An Examination of the Banking Crises of the 1980s and Early 1990s Volume I
174 History of the EightiesLessons for the Future
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Supervisory goodwill was created when a healthy S&L acquired an insolvent one, with or without financial assistance from
the FSLIC. It is known as supervisory goodwill because the FHLBB allowed it to be included as an asset for capital pur-
poses. For a more in-depth discussion of goodwill accounting, see National Commission, Origins and Causes of the S&L
Debacle, 3839, and Lowy, High Rollers, 3841.
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An example of a typical transaction will help to explain the relevance of this change. The assets and liabilities of the thrift
would be marked-to-market, and since interest rates were very high, this usually resulted in the mortgage assets of the
thrift being valued at a discount. For example, a $100,000 loan paying 8 percent might have been marked down to $80,000
so that it was paying a market rate. However, the liabilities of the institution were generally valued at near book, so a
$100,000 deposit was still worth $100,000. Even if the acquirer paid nothing for the thrift, the acquirer was taking on an as-
set worth $80,000 and a liability of $100,000, a $20,000 shortfall. This would be recorded as an asset called goodwill with
a value of $20,000. One should note that the borrower would still have a $100,000 loan outstanding and would be expected
to pay back the entire loan balance. The $20,000 would be booked as an off-balance-sheet item called a discount. The ac-
counting profession considered the goodwill and the discount two independent entries.
After the merger, the goodwill would be amortized as an expense over a set period. The discount would be accreted
to income over the life of the loan, usually around 10 years. Under RAP accounting, before June 1982, goodwill was amor-
tized over the same 10-year period. Afterward, the accounting picture changed dramatically. Under GAAP, the goodwill
could be amortized over as many as 40 years. The expenses for the amortization of goodwill would be much lower than the
income from the accretion of the discount for many years. This allowed thrift institutions to literally manufacture earn-
ings and capital by acquiring other thrift institutions (Office of Thrift Supervision Director Timothy Ryan, testifying be-
fore the U.S. House Committee on Banking, Finance and Urban Affairs, Subcommittee on General Oversight and
Investigations, Capital Requirements for Thrifts As They Apply to Supervisory Goodwill: Hearing, 102d Cong., 1st sess.,
1991, 31).
former. As of September 1981, troubled S&Ls could issue income capital certificates that
the FSLIC purchased with cash, or more likely with notes, and they were included in net
worth calculations. That same month, the FHLBB began permitting deferred losses on the
sale of assets when the loss resulted from adverse changes in interest rates. Thrifts were al-
lowed to spread the recognition of the loss over a ten-year period, while the unamortized
portion of the loss was carried as an asset. Then in late 1982, the FHLBB began counting
appraised equity capital as a part of reserves. Appraised equity capital allowed S&Ls to rec-
ognize an increase in the market value of their premises.
Perhaps the most far-reaching regulatory change affecting net worth was the liberal-
ization of the accounting rules for supervisory goodwill.
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Effective in July 1982, the Bank
Board eliminated the existing ten-year amortization restriction on goodwill, thereby allow-
ing S&Ls to use the general GAAP standard of no more than 40 years in effect at the time.
This change was intended to encourage healthy S&Ls to take over insolvent institutions,
whose liabilities far exceeded the market value of their assets, without the FSLICs having
to compensate the acquirer for the entire negative net worth of the insolvent institution.
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Not surprisingly, between June 1982 and December 1983 goodwill rose from a total of $7.9
billion to $22 billion, the latter amount representing 67 percent of total RAP capital. The
FHLBB also actively encouraged use of this accounting treatment as a low-cost method of