Understanding obligations of the FSLIC.
FSLIC obligations do not now and never did enjoy the backing of the full faith and credit of the United States. At the time of its demise, the FSLIC was in the red by approximately 87 billion, according to the General Accounting Office. Financial Accounting Standards Board Statement no. 5,
Accounting for Contingencies, says a set of circumstances exists involving uncertainty about the possible loss to thrift institutions holding these obligations. In many cases it is necessary for financial reporting purposes to determine whether such a loss is probable, reasonably possible or remote.
This article describes the circumstances of the thrift industry and the FSLIC in the late 1980s, discusses relevant provisions of the recent thrift bailout legislation-the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA)-and shows how that legislation established a complex and politically sensitive mechanism governing future payment of FSLIC obligations. The goal is to provide an historical framework to help practitioners determine whether a loss on such an obligation is probable, reasonably possible or remote.
Before the enactment of FIRREA, the FSLIC was the federal insurer of deposits of most savings and loan associations. It also served as receiver for failed S&Ls. As failures increased in the 1980s, it became necessary for the FSLIC to find ways to resolve them other than liquidating the institutions and paying off depositors. The FSLIC began to look for acquirers, including supposedly healthier institutions, but found it had to assist the acquirers because the institutions being acquired had assets of uncertain quality or negative net worth.
FSLIC assistance took various forms-asset guarantees, yield subsidies, litigation guarantees and indemnifications, and capital notes (in lieu of cash, which was in short supply). Many of these assistance obligations are open-ended; projecting their ultimate cost involves assumptions about maturities, real estate markets, interest rates and management efficiency. (For a discussion of the accounting issues for acquirers of FSLIC obligations, see JofA, Jan.89, page 19).
As a result of FSLIC assistance to S&Ls, their portfolios came to hold a new and often material asset: an FSLIC note or other assistance obligation. By year end 1987, the FSLIC had issued obligations totaling approximately $4.7 billion. Even then, it had a deficit of $13.7 billion, according to the GAO, and thrift institution failures were increasing.
Practice bulletin no. 3. In 1987, the American Institute of CPAs issued Practice Bulletin no. 3, Prepayments into the Secondary Reserve of the FSLIC and Contingencies Related to Other Obligations of the FSLIC, which noted that a GAO estimate of the FSLIC's exposure over the next five years substantially exceeded its expected income. The bulletin advised practitioners that FSLIC obligations should be evaluated for the likelihood of loss and that uncertainties about the FSLIC's financial condition led to the conclusion that a loss was at least reasonably possible.
A member of the Federal Home Loan Bank Board FHLBB-operator and overseer of the FSLIC) requested in June 1988 that the AICPA rescind Practice Bulletin no. 3 on the grounds the FSLIC's projected resources would be sufficient to meet its obligations. In testimony before the House Banking Committee, AICPA representatives declined to modify the practice bulletin, citing rising resolution costs, uncertainty of FSLIC revenues, the FSLIC's deficit and thrift industry deterioration. The AICPA's position was clear: Removal of uncertainties surrounding FSLIC obligations would require a full faith and credit guarantee of those obligations.
Administration response. Almost immediately, senior Treasury Department officials denied full faith and credit was needed. The obligations were already on budget and were being treated by the administration as obligations of the United States. The administration's putting an agency obligation on budget, however, is not the same as Congress's backing that obligation with the credit of the United States. In addition, many of the FSLIC obligations in question were-and remain open-ended. The administration's record of estimating the amounts needed to discharge such obligations was poor. Finally, billions of dollars were about to be added to the FSLIC's exposure and the new obligations would sit on the FSLIC's books on par with the existing ones, swelling its liabilities beyond anything the administration had on budget or anywhere else.
Despite assurances by the FHLBB, all but one Federal Home Loan bank refused to accept FSLIC notes as collateral for loans to member institutions. (The Federal Home Loan Bank of Dallas had accepted such notes as collateral; it could not obtain an unqualified auditor's report in 1987 until it put the notes back to the FSLIC for cash.)
