There has been a small but increasing amount of attention being given to the “good bank” idea: instead of creating a government entity to buy toxic assets from existin banks – or nationalizing existing banks, removing their toxic assets, and then reprivatize them – why not create brand new, good banks with the same government money, enabling them to lend money unencumbered by previous bad decisions, and then privatize them? (Willem Buiter floated this idea on January 29, and Paul Romer has a similar proposal in the WSJ, although I’m proud to say that Nemo, who has his or her own blog, raised it in a comment on this blog two weeks earlier.)
Romer suggests using government capital to create new, healthy banks that can essentially compete with the existing banks, which can then be treated under existing rules and regulations – if they become insolvent, they get taken over; some of their liabilities (like FDIC-insured deposits) are guaranteed, and some aren’t – and that’s that. Buiter goes a step further and recommends taking away banking licenses from the legacy bad banks and making them institutions that just run off their existing assets, in part by selling their good assets to the new good banks.
These are elegant solutions because they get to where we want to be – healthy banks – yet avoid the problem of overpaying for toxic assets (which can happen in many forms, including non-recourse loans and asset guarantees), and the alternate problem of having to take over legacy banks (which will be politically difficult, given the antipathy that “nationalization” generates in the U.S.).
This approach faces some serious complications, however. First, there is the question of what happens to the legacy banks. Once such a program is announced, their stock prices should go to zero, since those prices are now predicated on friendly government intervention. That may not be so bad. More significantly, no one will want to lend them money, at least not without an explicit government guarantee. So either there will be a bank run – in which case we’ll have to figure out if they are still Too Big To Fail – or the government will have to guarantee all the liabilities that aren’t guaranteed already, which creates a big taxpayer liability. Of course, maybe this is just the same taxpayer liability we run into down any path we look, so this isn’t necessarily a fatal flaw with the plan.
Another complication is this: How do you get a few sufficiently large banks off the ground and running quickly? Romer proposes creating wholesale banks (the kind that only have businesses as customers) because they can be created more quickly (they don’t need huge branch networks), which would then buy good assets from legacy banks. Buiter also says that the new good banks will buy assets, such as deposit accounts and presumably branch networks, from the legacy banks. The legacy banks certainly won’t want to sell their good assets – have you noticed they’ve only been talking about selling the bad ones? – but Romer thinks that faced with being shut down by regulators they’ll have no choice. As a risk-averse person who found starting a small software company a huge endeavor, the idea of trying to create multiple large banks at once out of an office in the Treasury Department seems daunting, but arguably we couldn’t do much worse than the banks we’ve got now.
And who will be running them? Both Buiter and Romer bring up the problem of having the government owning the few healthy banks in the economy and thereby making lending decisions. But both correctly note that we are already committed to significant government involvement in the banking sector. And one of the problems to date has been the contortions the Paulson Treasury Department went through to try to minimize government involvement. Given the current state of the economy and the banking sector, we might do worse than having some lending decisions made by bureaucrats, influenced by political considerations. We also run a similar risk under the nationalize-clean up-privatize scenario. In any case, there are structural mechanisms that could be taken to try to limit government influence, such as creating independent boards of directors (presumably staffed with upstanding citizens from the financial sector, though where you’d find them I’m not sure – I would nominate John Bogle if he still wants to work) with sufficiently long terms to insulate them from Washington.
I may not have done the proposals justice, so read them yourself and see what you think. But before you get too excited, remember that there is nothing like this in Geithner’s Financial Stability Plan, so it is unlikely to happen.
Update (2/18/09): Since Paul Romer is one of the people whose work I discuss here, I want to point out a comment he left below. You can read it here.
55 thoughts on “The “Good Bank” Proposal”
A new bank is a far better idea than propping up the facades of the toxic-waste-banks. However, does it have to be that complicated? Why not devise an “orderly run” on the bad banks? Encourage and facilitate the move of depositors from “bad banks” to good financial institutions. At the same time, facilitate the sale & transfer of loans of the first order (i.e. no derivative products) – those for which there is a buyer (good financial institutions must have the right to use their own criteria for evaluation.) Leave the rest for the banksters to sell or keep as they choose.
