Don’t we have enough bad banks already?

Apparently, within the next week the Obama Administration will propose some sort of scheme where taxpayer money will be used to purchase “bad assets” from financial firms.

The Next Step for the U.S. Bank Bailout (WSJ via Calculated Risk)

Officials at the Treasury, Federal Reserve and Federal Deposit Insurance Corp., in consultation with the incoming Obama administration, are discussing a plan to create a government bank that would buy up the bad investments and loans that are behind the huge losses that U.S. banks continue to report, say government officials.

Commentators are referring to this as the “aggregator bank” or simply “bad bank” model.

Krugman hits the nail on the head:

The idea of setting up a “bad bank” or “aggregator bank” to take over the financial system’s troubled assets seems to be gaining steam. So let me go on record as saying that I don’t understand the proposal.

It comes back to the original questions about the TARP. Financial institutions that want to “get bad assets off their balance sheets” can do that any time they like, by writing those assets down to zero — or by selling them at whatever price they can. If we create a new institution to take over those assets, the $700 billion question is, at what price? And I still haven’t seen anything that explains how the price will be determined.

The “bad bank” idea is creating quite a buzz in the economics blogosphere this weekend.  If you just cannot get enough, go read Simon Johnson or Tyler Cowen or Robert Reich or Krugman again.

This sounds like Paulson’s original “Super-SIV” proposal — which was resurrected as the TARP — all over again.

Here is a thought.  Instead of using taxpayer dollars to create another bad bank to purchase bad assets, how about we create one or more good banks?  Then the good banks can purchase the good assets from the current crop of bad banks at distressed prices.  Then we let the bad banks fail.

That way, the cost of these failures would fall precisely where it belongs:  On the shareholders, bondholders, executives, and counterparties of the failed institutions.  We could go further and say that anyone who worked for a bad bank during the past 10 years is ineligible for employment at the new good banks.  (Sort of an American version of “de-Baathification”.  Call it “de-BofA-ification”.)

As a taxpayer, I can say such an approach would go a long way toward restoring my confidence in the system.

Or we could keep going the way we are going, and continue to confiscate my wealth to reward failure in proportion to the size of the failure.  That works, too.

1 comment to Don’t we have enough bad banks already?

  • snoopy

    I like the idea of creating more good banks with all the money. It seems obvious until you think one step further…

    I think the problem is that the money flow would stop if we didn’t pay up each time the bad bank showed up holding the taxpayer at gun point. The stalling of the money flow would be catastrophic, so we must keep paying. I think the goal is to try and create healthy banks but there is not a way to do it quickly.

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