Yes, we do have enough bad banks already

A week and a half ago, I wrote:

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.

To be honest, I was not sure this was really a viable idea; after all, I am just some random anonymous layman.

But today, the British economist much smarter than I writes:

The ‘Good Bank’ Solution

The favoured solution of the banks and other institutions holding these toxic assets is that the state pay them over the odds – preferably face value.  That would be unfair and costly from a budgetary point of view.  It would also represent a massive example of moral hazard by creating incentives for future excessive risk taking in the confident expectation that Mother State will bail you out.

There is an alternative solution to the problem of valuing the toxic assets.  It would not involve nationalising the existing banks.  Instead the state would create one or more new ’good’ banks – all state-owned and state-funded to begin with.  Effectively, some or all of the existing banks would become bad banks.  The good banks  would acquire the deposits and the good assets of the bad banks or legacy banks.

As regards the the legacy bad banks, the easiest and cleanest way to proceed is to stop them from doing any new business on the asset side of their balance sheets: no new lending and no new investment.  They would also not be permitted to take new deposits.  A simple way to ensure this is to take away their banking licenses.

I have been following this guy since I started writing a year and a half ago.  I was not sure about him at first, but I can now say with complete confidence that Willem Buiter is my hero.

What are the odds the Obama administration proposes anything remotely like this? Approximately zero, I suspect.  But until we see the actual proposal, I will hold out some small hope.

I strongly recommend spreading links to Buiter’s piece anywhere you happen to travel in the economopoliticoblogosphere.

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