The Good Banks, the Bad Banks, and the Ugly Assets

Paul Romer says forget about trying to repair bad banks, let’s create a few good banks:

Let’s Start Brand New Banks, by Paul Romer, Commentary, WSJ: Everyone agrees that the United States urgently needs a few good banks. Turning bad banks into good banks is a difficult and risky way to get them. It’s simpler and safer to start entirely new banks.

In this context, “good” means a bank with assets and liabilities that are easy to value using market prices. At a good bank, officers, regulators and investors can be confident about the value of the bank’s capital.

The government has $350 billion in Troubled Asset Relief Program (TARP) funds that it can use to encourage new bank lending. If this money is directed to newly created good banks with pristine balance sheets, it could support $3.5 trillion in new lending with a modest 9-to-1 leverage. …

If the TARP funds go to existing banks, much of them will end up stuck in financial institutions that are still bad after the transfer. We know from the previous round of TARP that giving more capital to bad banks generates very little net new lending. … Without reliable market prices for the hard-to-value assets, any proposal for turning bad banks into good banks could lead to huge transfers of wealth between taxpayers and bank shareholders.

If the government lets new banks provide the new lending that the economy needs, it could return to clearly stated and familiar policies for bank regulation. …

With a return to a clearly articulated and familiar pattern of bank regulation, investors from the private sector could invest in the banking sector without fear… [and] quickly create the new banks that the government backs. Over time, they can also buy the government’s shares… The government’s role is merely to act as a temporary bridge. …

The brewing backlash against the existing players from the financial sector is almost certain to burn hotter as the recession wears on, and new election campaigns get underway. If the new administration ties its fate to the existing players, it could lose its room to maneuver on countercyclical policy and be put under political pressure to intervene in bank decisions in ever more intrusive ways.

Because they can and will borrow, new banks will be much more effective in leveraging TARP funds. They will undertake more total lending,… and do more to limit the depth of the recession. …

Banks that are not viable, the ones with liabilities that substantially exceed their assets, will lobby vociferously against a return to historical patterns of bank regulation. They will say anything to postpone a looming FDIC takeover. The administration should not listen to threats and pleas from these doomed banks. … New entrants could give us a few good banks. That, plus an FDIC that can do its job, is all we need.

Originally published at the Economist’s View reproduced here with the author’s permission.

One Response to "The Good Banks, the Bad Banks, and the Ugly Assets"

  1. Anonymous   February 7, 2009 at 4:02 am

    In my opinion, can someone please help explain to the public why we needed Tarp in the first place? How much does it cost to buy all these houses that face foreclosure plus interest? Since the passage of Tarp, more and more people lost their jobs, which inevitably led to more defaults. The government keeps on saying we need to save the banks over and over again. Which banks is it talking about? Lets see, without any government intervention, Bear Stearns would have failed and taken JP Morgan with it since JPM was its major counterparty. After that Lehman, FRE/FNM, and AIG. With AIG failing Goldman Sachs would probably also have failed. In addition, Morgan Stanley and Merrill Lynch were doomed but the Japanese bank and BAC saved them. So in other words, instead of just guaranteeing deposits for would-have-failed banks such as JP Morgan and Citigroup, our Treasury and the Fed decided to dump billions of tax dollars into saving basically the Wall Street investment banks. At the same time, no help was given to non-Wall Street banks like Wamu and Wachovia, not even a bridge loan to get them through the Tarp vote. Why did FDIC pick Citigroup to save Wachovia when Citigroup was insolvent? Was it a scheme to help Citigroup stay alive? Testimony by the Wachovia ceo showed that FDIC refused to even wait a little more time for Wells Fargo to do more due diligence. So now do we even know why Wamu failed? What criteria was used to determine Wamu had to be seized on a Thursday? According to court filing Wamu had $5 billion in cash and access to the SF Fed for billions to help with liquidity, just like Wamu had said in its press release the week it was seized. The public wants explanation for all these actions. Is this all a scheme to use tax dollar to save the selected few? Are we also responsible to pay back the $2 trillion Bernanke lent out to the “unknown” institutions? What is going on? Why cant we know why and how? If the reasons are legit, then I am sure people will be more than happy to help out to get the country through the rough times. Instead we get nothing and have just found out $78 billion was overpaid for things we dont even understand.