As for shareholders and bondholders – anyone who is a shareholder of JPM, BAC, GS, etc. and hasn’t gotten out by now…deserves whatever gains or losses they get. And, after all, the highly competent and trustworthy leadership of these companies should be relied on — that is why they get paid the big bucks.
Okay…does this sound like a variation on bankruptcy? Yeah. Perhaps we should go right there — do not pass go, do not collect $200.
Once good banks are created, all the deposits (old and new) will go to good banks. Old banks will be doomed and forced to liquidate.
The two of you deserve a hearty round of applause for your outstanding public service over the past several months!
The question inevitably arises, however, at what point must we all move from exchange of ideas to more organized political activity?
The clock is ticking and powerful financial interests are hard at work pursuing their own self-serving interests. Where do we go from here? When do we call our elected representatives to account for themselves? How do we call our elected representatives to account for themselves?
Salman Khan from khancapital.com proposed similar ideas even earlier in november 2008:
This idea meets the “let-them-fail” tyne of the “let-them-fail-or-nationalize-them” fork, which makes it intrinsically meritorious. It puts the people of the United States into the banking business which, in the circumstances, is an idea that carries one heck of a lot more moral weight than throwing a lifeline to the slime that operate the existing institutions. But best of all, it might be arranged in such a way as to exclude from the mix anyone with either previous banking experience or anyone connected with politics going back at least four generations. We’d have to insure that directors and senior officers were picked at random from a random selection of telephone books so as to insure that persons of Geithner’s description were kept from anything but the most menial roles, the signing the enabling documents perhaps. Geithner could then feel at liberty to turn himself in to the authorities. And think of the re-hiring bonanza that would result, data processing and call center jobs lost to dwindling manufacturing capacity and to outsourcing a-plenty. And think of this: The next, sweet voice you speak to at home after hours that assists in your setting up on-line access to your checking account wouldn’t be someone with an undecipherable Indian accent who’s introduced herself as Megan O’Donnell (Yes, that actually happened). Only amateurs would need to apply at these ground-breaking institutions. And, thank God, the outcomes would be free of initial taint. I say let’s start in on this one while Obama/Geithner/Bush/Paulson choke on the resulting toxicity.
Ummm. These ‘good banks’. Where are the ‘good bankers’ going to come from? Or are we proposing a kind of financial system ‘draft’? Running a large bank needs people, does it not? Qualified people. And all those commercial customers, you know the ones that have banked with JPMorgan for a hundred years or so, we can rely on them switching overnight to these ‘good banks’ can we?
I love this idea. I just don’t see how we can make it work without screwing up all those big borrowers who are clinging on for dear life without having to worry about the ability of the lenders who provide them with credit.
Sounds better over a beer than it looks the next morning.
I think unfreezing lending is only part of the problem — I think the real problem is that if the big banks go down, they take most of the U.S. pension system with them.
Can we, the American people, do the “good bank” idea on our own? I suspect that if we join together and move our assets out of a few of the more egregious banks to some of the good banks (or even not-so-bad banks), we would see the remaining banks behaving more responsibly. Anybody have a list of good banks or even not-so-bad banks?
1) Good banks, as you describe them, sound an aweful lot like the Credit Union I already belong to.
2) While this should be the desired outcome, I think the banking/finance interests are too entrenched in the DC echo chamber called Congress to allow this to happen. I also suspect that Treasury is probably not the best agency to put it forward – but there isn’t a better one in the U.S. Anywhere.
3) I like the idea of rewarding banks that behaved by voluntarily moving deposits. Too many Americans are too lazy with their personal or business finances anyway. if we all mvoed our main banking to regionals, community banks, and credit unions, then when the big boys start failing because all they have is under leveraged business capitol (or is it overleveraged I forget), we’ll be better able to ride the storm. And a voluntary sell-off of personal holdings of bank stock wouldn’t hurt either.
But I digress.
Creating a ‘good bank’ will be possible once debt holders realize that their bank is insolvent. Simply carve off all assets and debt liabilities into a new entity, call it the toxic portfolio. Have the goverment recapitalize the now clean bank balance sheet and move forward with being a bank.
