GAOForr 1W(12/87
                      Failed      Thrifts:   Resolution    Trust
                               Corporation  and 1988 Bank
                               Board Resolution    Actions
                            SUMMARYOF STATEMENT BY
                               RICHARD L. FOGEL
                        U.S. GENERAL ACCOUNTING OFFICE
Almost ei-ght months have passed since the Financial        Institutions
Reform, Recovery,   and Enforcement    Act of 1989 created     the
Resolution   Trust Corporation    (RTC) to resolve insolvent       thrifts.
In January RTC believed      that it would have to resolve     at least
558 to 628 thrifts.
GAO has compared RTC's pace of resolution,               the structure      of its
resolutions,       and the marketing    and selection       process   used with
Federal      Home Loan Bank Board actions        in 1988.      In general    RTC's
approach to its tasks represents           a significant       improvement    over
the Bank Board's       approach prior    to and during        1988.   GAO found
that RTC's policies        if properly   implemented       should avoid the risk
exposure,      cost,  and uncertainties     that existed       and continue    to
exist    for the Bank Board's       1988 resolutions.        Nevertheless,     GAO
has some concerns        about RTC's resolution       process.
--   GAO recognizes           that startup     problems have impeded RTC's
     ability       to rapidly       resolve  its caseload,     but believes     it is
     now time to deal with any remaining                constraints     it faces in
     resolving        cases and speed up the pace of resolutions.                 For
     example,        RTC needs to adopt policies         and procedures       to quickly
     sell    thrifts      in which high buyer interest          has been expressed
     to accelerate          resolutions     and maximize the return        from sales.
--   RTC needs to continue    adhering    to its policies for an open and
     competitive   bidding process even though it might impede the
     pace of resolutions.     Negotiated    deals should be avoided, and
     RTC actions   must be auditable     and defensible.
RTC's extended        conservatorship       program can allow        it to control
insolvent    thrifts,      assess     their  condition,     begin liquidation
actions,   and determine         the resolution       method and priority.         There
clearly   are benefits        to this program,        but GAO believes       more
attention    is needed to reducing           management turnover,         training   RTC
managing agents,        and developing       guidance     on running    the thrifts.
GAO also emphasizes      the importance   of bringing              to justice      those
whose illegal     or improper  acts contributed     to           thrift    failures      and
describes     its work in this area.
Mr.     Chairman            and Members of                 the     Committee:

We are        pleased         to participate                    in your          hearings          on the         progress
being       mad-e by the               Resolution           Trust        Corporation               (RTC)         in meeting
its     legislative               mandate          to resolve             insolvent           savings            and loans.

My testimony                today       addresses           three         areas.          As you requested,                   I
will       first      compare           the    pace,        the        structure,            and the           marketing           and
selection           process            of RTC's           recent        and planned               resolution          actions
with       the     Federal          Home Loan Bank Board's                          1988 resolution                 actions.
Within        each of         those         areas,         I will         also      discuss            certain      concerns
that       we have about                RTC's       approach            to managing               and resolving              its
caseload.             Second,           I will          discuss         concerns          we have with              RTC
management            of     thrifts          in    its     conservatorship                   program.             And,
finally,           I will         briefly          discuss          some of GAO's work                     involving
oversight           of      the     federal         response            to    improper            or    illegal
activities            that        contributed              to thrift             failures.


The RTC and Bank Board                           faced      dramatically                 different             conditions.
Provisions             in    FIRREA and policies                        set      forth       in    the     RTC Strategic
Plan       establish          an environment                    that      should         insure         that      RTC will
not     repeat        the     mistakes             of     the    Bank Board.
Pace Of Resolution

Bank Board               delays           in taking         action               against       insolvent               thrifts
contributed                to     the      enormity         of      the          resolution           cost        that
eventually               had to           be funded         in FIRREA.                   The Bank Board                   did         not
take       resolution                  action      on the        ever-growing                  number           of     insolvent
thrifts            in    the      mid to late              1980s.                These      thrifts          were,        instead,
allowed            to continue              operating            in hopes              that        somehow their
fortunes             would        reverse          themselves.                     Bank Board           officials                denied
that       catastrophic                  problems          existed,                even as the           number           of
insolvent               thrifts           grew and losses                   in      insolvent           thrifts           mounted.
Then,        in      1988,        it      belatedly         began          to take            action.             Some      223

thrifts           were       acted         on that         year:       75 were              sold      in December                 alone.