Full faith and credit. In a letter dated October 11, 1988, the U. S. comptroller general opined that FSLIC notes and assistance obligations were backed by the full faith and credit of the United States. This was not an opinion many lawyers could accept as conclusive. The attorney general, not the comptroller general, is normally the authority on federal law. The "long line of attorney general opinions" on which the comptroller general relied is flawed. Further, the legislative history of the National Housing Act indicates a congressional intent that FSLIC obligations not be guaranteed by the United States. So, it remained doubtful whether the FSLIC could pay its obligations and, if not, whether the United States would be obliged to pay them.
Doubt was not dispelled when FHLBB Chairman M. Danny Wall decided not to seek an attorney general's opinion on the full faith and credit question but, rather, to repeat his request for legislation. Now the question was sharply focused; if Congress believed the FSLIC's obligations already enjoyed full faith and credit, as the comptroller general said, there couldn't be much fiscal harm in legislating to that effect. Apparently, Congress did not share that belief because the legislation never ensued.
At the end of 1988, the FSLIC rushed to complete pending transactions by year end, when important tax benefits to acquirers would expire and FSLIC costs would increase. From Thanksgiving through December, the FSLIC closed acquisitions of 35 thrift institutions at a cost it then estimated to be $27.6 billion. In January 1989, House Banking Committee members, disturbed by the cost of the FSLIC's year end deals, considered introducing a resolution that FSLIC assistance obligations were not backed by the full faith and credit.
The problems of the deteriorating thrift industry in 1989 were troubling. According to the GAO, 1988 acquisition assistance had cost the FSLIC $48.7 billion, increasing its reported deficit to at least $18 billion. The possibility of loss on FSLIC obligations was indeed greater than "remote."
FIRREA was enacted August 9, 1990. It abolished the FSLIC, along with its operator, the FHLBB. The functions of these organizations (and their employees) were reallocated: Regulatory functions fell to the new Office of Thrift Supervision, insurance functions fell to the new Savings Association Insurance Fund of the Federal Deposit Insurance Corporation (FDIC) and receivership functions fell in the near term to the new Resolution Trust Corporation (RTC) and in the longer term to the FDIC.
The FSLIC Resolution Fund. What happened to obligations of the FSLIC? FIRREA created a new fund, the FSLIC Resolution Fund, to be managed by the FDIC. The Fund received all assets and liabilities of the FSLIC, other than liabilities under certain 1989 guarantees of Federal Reserve Bank and Federal Home Loan Bank loans. The new Fund's money is not to be commingled with other FDIC money. FIRREA provides emphatically that the Fund's assets and liabilities are its own, not those of the FDIC or the United States.
The Fund is broke. The administration's 1991 budget showed the Fund with a deficit of $30.5 billion at year end 1989. It was reported in May 1990, however, that the FDIC estimated the Fund's yearend deficit at $56.7 billion. This is based on current assumptions, however, and may not be final. The FDIC viewed the deficit as "representing the remaining cost of S&L transactions assumed by the FDIC" through the enactment of FIRREA. Estimates of the remaining cost of S&L failures generally (not just those inherited by the FDIC) have been rising steadily. (The FSLIC Resolution Fund has no responsibility, however, for S&L failures that occur after the enactment of FIRREA.)
In FIRREA, Congress demonstrated it knows how to pledge full faith and credit by doing so for future obligations of the FDIC and the RTC, so long as the principal amounts and terms to maturity of such obligations are stated (a condition typically not satisfied by assistance obligations such as yield subsidies). Congress did not provide full faith and credit backing for FSLIC Resolution Fund obligations. FIRREA provides that the Fund is to be dissolved when it has liquidated its assets and satisfied its liabilities. But in order to satisfy its liabilities, the Fund will need more money.
