The Resolution Trust Corporation (RTC) was set up in 1989 to manage and dispose of the assets of failed savings and loan (thrift) institutions. According to a General Accounting Office report, the RTC closed 747 institutions with $402 billion in book value of assets. By the time it was wound up in December 1995, the RTC’s remaining assets were down to $8 billion and it had incurred estimated direct losses of $88 billion.

The Treasury, Federal Reserve and Congressional leaders are reportedly discussing plans to create an RTC-type body to purchase so-called failed assets from US financial institutions. Such an approach has been endorsed by a former Fed chairman, a former Treasury secretary and a former US comptroller of the currency. The original RTC, however, assumed assets only after savings institutions had failed and been placed into conservatorship (the current status of Fannie Mae and Freddie Mac) or receivership. By contrast, the latest proposal is designed to prevent further financial failures.

The original RTC bailed out the depositors of failing institutions but not equity-holders or junior creditors. Market participants are betting that the new scheme will be different, contributing – together with the ban on new short sales – to today’s surge in financial shares. The benefit to equity-owners, however, will depend on the price at which any new RTC-type body purchases toxic assets. Who will establish the “correct” level, and how? Too high a price will enflame criticisms of a bail-out and bolster calls for tighter regulation. Too low a price risks leaving banks with insufficient capital to weather future financial storms.