The RTC experience                         thus     far     has been quite                     different.                 As of
March        21,        some seven              months      after           it      was established,                     RTC had
sold       or      liquidated              52 thrifts            and was managing                       another           350
thrifts           as conservatorships.                           Of these              conservatorships,                         56 had
been publicized                        as "for      sale"        and were                in various             stages           of    the
selling           process.               RTC testified                in January               that       it      expects             to be
responsible                for         resolving          a total          of       558 to 628 institutions,
and that             around            300 more       thrifts          are          classified           as distressed                      by
the       Office         of-Thrift              Supervision.

While        the        pace of           resolutions            seems slow                 given       the          staggering
number          of      insolvencies,               there        is       little           question            that      RTC, unlike

the     Bank Board,                has recognized                  the      need to deal                 with         these
institutions                as promptly               as possible               and seems prepared                        to
recognize            the     financial               magnitude           of       the       losses       involved.                It   is
important-           to     realize           that     since         the      RTC's          creation           last      August,
it    has had to simultaneously                               scope         out       its      enormous          job,         help     the
Oversight            Board         develop           the     Strategic               Plan,      develop          implementing
policies            and procedures,                   and design               and staff             a new organization,
while        also     waiting           for      the Administration                          to make arrangements
for     needed working                  capital.              These         constraining                 factors          have now
been largely                removed.

It     is    time     for       RTC to          identify           and deal             with      any remaining
constraints,                move ahead more expeditiously                                      in resolving
institutions,                and adjust               the     marketing               schedule           to     take
advantage            of     franchise            value        that       some failed                 thrifts           may still
have.         RTC officials                   tell     us that           one factor               contributing                  to the
slow        pace of         resolutions               is     low market               receptivity               for     the
insolvent            thrifts.            The unexpectedly                         low level           of market                interest
in purchasing                thrifts           may be related                     in part         to erosion              in the
value        of     the     thrift        charter            as a result                of     certain          FIRREA
provisions,                such       as the         increased             capital           requirement.

RTC has acted                 to      remove         one factor               that      was inhibiting                   thrift
purchases.                The Strategic                    Plan    had limited                 the    period           during
which        RTC would               buy assets             back     from         an acquirer              to 6 months.
Potential            acquirers            felt        this        was not            sufficient            unless         extensive

pre-bid           due diligence                  was provided                     for.          The RTC Oversight
Board's           recent          approval             of a longer                    "put"      period         will          allow
acquirers             to complete                due diligence                        after      the       acquisition.                 This
action     may attract                    more bidders                     and may also                 speed          up the
resolution     process.

Another           factor          that        may be inhibiting                             the pace of             resolution              is
the       fact     that          RTC's        priority              system            for     resolving             thrifts           does
not       allow       for        the     sale         of    thrifts              in which            there        is more market
interest           and less              deterioration                     than        in others.

RTC's        prioritization                     system             for     dealing            with      its      caseload             gives
first        priority             to     those         institutions                    where         losses         are       mounting
most       rapidly.               We have no objection                                to that         priority.                 However,
total        reliance             on it         does mean the                     better         thrifts            may stay           in
conservatorship                    for        long         periods,              which        erodes          their       franchise
value.            Not allowing                  for        their          sale        outside         of      the      priority
schedule           may slow              the     overall                 pace     of        resolutions               and increase
their        ultimate             resolution                costs.               While        we do not               know how many
thrifts           are       of    interest             to potential                    buyers,          a large           number of
thrifts           have been              in     the        RTC conservatorship                          program           for     quite
some time.                  Of the        350 thrifts                     in     the        RTC's      conservatorship
program           as of          March        21,      223 have been in conservatorship                                           over        6
months           and 126 of              those         have been                 in     the     program           over        12 months.
We are pleased                    that      the        RTC has now recognized                          the     need to take
advantage            of buyer             interest                 in certain           thrifts.          We believe           it

should       move         ahead          to set             up a separate               track       to accept         bids     on
and sell           the       institutions                    with      more franchise                value.

Structure            of Resolutions

As we reported                    to you last                 year,         there       were major           problems         with
the       1988 Bank Board                   transactions.1                       The assisted             sales       created
thrifts           that       were        thinly             capitalizedz,               had cost        advantages            over
healthy           thrifts,           and lacked                    incentives           to manage the             assets       whose
book value               and yield              the         government           is guaranteeing.                    In
addition,            the      transactions                    may      have      cost      more than           liquidations
and the           agreements              reached              in the        transactions              require        a huge
monitoring               effort          because             of     their       complexity           and the         length         of
time       they      remain          in effect.