Sources of money. The key to evaluating the likelihood of loss on FSLIC obligations, now liabilities of the Fund, is its source of money. In addition to satisfying its liabilities, the Fund is obliged to pay the administrative and supervisory expenses of the Savings Association Insurance Fund (SAIF) through September 1991 (reported to be $5.6 billion in 1989) and to transfer to the Resolution Funding Corporation (REFCO) any net proceeds it receives from sales of assets acquired from the RTC upon termination of the RTC (on or before December 31, 1996). These statutory obligations don't continue indefinitely; at some point the Fund will be able to use all its money to satisfy its liabilities-barring new legislation.
The ultimate measure of FSLIC obligations is the sources of funds for the FSLIC Resolution Fund. In the statutory order of priority, those sources are
* Income from the Fund's assets.
* Income from receiverships (liquidating dividends and payments on claims) to the extent such funds are not required by REFCO or the Financing Corporation (FICO).
* Proceeds of borrowings by FICO.
* Amounts assessed by the FDIC against members of SAIF until December 31, 1991, and not required by REFCO or FICO.
* If these sources are insufficient, the secretary of the treasury may provide additional funds, as discussed below.
Will there be enough money? It seems unlikely income from the Fund's assets and leftover receivership income will be sufficient; nor will leftover funds from assessments through 1991 close the gap. What about the proceeds of FICO borrowings? Congress established FICO in 1987 as part of a plan to recapitalize the FSLIC. FICO's own capital came from the Federal Home Loan banks in an amount capped at $3 billion. FICO issued bonds not backed by full faith and credit, with interest and issuance costs borne through assessments against FSLIC-insured S&Ls and principal supported by FICO's purchases (from its capital) of zero-coupon government obligations. Bond proceeds were to be used to purchase FSLIC capital certificates and stock. The amount of FICO bonds outstanding could never exceed $10.8 billion.
Under FIRREA, proceeds of FICO bonds now go to the FSLIC Resolution Fund, but the $10.8 billion ceiling remains. FICO has authority to raise what's left of its original $10.8 billion for the FSLIC Resolution Fund. Even before the Fund was established, FICO had used all but $2.6 billion of that authority. FICO borrowings will not provide sufficient funds to solve the problem; more money will be needed.
Treasury backup. FIRREA provides that, if other sources of money are insufficient to satisfy the liabilities of the FSLIC Resolution Fund, the secretary of the treasury "shall pay to the Fund such amounts as may be necessary, as determined by the [FDICI and the Secretary, for FSLIC Resolution Fund purposes." While FIRREA authorizes appropriations to the treasury "as may be necessary" for the FSLIC Resolution Fund without fiscal year limitation, this is only an authorization. It does not appropriate any money. The key to payment of FSLIC obligations is the politics of the budget and appropriations process. Unless money is appropriated, the treasury will not make disbursements to the FSLIC Resolution Fund.
Appropriations were forthcoming for fiscal 1990. Title IV of the 1990 Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act, enacted November 9, 1989, appropriated such funds "as may be necessary" for payment of expenditures of the FSLIC Resolution Fund during fiscal 1990 (which ended September 30, 1990). If FSLIC obligations are to be paid in the future, Congress will have to appropriate sufficient funds for each fiscal year until the Fund has discharged those obligations.