At some point down the line, say five years, do an IPO and pay the goverment back the seed capital with return. If there is excess from the IPO throw some at the ‘toxic portfolio’ to help mitigate bond losses. Conversely, if the toxic portfolio actually recovers, send any surplus to the ‘good bank’.
This good bank proposal is a very good idea from Nemo that I’ve heard. I’ve also collected a series of other proposals on from various other web site, you can see them at:
There are many ways to end up with a “good bank”. In essence, you do end up with good banks thru these more traditional channels:
1. In a regular bankruptcy, the bank is sold off in pieces and if there’s a buyer, the good parts can be bought and later rebuilt as a “good bank”.
2. In a nationalization event, almost by definition, the banks being nationalized becomes the “good bank”.
However, when it becomes obvious that the powers that be, or the market players, are not willing to accept either #1 or #2, then in that scenario setting up a good bank from scratch is a viable strategy to break the logjam.
By setting up a good bank, one is also, in essence, forcing the death of existing bad banks. The main reason everything is at an impasse today, is because all the banks are “grey” and financially shady, and there’s no way to tell which one is viable or not.
Setup a good bank, and immediately you shine a light to contrast the differences. Suddenly, the depositors will shift their deposits; the bond buyers would value the good bank’s bonds more than the bad banks’; and market would work again — although towards the death of the bad banks.
(This is a good thing, and to speed up this beneficial change, other policy changes can be implemented as well.)
This is one idea I have been bringing up every opportunity I have had.
It makes so much more sense that it is probably the last thing that will be considered. But PLEASE let’s make our voices heard on this so they can’t say they didn’t hear us.
I just think when corporate honchos have so little consideration for the long term good of their fiduciary duties and their shareholders they should suffer severe consequences.
Good banks already exist. We need a way for private investors to “bankroll” them. What about a 5 year suspension of corporate income taxes on any bank that raises a significant amount of new equity capital and meets certain growth-in-lending targets?
There is also the recent proposal here at Angry Bear.
People who think the US Govt. is incapable of managing a big nationalised industry should refresh their memories of the US Railroad Administration. The US Govt. nationalised and ran US railroads (a pretty fair-sized business) 1917-1920. During both World Wars, the US Govt. managed a whole lot of things “out of an office in the Treasury Department” or similar places. Are Americans less capable nowadays?
In relation to bank runs and what would happen to the “legacy banks”, I tried to address that issue at least partially in the comments thread under the linked Angry Bear post. Interested readers might have a look there.
Finally, I’m puzzled by Prof. Romer. In the article you linked to, he didn’t propose a good bank/bad bank split as Buiter subsequently proposed. Yet in the comments thread under Buiter’s post (where Buiter made his proposal), Prof. Romer inserted a comment saying that his (Prof. Romer’s) proposal was very similar to (actually, from memory, the same as) Buiter’s. Does this mean Prof. Romer has abandoned his original proposal and now supports Buiter’s?
I forgot to mention in the post that a variant of the “good bank” scenario might be to find existing good banks – there must be some out there, although they are probably relatively small – and give them more capital to help them grow and increase lending. That might be less complicated.
Doesn’t make sense to me. As you point out, as soon as the program is announced, there will be a run on ALL the rest of the banks, good and bad, as people rush to the government backed “good” banks.
How is this any different, than declaring a bank holiday, identifying all the solvent banks and all the insolvent banks, closing the bad ones and selling the good assets from bad to good. No need to try and rush into trying to create a giant “good” bank.
Unless of course; there are NO solvent banks left!
Excellent ideas. Why let these disastrous companies remain in business at all?
The finance companies are holding our economy hostage. We have to force them to let us go.
I’m certainly no expert but here’s what I don’t understand. Won’t creating “new” “good” banks cause a run on the “old” “bad” banks thus destroying them? And won’t wiping out all shareholder equity in “old” “bad” banks have a devastating effect not only on the share prices of those banks but also on the share prices of all financial institutions and the overall stock market as well (after all the financial sector makes up a substantial portion of the S&P 500)?