One of       the         reasons          for     the          structure            of the         1988 Bank Board
transactions                 was FSLIC's                    lack     of     financial           resources         to pay for
thrift       insolvencies                   and effectively                      close        the    institutions.                  Now

that      RTC has a process                           for      obtaining            working         capital,         a lack         of

lGAO/T-GGD-89-10                     (March            11,         1989)     and GAO/GGD-89-59lMarch
11, 1989)
2The Office      of Thrift     Supervision      has announced that FIRREA
supercedes     capital     forbearances     given in connection    with the 1988
transactions.        Twenty-one     thrifts     that did not meet the new
capital    requirement       as of December 31, 1989, have submitted       plans
detailing     how they will       meet it,    in accordance   with FIRREA.

financial               resources          should       not      lead       it     to designing                 resolutions
that         involve       extended           guarantees             and other             noncash            approaches.
Indeed,            RTC policies,              together           with      those          of     the     bank and thrift
regulatory               agencies          should       prevent          a repetition                   of    these        types      of
transactions.                   RTC resolved              thrifts:

--     Are        to meet applicable                   capital          standards              and other

--     Are        not    to be given           long-term             asset         book value                and yield
       guarantees.                 Tax costs           to the        government                are      to also           be taken
       into        consideration              in comparing               resolution               methods.

--     Are        not    to be sold           in prearranged                     and administratively
       determined            groups         that       include          thrifts           that        should         be

In     its        resolutions          so far,          we have seen no evidence                                that       RTC is
not     following            these         policies.             However,           only         10 of        the      52 thrift
resolutions               as of      March         21 have        involved               the     sale        of more than
half         of    the    failed       thrift's           assets         and only              21 have          involved           the
sale         of    any assets.              Assets        sold       have been the                    more desirable
ones,         typically            cash,      securities,               and performing                      loans.

In many instances,                     RTC has contracted                         with     the        acquirers            of   the
deposits            to manage any of                   the    thrifts'             assets            they     do not

purchase.               These            contracts,           under          which       billions            of         dollars       of
assets          are     being            managed,           run     for      a limited            period           of      time.       This
arrangement               may be necessary                        until       RTC implements                      its      own asset
management              and disposition                      structure.                However,             the         present
contracting               arrangements                   concern           us because             they       do not           appear        to
provide             adequate             incentives           for         good asset            management.                   Also,
RTC officials                    tell       us that          these         asset       management             arrangements
are      not        welcomed             by the         acquirers.              For both             these         reasons,           RTC
needs          to     implement             as quickly              as possible               the     asset             management
and disposition                         structure           envisioned              in the        Strategic                Plan.

Marketing              and Selection                    Process

We expressed                concerns                about     the marketing                   and selection                   process
used      in        1988 by the               Bank Board,                 particularly               with         respect          to the
Southwest              Plan.             Under       this     plan,          potential              investors              were      asked
to      submit         initial            proposals           without           knowing           which       thrifts              were
being       marketed,               how they             were       to be combined                   into     groups,              or what
their          true     financial                condition           was.           We testified                  that      this
"blind"             process,             along       with     FSLIC's              practice          of     combining              less
desirable              insolvent              thrifts          in packages               with        those         for      which
there       was more               interest,             may have            (1)     decreased              the         likelihood          of
attracting              the        largest           pool     of qualified                  prospective                  bidders,          (2)
inhibited              FSLIC's             ability          to evaluate               the     acceptability                   of
proposals,              and        (3)      resulted              in a less           efficient             use of FSLIC's
limited             resources.

Our work             on Southwest                  Plan        and other           transactions,                      including
follow-up             work      done by our                    Office      of      Special                Investigations,
found         that:          FSLIC often              negotiated                the     terms             of    the     sale         with          a
selected             j?otential             acquirer,             excluding             other             qualified               bidders;
only         a few officials                   at     the       highest          Bank Board                    and FSLIC levels
were         involved          in the          decision-making:                       and,          the        documentation                      for
the     basis          of     the     decisions                was inadequate.                       Because            of        these
characteristics,                       it     is     extremely            difficult,                 at best,             to determine
if     the     most          cost     effective                action      was taken.

FIRREA sought                  to prevent                 a repetition                 of         these        marketing             and
selection              problems             by requiring                 that      RTC develop                   fair          and
competitive                  bidding          procedures                and that             it     document             its       selection
decisions.                   The RTC Oversight                     Board's             Strategic                Plan         says RTC
will         have an open and widely                              publicized                bidding             process            and will
broadly          disseminate                  information                about         institutions                   being          marketed
and the          terms         of      previous             transactions.                         The process                is    to be


A central              feature              of RTC's           resolution              and acquirer                     selection
method          is     its      "menu"             driven        approach             to bidding                on institutions.
This         approach           is     intended             to allow            market             flexibility                 and access
to the          bidding             process          and to minimize                        RTC's         costs.             Under          it,         a

qualified              party         may bid           on the           whole         thrift          or       standardized                   parts
of     it.       We are             satisfied             at     this      point            that      the        process            laid          out

for      comparing         bids      should         result         in selection                decisions               that    can
be understood              and evaluated.

