Simple: assign the equity to the bad bank. Convert the subordinated debt in the good bank into equity in the good bank in an amount sufficient to leave the good bank well capitalized.

Could you explain why any of the existing banks would sell their good assets to the new, “good” bank? They simply wouldn’t. The only way that this new “good” bank would get the non-toxic assets of the current banks is if the federal government stopped propping up the existing banks, which would lead to toxic assets and their resulting write-downs bleeding out the capital of existing banks, making them insolvent (and therefore forcing them into liquidation), at which point the new “good” bank could acquire the good assets of the existing banks.

Unless you have another method in mind for transferring the good assets, your proposed solution to saving our financial system is to to just let it crash so a newly capitalized bank can acquire the good assets (which, by the way, wouldn’t be quite that “good” anymore because the whole financial system would have collapsed) of the existing banks?

Also, considering that the creditors and shareholders getting wiped out by the failure of the existing banks would be a substantial chunk of relatively healthy corporate and individual creditors/investors, your plan would sign the death warrant of the entire economy.

Apparantly I’m missing a part of your simplistic and genius plan. Could you clarify your solution?

Making massive allocations to failing companies is effectively the opposite. Today, prudent people and companies have cash in the bank (mattress).

Instead of having the government borrow and put $2T into rescue for the imprudent, it should let inflated asset values drop to market value (or lower). Then prudent investors will come out with their cash and invest their own private $2T where it belongs. They will take power and they will be the leaders of the recovery.

This should be a great time to start a new bank, with private or public startup funds. NEWBANK would be unencumbered with bad debt. That would give it more flexibility, and of course the ability lend, which toxic banks do not have, and the economy needs.

Toxic banks may need to sell good assets in order to raise capital to cover writedowns. NEWBANK would be able to be a buyer if it wanted to, at market prices.

And yes, the existing banks are left to meet their fate. They and their shareholders will reap whatever they sowed.

I picked up Greenspan’s memoir yesterday at the library and looked up his comments on the Japanese experience. In 2000, “I suggested that the US government strategy of (1) bankrupting a large part of our failed thrift industry, (2) placing its assets in a liquidation vehicle, and (3) unloading the assets at large discounts in a manner that would reliquify the… market fit the Japanese situation rather closely.” p.290

Greenspan goes on to state, “The Japanese had purposely accepted hugely expensive economic stagnation to avoid a massive loss of face for many companies and individuals. I cannot imagine US economic policy following such a track.”

He claims a cultural norm (avoiding loss of face) as the reason for inadequate policy response. Might the US have a cultural norm (avoiding “socialism” in this case bank nationalization) that is producing similar results?

BTW the Japanese are terrific at playing with outsiders’ stereotypes of Japan. Rather than thinking of “saving face” we should think of “preserving the powers that be.” They muddled through without experiencing high unemployment, maintained their system of single-party “democratic” politics, and the LDP still holds power. This example is unlikely to be overlooked by the Chinese Communist Party.

“Instead of rewarding the existing failed institutions for their failures, we simply replace them.”

Regardless of other issues with that plan, it’s a lot easier to say it than it is to actually create from scratch a number of multi-billion dollar banks. You’re talking about institutions consisting of thousands of people organized and working together, built up over years.

You could probably create something like that, given access to enough cash, but even assuming an all-star management team you’re talking about a process that would take on the order of half a year to create, and then it would probably be pretty inefficient.

This is the same reason the government can’t ‘just buy all the toxic mortgage-backed securities, unpackage them, rewrite the terms on the at-risk loans, and then resell them as good assets’. Something like that takes /enormous/ administrative manpower that we just don’t have.

It’s like suggesting all the people on the Titanic ‘just’ use the materials on board to make more lifeboats. Even if there are enough people to train workers with the necessary skills and if there is enough raw material available to use, it takes significant time to interview people, organize them, get them trained and to actually do the work. By then even the band has given up.

We already have a crisis of confidence. The only reason Citigroup and BofA can issue debt today is that it is guaranteed by the FDIC. The only reason anyone accepts them as a counterparty is that they are implicitly backed by the U.S. Government. Heck, the only reason they still have DEPOSITORS is that the accounts are FDIC insured.