Everyone says it’s terrible for the government to stick taxpayers with the cost of bailing out “bad” banks; but I don’t understand what’s so terrible about it. The tax code is profoundly progressive. The top 1 percent of taxpayers (AGI above $365,000) pay 39 percent of all federal income tax. The top 5 percent of taxpayers (AGI above $145,000) pay 60 percent of all federal income tax. The top 10 percent of taxpayers (AGI above $104,000) pay 70 percent of all federal income tax. Meanwhile the bottom 50 percent of income earners pay no federal income tax at all. By sticking the taxpayer with the cost of the bank bailout or by having taxpayers “over pay” to buy bad assets from “old” banks the rich pay almost all the bill, the middle class pays very little and the poor pay nothing.
Conversely if the government nationalizes the banks or creates “new” “good” banks thus hastening the death of the “bad” “old” ones, the effect on the stock market will be devastating. It could easily fall 20 to 30 percent from the already low level it is already at. The results of this are far worse for middle class and poor people than for the wealthy.
Yes, the wealthy may own most of the equities but what about pension funds and what about endowment funds?
Sure the wealthy will be punished but even after dramatic losses to their stock portfolios they will still have enough to send their kids to college and to contemplate a reasonable retirement.
But what happens to the poor? If they want to send their kids to college they need for those colleges to have healthy endowments. If the market crashes and the endowments plunge, the poor can kiss any chance of a scholarship goodbye. What about a poor person who wants to go to a museum or a concert; don’t those institutions subsidize inexpensive tickets through their endowments? And when cities have to increase contributions to their employee pension funds to make up for reduced principal in those funds aren’t they going to take this money from programs designed for the poor?
What happens to middle class people if government intervention in the banking system is done in a way that spooks the equity markets? There are 20 million taxpayers who have AGIs between $62,000 and $104,000. Don’t many or most of these people have large portions of their retirement savings in IRAs and 401ks invested in equities? Don’t many of them have college savings for their children at risk because those savings are in various vehicles with significant exposure to equities? What happens to the retirement plans and college plans for these families if the government takes action that causes equity prices to plunge even further?
It seems to me that paradoxically,the progressive thing to do is to allow taxpayers (who are disproportionately wealthy) pay to fix this mess while the government does everything it can to arrive at a solution that leaves stock prices as unaffected as possible.
Letting taxpayers bail out the banks helps poor and middle class people while hurting rich people.
Isn’t that what we should be doing to fix the banks?
Is their something I’m missing?
Taxpayer liability == future dollar devaluation. I’m sorry, but the mechanics of money creation allow no solution that changes the above, though many things can buy time. Consider that the fundamental problem is fractional reserve banking and the basis of money supply on debt + interest.
In a similar vein, George Soros had a nice op-ed suggesting that we should create capital pockets for bad-assets.
Both ideas suffer from the same potential flaw: deposits are insured by the FDIC. So, very quickly the government could be back on the hook. Moreover the Treasury’s money-market guarantee program is now backing substantial pools of bank paper, but the Treasury has collected premiums amounting to a paltry $900M.
No go. The whole issue of toxic assets is a red herring. The January loan officer survey results made this clear: capital concerns and liquidity concerns are not significantly responsible for tightening lending standards. Declining borrowing is due primarily to declining demand which is due to reduce financing needs: fewer investment programs, less inventory held. Both of which are products of the recession not causes.
Karl Denninger over at the Market Ticker seems to have been slightly ahead of the curve on this. He doesn’t claim to have invented this, but he did make the suggestion back in October.
I thought I was way out in left field when I suggested the possibility of a “good bank” on my blog a couple of weeks ago, but maybe I’m not crazy after all. If the idea is to restore the availability of credit for businesses and individuals, why is it necessary to process taxpayer bucks through mismanaged zombie banks?
Oh, right — I forgot! Anything that turns a profit must be private in the USA. We only socialize the losses.