The RTC Chairman
         :       noted in February,                                     however,              that     one side
effect of the menu approach is that                                     since          the     options           are      fairly
standardized,              negotiations              with       individual                 bidders        for      more
complex         or customized             transactions                 are        precluded           in the           interest
of      open and competitive                   bidding.               He warned             that      this       may
discourage             some potential               bidders,           especially              in an ever-
increasing             buyer's       market.              In light           of    the      unacceptable                process
used by the             Bank Board,            which         relied          heavily          on customized
negotiations,              we believe              that      the      side        effect       of     the       menu
approach         voiced          by the      Chairman           is a reasonable                      price       to pay for
a process         that      occurs          in the         open and can be understood                                  and


Although         we believe            RTC should             speed          up the          resolution            process,
we appreciate              the     need      for      and utility                 of RTC's           extended
conservatorship                  program.           Indeed,           under        the       approach           that      RTC has
taken      to    its     conservatorships,                    partial             liquidations               are       occurring
prior      to actual             resolution.               We do,       however,              have      some concerns
about      the    management            of     conservatorship                     thrifts.

RTC typically               places       a managing            agent         and a credit                     specialist            at
each thrift.                The agent           is    to take         control           of       the      thrift        and
direct       its     operations,             while      also         assessing             its         condition.              These
thrifts         spmetimes          have      extremely          poor         records             and management
information           systems.            And,        they     are        often       still            run     on a day-to-
day basis           by their         previous          officers            and staff.                   The managing
agents       must     know not           only        how to run            thrifts            but       also        how to
implement           FDIC and/or           RTC policies                and procedures.

RTC has only            a limited            number of officials                        with           FDIC experience
and often           has had to reassign                      them.         As a result,                   turnover            of
managing           agents      in RTC conservatorships                            has been high.                       For
example,           some 53 of         the       103 thrifts               in the        Dallas            RTC region               have
had 3 or more managing                       agents          since        they       entered            the
conservatorship                program.              On average,             these         103 thrifts                 had been
in   conservatorship                 about       9 months,            as of mid-March.                             Two thrifts
have had 7 managing                     agents        during         a one-year               period.               Such
frequent           changes      result          in a lack            of    continuity                  and impede RTC's
ability         to effectively               manage the              thrifts.

There      is      a need for           a formal         training            program             for         the    managing
agents.            RTC has been hiring                  managing             agents           from           the    private
sector       to supplement               or replace            some of            the      FDIC employees                     who
have      filled       this     role.           One-third            of    the       managing                agents     in the
Dallas       region         have     been hired              from      the       private            sector.            Such
individuals           are      not      familiar        with         FDIC culture,                     policies,             and

procedures.                While        "on-the-job"                training,                 often          as the         credit
specialist,               is     important,           it     cannot              replace              comprehensive                  formal
training.             For example,                training               should          address             conflict-of-
interest-situations                      and the            application                  of policies                 for        dealing
with delinquent                   loans.

We are        also        concerned           about         the     lack          of guidance                 with         respect           to
"downsizing"               thrifts         while           they     are          in     the        conservatorship
program.             Downsizing            involves               the         selling           off     of     assets           and
removing          or replacing                high-cost              liabilities                      and is,        in essence,
the     start        of    the       liquidation             process.                   Billions             of dollars               worth
of    conservatorship                   assets        have been sold                         by thrifts.                   Liquidating
certain          assets         while      a thrift               awaits          resolution                 is expedient                   and
can reduce            ultimate           resolution                costs.               It      also        serves         to
mitigate          to some extent                  the       urgency              of     final          resolution               actions.

The fact          that         so many thrifts                    have been kept                       under      RTC management
for     so long           necessitates,               we believe,                     the       need for          detailed
policies          on how to manage and “downsize”                                             them.          As noted            earlier,
223 thrifts               have been operating                           in conservatorship                        status             for     six
months        or more and 126 of                      these             for      over         a year,          as of        March           21.
But we have               found       no specific                 policies              regarding              either           the        type
or quality            of       assets      that       should             be sold              in      (1)    those         thrifts
judged          to have assets                that         are     transferrable                       in a sale            and (2)
those       assessed            as deposit            transfer                 or pay off               candidates.