Since the only things these institutions bring to the table today is the guarantee from the U.S. taxpayers, it seems to me the taxpayers ought to be the only ones benefiting. So use taxpayer money to capitalize new institutions, and let the old ones fail like they are obviously trying to do.

As a taxpayer, I can say with certainty that this would help restore my confidence in the system. Or we can continue confiscating my money and giving it to these clowns to pay themselves bonuses and dividends. That works, too.

Sounds great! Let thousands (millions?) of creditors and investors at a number of major banks get wiped out because of the idiocy of a few executives.

Won’t be long and we will be where we were in September: a crisis of confidence, the financial system frozen up, and the economy dropping into a deflationary spiral.

By the way, it won’t be long before your GOOD banks turn into BAD ones. So much for saving your precious tax dollars.

You may be fond of standing in bread lines. I’m not.

“Could you please explain who is going to capitalize the new GOOD banks that you want to create in today’s environment?”

Certainly. The U.S. taxpayer. Instead of rewarding the existing failed institutions for their failures, we simply replace them. Saving the system does not mean saving the existing firms.

“And if you were the CEO of a distressed bank, would you be willing to sell your good assets to the GOOD bank just so your company could go belly up?”

Oh, that would happen automatically as your company entered liquidation. The taxpayer-owned new bank would get an excellent deal for your assets, which is the point.

“Seems you would like to really stick it to shareholders, bondholders and counterparties (actually managers are the ones who have really screwed up).”

Shareholders, bondholders, and counterparties voluntarily took on the risk of doing business with those managers. (If they have a problem, by all means, they can go after the managers.)

As a taxpayer, I still do not see why this is MY problem.

Look, the losses have already happened. All we are doing now is deciding who is going to pay for them. I fail to see why that should be anyone other than those who took on the risk hoping to profit.

If my company screws up to the point where its liabilities exceed its assets, it enters bankruptcy. Let Citigroup do the same; stop confiscating my wealth to reward failure in proportion to the size of the failure.

I completely disagree with everything you say. What a joke this “bad bank” idea is.

According to FDIC Chairwoman Sheila Bair (and she should know), this is far from the truth. In an interview on CNBC today she stated,

“I think it needs to be emphasized and re-emphasized these banks are solvent, they’re well-capitalized overwhelmingly, and that really is what creditors and depositors seem to be focusing on right now.”

See http://finance.yahoo.com/news/Nations-Banks-Are-cnbc-14116000.html.

The problem of course is that, with the recession continuing to erode revenues and employment, the situation could be drastically different in 6 months.

Now imagine we could take a distressed bank, say Citigroup, and shift it with its current assets ahead in time to the middle of 2010. It is quite likely at that time that the economy will be in full recovery mode, the future will look rosey, and Citi’s toxic assets will have recovered somewhat from their erosion (unemployment is going down, government loan modifications are reducing foreclosures, etc). Even if those toxic assets end up being drastically devalued, Citi will likely have generated the required revenue in the intervening time to make up for losses.

The problem, therefore, for Citi and other banks is not the long run, but making it through the near term without going bankrupt. This is why removing the toxic assets right now from the balance sheets can be so effective. It provides the cushion they need to survive the near term.

This is also the reason why I advocated in another comment (under “Nationalization Is Not Inevitable”) that the final purchase value of toxic assets by the government-sponsored AGGREGATOR BANK be delayed for a period of time. A more realistic appraisal of the assets can be established in the future and the banks will be more capable of making up any losses generated by liquidation of the assets in the future.

A lot of the banks that appear to be under stress are very powerful revenue and income generators. The function they serve in the economy is obviously vital and the wealth they can generate for the economy is substantial. It simply does not make sense to allow these firms to go under and try to start over again. Better to fire the managers and hire new ones.

I believe the AGGREGATOR BANK concept can really work because it will get the banks through the dangers of the near term. And if it is implemented correctly, I believe everybody, including the tax payer, will come out ahead.

What more could you ask for?