[jyl]

In the early 1990s, the savings and loan industry was collapsing due to a housing bust. The govt set up the Resolution Trust Corp (RTC) which took over the failed S&Ls and liquidated their assets, mostly real estate and housing, over several years. The RTC-liquidated assets were originally valued at $520BN, the govt utlimately recovered $400BN, for an ultimate cost to the taxpayer of $120BN (all numbers appx).

There are obvious parallels between the early 1990s and today, and the concept of a second RTC is pretty logical. A lot of people who know what is at stake have been calling for this - like former Fed Chairman Paul Volcker, a guy who has plenty of credibility.

Of course, there are some major differences too.

In 20 years the financial system became much more complex and intertwined. Commercial banks, investment banks/securities brokers, and (some) insurance companies are all competing in each others' business. Lenders took more risk, a 10%-down ARM mortgage was racy stuff back then but in 2006 we had 0% stated-income subprime Option ARMs. Securities are more complicated, not merely single mortgages but pools of mortgages divided into tranches and resold to thousands of investors. Institutions are tied together by US $ trillions in derivatives and other counterparty relationships, CDS being just one example. A substantial portion of trading goes on in over-the-counter markets where it is hard to observe. And, finally, the valuation of these complex securities and derivatives, and the institutions that hold them, is more difficult - not just analytically, but small changes in assumptions produce a wide range of outcome (the formulas are non-linear).

The system is bigger, is harder to understand and control, and is sitting on more risk, than it was 20 years ago.

So today's RTC has to be different too. The govt cannot wait until major institutions collapse and then sweep their assets into the RTC, because that one collapse will weaken 1000s of others and at some point the whole thing comes crashing down. Instead, the govt has to step in before the institution collapses, and take the toxic assets into the RTC, exchanged for cash at a discount.

I know lots of you are protesting that "the govt shouldn't bail out companies". One of the Presidential candidates said that today. Honestly, we are beyond worrying about that. The crisis is already bringing down the "real economy", i.e. has spread and is continuing to spread from Wall Street to Main Street. Stabilizing the financial system will mean the difference between a depression and a recession.

I agree that if a company turns to the govt, it should be penalized, by surrendering equity to the govt or by paying a steep interest rate on the cash received. Inflicting pain on management teams and shareholders is fine too, as long as it is workable - remember, without enough management left to run the companies and enough shareholders to provide capital, we've kind of cut off our nose to spite our face.

So, I hope Paulson and Bernanke are able to push a plan through the Congress and the White House. This crisis is big and developing rapidly, these guys are are being aggressive and bold, and seem to be trying to move from the defensive/reactive to the offensive/proactive.

They are not doing a perfect job, the history books will have plenty of criticisms for each of them. But in the here and now, I'm glad we have Paulson who is not a timid guy, and has a better grasp of Wall Street than any Treasury Secretary since Rubin. If either Snow or O'Neill were in the job, we'd be dazedly watching the US financial economy and real economy melt down by now. And thank goodness we have Bernanke, who spent his life studying the mistakes the govt made in the Great Depression, and thus is better prepared than anyone for a crisis where the Fed needs to do more than merely lowering the Fed Funds Rate. Greenspan might be equally capable, but since the crisis developed on his watch he'd be politically ineffective by now.

(Hmm, I wonder if Greenspan proposed Bernanke as his successor for a reason - because he knew what he might be leaving behind? Obviously he knew what Bernanke's strengths are.)

So, we'll see what form the new RTC takes, and if it can be put into effect quickly enough.