APPROPRIATIONS FOR 1991
The administration proposed the same open-ended appropriation for fiscal 1991. During testimony by FDIC Chairman L. William Seidman before the Senate HUD-VA Appropriations Subcommittee, however, Subcommittee Chairman Barbara Mikulski expressed concern "about providing the FSLIC Resolution Fund with the same kind of indefinite appropriations" for fiscal 1991. Senator Mikulski said the FDIC's estimate of the Fund's needs for fiscal 1990 had been only $1.8 billion, whereas it appeared that $5.2 billion would be spent. Chairman Seidman responded that uncertainty about interest rates and real estate values made it difficult to predict the Fund's needs accurately. For this reason," he concluded, "the current, indefinite appropriation is essential to avoid the possibility of a default on FSLIC Resolution Fund obligations later in the year." In June 1990, the House passed the 1991 version of the Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act, with the indefinite appropriation for the Fund intact. House Banking Committee Chairman Henry Gonzalez, however, warned he intended to do something about the indefinite appropriation, which he characterized as "an open-ended run on the Treasury. " The bill went to the Senate, where the Appropriations Committee reported it out in September, with amendments. Senator Mikulski had not forgotten her statement in May-the Senate amendments replaced "such sums as may be necessary" with a finite 4.398 billion.
Stanley J. Poling, interim director of the FDIC's Division of FSLIC Operations, explained to the House VA, HUD and Independent Agencies Appropriations Subcommittee the Senate's $4.398 billion was no longer enough. That figure was based on earlier estimates. The FDIC believed 4.8 billion would be needed for the FSLIC Resolution Fund for fiscal 1991. The FDIC was not asking for $4.8 billion; it was asking for another "current, indefinite appropriation. " In addition to the estimated $4.8 billion for basic payments, Poling said the FDIC wanted the Fund to spend $6.6 billion to resolve certain "stabilized" cases and $13 to $15 billion to save money for the government by exercising certain rights under the 1988 assistance agreements.
In its report to Congress in September 1990 on the 1988 assistance agreements, the RTC had identified and discussed cost-saving opportunities through prepayments of FSLIC notes and write-downs of covered assets to fair market value. By spending some $20 billion now, the report concluded, the government could save $2 billion. House and Senate conferees agreed to an appropriation of $22 billion for the FSLIC Resolution Fund for fiscal 1991. This appropriation is intended, they said, to permit payment of Fund obligations as they come due and prepayment of certain obligations bearing higher rates of interest before they come due, with significant savings to the government. Congress passed the bill and on November 5, 1990, the president signed it. The act appropriates $22 billion for payment of FSLIC Resolution Fund expenditures in fiscal 1991. The FDIC chairman will report to the appropriations committees quarterly on the financial condition and estimated needs of the Fund.
The AICPA accounting standards executive committee withdrew Practice Bulletin no. 3 in June 1990 in light of current circumstances, including the termination of the FSLIC. This action does not alter the problem of evaluating existing FSLIC obligations, which remain on the books of thrift institutions. FASB Statement no. 5 continues to require the evaluation of the likelihood of loss on these obligations. The current exposure draft (dated August 31, 1990) of the AICPA audit and accounting guide Audits of Savings Institutions addresses the problem of reporting on the financial statements of thrift institutions holding FSLIC Resolution Fund obligations. It advises that those obligations should be evaluated for the likelihood of loss in accordance with the guidance of FASB Statement no. 5. Evaluations should be reconsidered periodically in light of current circumstances.
EVALUATING FSLIC OBLIGATIONS
FSLIC obligations are now liabilities of the FSLIC Resolution Fund, which is almost totally dependent on treasury disbursements for money to discharge those liabilities. In turn, treasury disbursements depend on congressional appropriations, which are made annually. Congress has appropriated $22 billion for the fiscal year ending September 30, 199 1. Depending on what the FDIC does with the "stabilized cases" and the 1988 assistance agreements, there should be enough money to pay FSLIC obligations during fiscal 1991. (At this writing the FDIC is considering what it can do and what it wants to do with the 1998 assistance agreements.) After fiscal 1991, the Fund's ability to discharge its liabilities will depend on further appropriations.
Practitioners interested in whether a loss on FSLIC obligations is probable, reasonably possible or remote must gauge the appropriations process in a rapidly changing world. Whether appropriations for a particular fiscal year will be sufficient to assure payment of FSLIC obligations, and whether such appropriations will be sufficent to make payment in future fiscal years probable, are questions that will require careful analysis. n