Obama Team Considers Bad Bank

Discussion in 'Economics' started by Aaron Copland, Jan 19, 2009.

  1. Britain’s decision on Tuesday to announce another bank rescue plan comes as the incoming Obama administration is considering creating what economists call a “bad bank” to take on the toxic assets in the US banking system.

    The Obama team is also looking at providing more widespread insurance on pools of toxic assets that remain on bank balance sheets – an approach used in the Citigroup and Bank of America bail-outs and now adopted by the UK.

    The two approaches are not mutually exclusive. Some economists favour a third approach – separating banks one by one into good and bad banks. However, the momentum appears to be with the proposal to create a systemwide bad bank – dubbed an “aggregator bank”.

    Sheila Bair, chairman of the Federal Deposit Insurance Corporation, and Hank Paulson, the outgoing Treasury secretary, both endorsed the idea of an aggregator bank on Friday. Ms Bair said such a bank could be capitalised with equity from the second $350bn tranche of the Troubled Asset Relief Program and geared up with debt, allowing it to purchase assets on a large scale.

    The decision will rest with Lawrence Summers, incoming director of the National Economic Council, and Tim Geithner, nominee for Treasury secretary, who have so far kept their thinking to themselves.

    The Obama team is stepping into a banking crisis that has intensified again, with concern spreading from writedowns on securities to revenues and rapidly mounting provisions on loans.

    The administration needs to restore the flow of credit to the economy while finding durable solutions for frail but systemically important financial institutions.

    Policy bulwarks put in place to shore up the banking system in October have helped contain fresh stresses in the financial system. The recent easing in the interbank money market has largely held.

    But lending has not recovered, while the spike in the cost of buying insurance against a default by Citigroup suggests investors see risk of default in spite of all the layers of official support.

    Banks like Citigroup have little ability to raise fresh equity from private sources because of the uncertainty over their assets and the risk of dilution in the event of further bail-outs – a dilemma similar to that which faced Fannie Mae and Freddie Mac in August 2008.

    Last week Federal Reserve chairman Ben Bernanke argued that dealing with toxic assets through purchases of these assets, insurance-style guarantees or one or more bad banks could help banks to lend and raise new capital.

    Policymakers used the insurance model for Citi and BofA. It directly addresses the so-called “tail risk” of extreme loss, but some experts think it lacks the finality of taking the assets off balance sheet.

    The Fed would not want to take the lead role in providing system-wide insurance due to credit risk and balance sheet concerns, while Treasury has accounting problems.

    There is more enthusiasm for an “aggregator bank” through which, for instance, $100bn of Tarp equity could be geared up five times to provide $600bn of purchasing power.

    The aggregator bank would issue its own long term debt – probably with a guarantee from the FDIC or Treasury...
     
  2. Sure after we give the banks billions of tax payer money.....now we create this dumping ground for toxic waste.

    WHAT A FREAKING TAX PAYER RIP OFF &^%$%^*()_(&*^%
     
  3. Banff01

    Banff01

    I'm all in favor of the third approach mentioned in the article – separating banks one by one into good and bad banks. The long-term viability of the bad banks should be evaluated and the ones that are basically bankrupt or close to bankruptcy should be closed with government guaranteeing their obligations. It's been said a thousand times before but again why do we keep throwing good money after bad? Can someone explain why the third option is not given more attention?
     
  4. Hopefully someone in the admin will stumble across Krugman's Wall Street Voodoo.

    Bring back the RTC and wipe out the banks. Or how about the idea to buy the bad debt, package it into an ETF and kick it back out in the market.
     
  5. Fade the rally when this nonsense gets announced.
     
  6. Banff01

    Banff01

    Great article. I don't get it - what's the point of keeping these zombie institutions around. They made big mistakes and now it's time to close the shop. No financial gymnastics will bring them back to what they used to be. Perform some sort of orderly shutdown of the weak banks and let the strong ones take their place. If anything part of the bailout money should go to the strong players to take over and restructure the bankrupt banks. Everyone will be much better off in the end.
     
  7. Great article. I don't get it - what's the point of keeping these zombie institutions around. They made big mistakes and now it's time to close the shop. No financial gymnastics will bring them back to what they used to be. Perform some sort of orderly shutdown of the weak banks and let the strong ones take their place. If anything part of the bailout money should go to the strong players to take over and restructure the bankrupt banks. Everyone will be much better off in the end.


    Totally agree.....

    Too big to fail is the reason given....