Sheila Bair is delivering a sensible general message: we need dramatic action to clean up banks’ balance sheets and, presumably, to recapitalize them. This initiative apparently has support from influential senators, such as Kent Conrad and Charles Schumer. Many Republicans also seem inclined to come on board.
I like an aggregator-type approach; this is quite consistent with the RTC-inspired structure that we have been advocating (see the WSJ.com article linked through that post for details; such ideas are consistent with and an update of our proposals from September, November, and December). But some of the details currently being floated seem less than ideal. Given that the design work on this program is still ongoing and the new Administration will, without doubt, seek broad support on Capitol Hill, I would suggest that the following points be considered or even stressed in the upcoming deliberations.
1. The idea that banks should take equity in the aggregator really doesn’t make sense. We are trying to increase available capital in the banking system, not find new ways to commit it. (Historical aside: back in the early spring of 2008, when I was still with the IMF, our proposals contained something equivalent to such a structure; but that train has now left the station.)
2. There is really no reason for the aggregator bank/RTC to overpay for the toxic waste. We should pay market prices – this is the only fair and reasonable thing to do, and anything else will surely lead to a nasty political backlash. Market prices are sometimes hard to determine, but this is a matter where outside evaluation and transparent procedures can deal with the issues. (Note: no need for a complicated auction of the kind proposed this fall.) If these market prices are below the banks’ marks, then they will need more capital. The RTC should be set up to provide this capital, for example on the terms that we have suggested. In any case, it is essential to have full reporting to Congress on all details (Open Door or Closed Door, as appropriate).
3. Banks need capital and the taxpayer needs to see value from this unprecedented and regrettably necessary intervention. There may be a temptation to conduct the entire banking program just through waste disposal, and this is what powerful people on Wall Street want. But at the very least, the RTC should receive a considerable amount of warrants (options to buy stock) at a low strike price; these should convert to common stock (with full voting rights) when the RTC sells them. This will enable the RTC to recover value, while selling stakes (and perhaps even control) to new owners. Given that large banks have repeatedly demonstrated their inability to measure risk, let alone control it, we should have some confidence that this process will lead to the break up of behemoths and a more competitive financial landscape (and let’s back this up with supportive anti-trust legislation, just to be sure.)
The leadership of the US banking system failed completely. It’s time to clean up the mess that they made, and Sheila Bair’s proposals are along exactly the right lines. But let’s make them operational in a way that is fair to the taxpayer. This would be appealing change for President Obama to present to the country in his first 10 days (I don’t think we can wait 100 days).