Well, if Geithner actually wanted to do this, the first thing that he would need to do is have something like a ‘Stress Test’ to figure out which bank was the worst and expose them publicly. That way, the good banks that passed the stress test could be given access to something like a ‘Capital Assistance Program’ that would make them more attractive than the bad bank to private investment and give investors a place to put there money once there was a run on the worst bank. Since the worst bank might be too big to fail, he’d need something like a ‘Public-Private Investment Fund’ to buy up the best assets until the bank is small enough to fail and and at the same time be left with the most toxic assets of all to take with it when it fails. This whole process would periodically freeze up the credit markets, so he’d need something like a ‘Consumer
& Business Lending Initiative’ to maintain liquidity during these freezes. Since even the best banks are pretty lousy, he’d need something like a ‘New Era of Conditions’ to make them even better. And finally, since most people wouldn’t be able to begin to understand the reasoning behind this plan, he’d have to throw out a couple red herrings like ‘Foreclosure Prevention’ and ‘Small Buisiness Lending’ intitiatives to keep them satisfied and get a generally positive knee-jerk response across the political spectrum. Ultimately, to keep the stock market from crashing the second he proposed this, he’d have to avoid any suggestion that he intends to let banks fail, and since this administration frowns upon outright lies, the wording would have to be kept
somewhat vague and mysterious. We’ll just have to wait and see if he ends up proposing anything like this and then we’ll know if this is his intention after all.
Denninger has been all over this. Give credit where credit is due. http://www.market-ticker.org
This is a logical idea so of course is would never fly, just as the idea that stimulus could go to those who have great credit, are not in debt up the wauzuu, and live within their means. Why not give money to those who have proven they are frugal and not greedy? Oh, that’s right, they are the ones who get screwed.
I tried to register to post comments on your blog, but I had no luck — I never received a confirmation email with my password. Anyway, I just wanted to point out to you that you may want to save yourself some embarrassment and stop claiming that a former chief economist of the IMF referenced your blog.
Simon Johnson and James Kwak are both talented intellectuals, but they have very different backgrounds. Give the ‘About The Baseline Scenario’ link a click some time :)
although I’m proud to say that Nemo, who has his or her own blog, raised it in a comment on this blog two weeks earlier
I think here you should keep better trail of comments and references to know where the proposal comes from, bearing in mind that:
a) Nemo (???) profeta in patria = No one is a prophet in his own country, and I am not American neither post from US.
b) Dare a Cesare quel che è di Cesare = Give the devil his due.
Having said that, I still contend that the “good bank” proposal could be elaborated towards something feasible which will: a) avoid nationalization strictu sensu as we can have non-state ownership and private and taxpayers investors as shareholders and why not a temporary management appointed by even government; b) break up the largest banks and sell off individual operations and assets to the public sector or whoever from the private sector would like to buy them to create and set up new good banks or strengthen existing good banks.
The policy announcement to accompany a good bank creation is that no further public funds or Fed support will be used to prop up current big banks. Treasury/Fed intervention would be limited to guaranteeing depositors (not bondholders) and to backstopping DIP financing for Chapter 11. The most singular lesson of this financial crisis thus far is that bank losses are consistently much higher than original estimates. Even the US Treasury cannot afford them.
It sounds like a great idea, but I can’t imagine that it is actually do able without massive pain for all of the depositors. I work for a financial institution that has spent 2 years preparing to move 300k customers from one software platform to a new one. I can’t imaging what would be involved in moving 10’s of millions of customers from bad banks to good banks. The upside to creating bad banks and recapitalizing existing (newly good) banks is that the end customers/depositors get to stay right where there are. No conversion is perfect, so it would be guarranteed mess for everyone forced to move. There is a reason people stay with banks they hate – they hate the idea of moving more.
The policy announcement to accompany a good bank creation will have great effects on the markets! We have to work out the details but definitely the mutual or cooperative model could solve the problem either of nationalization or public ownership. New good banks owned by non-state agents (taxpayers, private investors, etc.) could take over operational and good assets of insolvent banks by breaking up larger banks in smaller ones to act at local community level in narrow banking activities. The system of new good bank will run in parallel sometimes “mirroring” those of insolvent banks. The transition can be smooth and gradual provided that we know what we are “touching” and moving in terms of assets, including troubled and operational ones. To this we need more transparency and disclosure in the process. The stress test may help.