During        our      review          of    FSLIC's            1988 assisbnce                     transactions,               we
became aware
           .   of several allegations     of risconduct. We found some
situations   in which we believe    there might have been misconduct.
For     example,           examiners               found        that        one quired                   institution,            in     a
series        of     transactions,                   loaned        over        $40million                 to   the      cousin        of

the      institution's                 Chairman            of    the        Boardof           Directors,              in
violation            of    the       loans         to one borrower                       regulation.             After
receiving            the     loans          from      the       institutia,                  the     cousin          loaned      the
Chairman           $250,000.                This      matter           is    nowbeing               investigated              by the
Federal         Bureau         of      Investigation.

In another             case,        we found           that,           due tolax               supervision,                FSLIC may
have been the                victim          of      false       submisstis                  by an asset              management
contractor             regarding             the      sale       and repuchase                      of    time-share           units.
We have         referred             information                on this             rd     other         matters         to the
Department             of Justice              for      further             investigation.

It     is    essential           for        the      Justice           Deparlment,                 as the      agency         charged
with        criminal         law enforcement,                      to       invatigate               and prosecute               those
individuals               whose misconduct                      contribuwd                  to thrift           insolvencies.
The government                 must         send a strong                   sigrl           to directors                and
officers            of all          insured          institutions               sat          such misconduct                  will
not     be tolerated.

We are          now     assessing                 federal            efforts           at prosecuting                         those        whose
fraud        and wrong-doing                         caused          losses           to     thrifts             and banks.                  Our
work       is    currently                 focused            in two areas.                     First,                we are        assessing
the  information     systems available                                          for        managing              the      federal
response     to fraud and wrong-doing.                                                So far,             we have             found        that
there        is no centralized                          or     integrated                  system          for         monitoring              and
tracking             actions              taken       against           banks,             thrifts,              and affiliated
parties.              This          concerns            us.

Because          systems             used by the                bank and thrift                           regulatory                 agencies
to     track         their          own activities                    lack        uniformity,                    it     is difficult                 to
get      a clear             picture            of    the      overall            federal              response.                   For
example,             because              the     regulators'                criteria               for     tracking                 referrals
to     the      Justice             Department               vary,       we cannot                  determine                 the     total
number          of     referrals.                    The Office              of       the     Comptroller                     of     the
Currency             tracks          referrals               where        there             is an estimated                        loss       of
over       $200,000,                where         a bank        insider               is     involved,                 or where             there
is     some      unique             circumstance                --      824 in              1989.          The Federal                    Deposit
Insurance              Corporation,                   on the          other           hand,         tracks             referrals              where
the      estimated                 loss      exceeds           $10,000            or where                a bank director,
officer,             or principal                    shareholder                is     involved             --         902 in         1989.
The Office              of Thrift                 Supervision                  (OTS)         and the             Federal             Reserve
Bgard        track           all     their           referrals,              but       unlike             the         other        three
agencies,              the         Federal           Reserve          tracks           referrals                 by individual
rather          than         by     activity.                OTS made 5,014                      referrals                in        1989:      the
Federal          Reserve             sent         referrals             on 3,239               individuals.

Because       of      the        absence      of      a centralized             or    integrated           system,        we
have also           been unable              to tie         the     1989 referrals              tracked       by the
regulatory            agencies          to    investigations                 being      performed          by the        FBI.
The FBI h.ad 7,819                   investigations                 underway as of              September          30,
1989,       about         46 percent          of which             involved       potential         dollar         losses
of     $100,000           or more.

Finally,        we are            reviewing           the    Justice         Department's           establishment
of     a regional            fraud     office          in the         northern       district         of Texas           and,
as mandated               by FIRREA,          determining              ether          regional        fraud        offices
should       be established                  elsewhere.               The Dallas         fraud      task       force
was begun           in     1987 with          50 investigams,                     prosecutors,             and support
staff.        The newly              established             Dallas        Regional        Fraud      Office
numbered        74 as of             February          1990 and has plans                  to add another                38
staff.        The office              has charged                 58 inrtividuals          involved          in
financial           institution              fraud,         obtain-            46 convictions.                 Those
convicted           include          22 bank officers,                  two accountants,                  a real
estate       broker,             two developers,               a comultant,              and 18 borrowers.
Sentences           for      those      convicted            ranged        from      6 months       to     35 years,
and fines           and restitution                   orders        rawd        from     $1,000       to $2.5
million.            The fraud          office          currentlrhas               over     500 individuals
targeted        for         investigation,              and has -ened                  investigations              on 38
failed       financial             institutions.                   Ouruork        to determine             the
adequacy        of        this     effort       continues.

This       concludes             my testimony.               I wou3d be pleased                  to answer          any