Thursday, April 15, 2010

Resolution Corporation a la 1933

When Felix Salmon and Peter Wallison debated the newly proposed "Resolution Corporation" on the PBS New Hour last night neither drew any parallels with the national experience in the 1930s, but they easily could have, for we have been here before--sort of.

In 1932-33 Virginia Senator Carter Glass (of Glass-Steagall) pushed mightily for the federal incorporation of a "Liquidation Corporation" to assume the assets of failed banks for orderly disposal. Glass argued that liquidation over a period of years rather than months would prevent sluggish markets from being inundated with unwanted (and weak) assets that might raise only pennies on the dollar. A slower liquidation would raise more money and in the mean time some assets, like railroad bonds, might fetch their full value rather than some hefty discount.

Glass's idea never came to fruition because others in Congress argued that the federal government had already created the Reconstruction Finance Corporation (RFC) that could perform the same function. In fact, it did.

Felix Salmon argued on the News Hour that "No one is going to lend to a bankrupt bank. Banks have to be liquidated. They can't operate in bankruptcy." Oh, no? The RFC loaned hundreds of millions of dollars to banks in receivership in the 1930s, and it made perfect sense to do so for the very reasons that Sen. Glass wanted the Liquidation Corp. The RFC loans allowed banks to pay off creditors (depositors), which presumably would be the purpose of the Resolution Corp., and sell off assets over time. Various states (like Iowa and Montana) also passed laws allowing banks in receivership to continue operating on their "good assets" even while their affairs were being unwound. That, too, was a sound policy that worked pretty well.

Peter Wallison's principal objection to the Resolution Corp. was that it will only be used to pay off the creditors of the biggest non-bank institutions. Banks are already covered by FDIC, so the Resolution Corp. is intended only for non-bank institutions and only for those companies that are "too big to fail." This would be untrod territory. The RFC loaned money to railroads, insurance companies, and mortgage and agricultural credit companies, but it never loaned any money to private banks (which served the purpose of today's investment banks) or any other underwriting corporation. So the very entities that would presumably be the target of today's Resolution Corp. never received a dime in the 1930s from the RFC.

The fact that Wall St. firms like J.P. Morgan and Kuhn, Loeb received money as creditors of companies that received RFC loans, (i.e., railroads used RFC loans to pay back loans from Morgan) caused a storm on Capitol Hill that nearly sank the RFC that required Congressional reauthorization. The animus among politicians was so strong that such entities would never have directly benefited from the largess of the Treasury. The proposal to do so today is in dramatic contrast to the 1930s.

No comments:

Post a Comment