In the eyes of the public, the banks are to blame for the current debacle. The real outcome may therefore be determined by a confluence of three events that could unfold very quickly over the next couple of months:
(a) Further financial bad news from the “financial weapons of mass destruction” and Eastern Europe.
(b) Industry contagion – will the automobile sector fail and start a domino effect?
(c) Social conflict – of which there is growing evidence e.g Latvia.
Taken to an extreme, these events could once and for all destroy the public credibility of the old banks. New good banks may then be upon us by default.
I’m a believer that if you keep things simple, everyone understands them better, and therefore the chance of success is improved.
With that in mind I favor a national bank. You declare one or two of the major banks insolvent. You remove identified illiquid securities and place them in a warehouse bank. You do not pay anyone anything for all of this, other than taxpayer funding for expanding capital at this new national bank (taxpayers paying themselves). Once these warehoused illiquid assets are recognized as worth something, you sell them off and pay them to taxpayers first, then secured bondholders. If there’s still value left, you pay them out in order of classic bankrupty payouts.
National banks are there to support and enhance the common good, not just to make a buck. The entire attitude is different. Funding long term national goals are part of this bank’s job. Having pointed that out, in this recession a national bank can do something private banks cannot: Lend. This lending can break credit logjams and will bring in private wealth because of the creditworthiness of the nationa bank.
This bank will be a public utility. It’s functions will be utilitarian. No investment banking functions. If you want an example of how this bank will operate, think of a credit union. It will be more transparent because it’s public. Employees will be civil servants, members of the world’s best union.
Right now, I don’t want sexy. I want solid.
1. Toxic assets are created by toxic credit cultures. There must be triage, necessarily judgmental, that puts the “clearly insolvent” banks under the control of well-run banks. After WaMu there no credible argument why this can’t be done. This is the hard part, taking on the oligarchs. The well-run banks pick up the assets at market and the deposits, and manage the legacy systems as their own. The current negative analyst press from Wall Street attacking U.S. Bank, one of the best-run big banks, shows how afraid the oligarchs are of this outcome. They have sicked their analysts on U.S. Bank.
2. As Roubini and others point out, the whole system may be insolvent and require a capital injection. Why can’t the Fed just write this check out of thin air?
Propping up the zombie banks is throwing good money after bad *and* asking for more of the same wealth-extractive games under the guise of a “public-private” bailout. What a boon for all the unemployed investment bankers!
Sorry to repeat what you guys have already said, but someone in Washington’s got to get this sooner or later.
I’ve been hoping for this to come up for discussion for months. Go look at the Flow of Funds: when I looked, it struck me that average annual net borrowings for the total non-financial business sector over the last ten years are LESS THAN THE TARP PROGRAM TOTALS! I don’t think anyone could argue that borrowing demand in the business or household sector is going to be high relative to the recent past in the next few years; if you took the TARP money and geared it 5 to one, you’d be set for a good long time.
– you already have good banks, they are just small in comparison to the “old banks picture” that you think you see there on the wall (but huge in relation to their factual non-existence)
– fdic guarantees of the old banks (picture) new debt should be removed as from x.feb. or march of 2009; that was a temporary stabilization measure meaning a BIG and stupid mistake, and now it s gone; puf
– and yes, there is nothing in ust s plan about all this. hence you ll nationalize the black hole. congratulations!
– as for europe, there s a slim glimmer of hope there for a good bank. not because they are smarter but they really can t afford the nationalization of their black hole part. but again they have no way of deciding (anything) fast (enough).
