1997 Asian Crisis-style asset management companies
for US financial markets?
By Jon Fernquest |
Asset management companies (AMCs) to sell off bad debt may end up being a similarity between the 2008 US Subprime Crisis and the 1997 Asian Financial Crisis.
AMCs were set up in Thailand after the 1997 Asian Crisis to sell off the real estate behind the non-performing loans of failing financial institutions.
Bangkok Commercial Asset Management Company (BAM) was the first and largest of the AMCs.
Earlier during the 1980s, the US government also set up an asset management company, the Resolution Trust Corporation, to sell off the non-performing loans of the Savings & Loan Crisis.
By quickly liquidating the assets of failed financial institutions Asian economies as well as the US economy were able to get quickly back on their feet and end the crisis.
In stark contrast, Japan failed to act promptly and liquidate non-performing loans and this led to a decade of sluggish economic activity known in Japanese as the "lost decade." From 2003 to 2007 Japanese banks finally started to recover when they got rid of non-performing loans which decreased from 8.4% in 2002 to 1.5% in 2007 (Source: BIS Seminar 2007).
An asset management company needs to be set up immediately to liquidate the toxic financial assets driving the current financial contagion.
This is the message in an op-ed piece yesterday written by three former former high-ranking US government officials including former central bank chief Paul Volcker, published in the Wall Street Journal, the leading financial newspaper in the US.
Here is the article in full:
Resurrect the Resolution Trust Corp.
By NICHOLAS F. BRADY, EUGENE A. LUDWIG and PAUL A. VOLCKERArticle
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.
It is certainly the case that the new institution we are proposing will in the short run require serious money. That will involve a risk to the taxpayer; but the institution, administered by professionals, means that ultimate gains to the taxpayer are also possible.
Moreover, a failure to act boldly in the fashion we are suggesting would cost the taxpayer and the country far more. The pathology of this crisis is that unless you get ahead of it and deal with it from strength, it devours the weakest link in the chain and then moves on to devour the next weakest link. A deteriorating financial system, diminished economic activity, loss of jobs and loss of revenues to the government is enormously costly. And the cost to our citizens' well-being is incalculable.
Crisis times require stern measures. America has done well in the past to face up to economic turmoil, take strong measures, and put our problems behind us. RTC-like mechanisms have worked well in past crises. Now is the time to take a similarly forceful step.
The American economy still has enormous underlying strengths. What we need, and in part are proposing, is a road map to financial stability.
Mr. Brady was U.S. Treasury secretary from 1988-1993. Mr. Ludwig was U.S. comptroller of the currency from 1993 to 1998. Mr. Volcker was chairman of the Federal Reserve from 1979-1987.
(Source: Wall Street Journal Online)
Vocabulary:
Asset Management Companies (AMCs), debt-management companies - special companies with special rights to deal with "significant banking sector problems." (See Bank of International Settlements Paper (2004) and BOT's list of AMCs in Thailand and 2004 ADB paper and ADB book)
Bangkok Commercial Asset Management Company (BAM) - one of the first and largest AMCs in Thailand (See Wikipedia)
US Savings and Loan Crisis - a very large financial crisis in the US during the 1980s (See Wikipedia)
Resolution Trust Corporation - an asset management company owned by the US government that sold off real estate loans of banks (actually "Savings & Loan Associations) that failed during the US Savings and Loan Crisis of the 1980s (See Wikipedia)
Home Owners Loan Corporation - a US government agency set up during the Great Depression of the 1930s to refinance homes and prevent foreclosures (See Wikipedia)
foreclosures - when the lender takes possession of a person's home after they fail to pay back a loan
toxic - poisonous
financial contagion - when a small financial problem increases in size to include the whole system
turmoil - a state of disorder (accompanied by worry and confusion)
financial turmoil
Great Depression - a worldwide economic downturn that originated in the United States in the stock market crash on October 29, 1929, known as Black Tuesday. The end of the depression in the U.S. is associated with the onset of the war economy of World War II, beginning around 1939 (See Wikipedia)
bank examinations - a bank audit, when the government inspects the accounting records of a bank to make sure it is following the rules
ratings, credit ratings - a number that measures the likelihood of a lender not paying back a loan, used by banks in deciding whether to lend money or not (See Wikipedia)
rating downgrades - give a borrower a lower rating, which makes it less likely they will get a bank loan
extraordinary emergency actions - do special things because there is an emergency
resolve the crisis - take action to end the crisis
overextended - have lent too much money
in robust shape - in a strong condition
clogged with - blocking and preventing regular flow
will not repay according to its terms - will not repay all the money borrowed
structured financial instruments - a financial instrument made by combining or "structuring" other financial instruments
designed for "highly customized risk-return objectives. This is accomplished by taking a traditional security, such as a conventional investment-grade bond, and replacing the usual payment features (e.g. periodic coupons and final principal) with non-traditional payoffs derived not from the issuer's own cash flow, but from the performance of one or more underlying assets." (See Investopedia and Wikipedia on structured finance and structured product)
levered, leveraged - bought with borrowed money
levered as much as 30 times - value of asset bought is worth 30 times more than you paid for it, the difference was borrowed
structured financial instruments, levered as much as 30 times -
temporary resolution mechanism - a short-term system for solving the problem
precedents - events in the past that are similar to the current event
paper, commercial paper - a security issued by large banks and corporations, used for short-term needs such as purchasing inventory or managing working capital, low return and considered safe (See Wikipedia)
troubled paper - paper that looks like the borrower may not be able to pay it back
buy up the troubled paper at fair market values - buy giving the price the paper would have if people did not panic
orderly liquidation of this paper - selling the paper after the panic at a more reasonable price
[paper] recover a portion of its value - during a panic sell-off the paper lost its value, but later regains this value
warehousing the troubled paper - keeping the paper for a time, so it can recover its value
nonpartisan - not working for any political party
restore liquidity to the marketplace - change the market so that people can once again buy and sell assets in the market
function more fluidly - have less problems
the Fed's discount window - when banks borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions, the interest rate charged on such loans by a central bank is called the discount rate (See Wikipedia)
Federal Deposit Insurance Corporation (FDIC) - the US government organisation that provides insurance on bank deposits in the US
solvent - can repay your debts in full
insolvent - cannot repay your debts in full, not having enough money to pay what you owe
solvent banking institutions - a bank that can pay back all the money it has owed and stay in business
pathology of this crisis - (like a disease) how the crisis started and continues to grow
stern measures - strong action to solve a problem
a road map to financial stability - a plan for financial stability