Early on when this crisis began I knew that injections of capital, buying toxic assets, et al was destined to fail. I wrote a piece calling for the establishment of new channels to get money down to lower levels where it could be lended. It’s on:http://denver.yourhub.com/Parker/Stories/Voices/Columns/Story~540086.aspx
I continue to believe that the hierarchy of the global financing system harkens back to the system used to finance the industrial age. It must be positively disintegrated and replaced by a leveller, more networked system. By the time the intra-bank lending system gets money to the local bank, it still requires government guarantees for student loans, mortgages and SBA loans. How many small businesses are financed using credit cards? This is no way to run a 21st century innovation & entrepreneural based economy. The benign neglect and inattention have resulted in massive amounts of capital being sucked out of the US and into the hands of the Saudis, Chinese and others. When there is no moral leadership, the people perish.
I have nothing but contempt and derision for these people whose independent, self-serving, ruthless maximizing behavior has betrayed the common man. Let them twist in the wind.
First: Do not to take any assets (500 B should be enough). There won’t be a run on the banks.
Second: Lend money at 1% over the average rate…always. This national bank will go out of business as soon as there are enough banks willing to lend money and, at the same time, will make enough money to pay for it’s overhead.
The problem is that nobody’s lending…not that nobody’s lending at a low enough rate.
Just build in the obsolescence.
PETITION: POLS, INVEST IN NEXT-GEN BANKS. Based on a business plan praised by analysts at Microsoft, Amazon, etc. A 1.0 next-gen bank will provide innovative ways to customize education, and to showcase and earn money from expertise (i.e., ways to become (more) creditworthy). BE THE CHANGE! :-)
The petition is at LandofOpportuniTV.com
IRA says go the Lehman way:
To Big to Bail: Lehman Brothers is the Model for Fixing the Zombie Banks
The summary by James is very helpful, but I have one small disagreement regarding the interpretation of the Geithner plan. The additional $80 billion from TARP that he proposed as support for the TALF program is designed to support a large and rapidly growing new wholesale bank that is being created inside the Fed. So de facto, Geithner has gone at least partially in the right direction of dedicating TARP funds to new institutions that can increase credit quickly. (The Fed is doing just what a private bank would do, treating the TARP funds as capital and borrowing to buy assets worth about 10 times the capital.) The Fed’s experience also shows how quickly one could build up a new wholesale bank.
Thinking a bit further about Prof. Buiter’s proposal, it seems very bondholder-friendly. If zombie banks can unload their depositor liabilities onto the new “good bank” and receive market price for their good assets, they are in a better position to cover bonds if they then go bankrupt. Senior debtholders in particular might find this proposal very attractive for that reason. And since it is not a nationalisation proposal, there would be no pesky Govt. accountants running around digging up bodies!
Attached is a comment piece I wrote in the Australian Financial Review on Jan 16…
Time to create a lender you can bank on
In Australia we like to moan about our banks. The poor service levels, the high costs. But at least we’re faced with a functioning system, still remarkably intact after the trauma of the past 18 months.
Contrast that with the mess that is banking today in the United States and Europe.
These prior pantheons of the “Great Moderation” are struggling to survive, shadows of their former selves. Lost without generous state handouts, they have proved poor servants of their customers and their ailing shareholder base.
Which raises the question: Why rescue these shoddy shells? Is there any lasting value in pouring billions and billions of good dollars into patently bad businesses?
Or should we start again, through some form of state-owned, state-funded, banking model?
We’re in the throes of nationalisation by default. Governments are moving up the share registers of a range of ailing banks. Not through any desire to part-own a failed business model, rather because it appears to be the only viable option.
But is it? Why not a more radical alternative? Welcome to “Government – the bank”. And I don’t mean state funding of the banking system. I’m talking direct consumer and business lending. By government. To the people. Supplanting the bank’s traditional middleman role.
Rubbish, I hear you say. Banking is an intermediary function that has no place for government. Too complex. Innovative. Boasting efficiencies driven through competition.
Perhaps, but these are concerns that are hardly borne out by the mess we’re facing today.
Let’s look at that mess. New capital supplied by the state. Lending and borrowing guaranteed by the state. An old model teetering under the burden of past innovation.
It’s also a model that is proving surprisingly inflexible to change. Governments and central banks have been pleading with banks to increase lending as a means of boosting economic activity. But to no avail.
Cash has been pushed into the system only for it to sit unused on balance sheets. You get the feeling that if any one factor ultimately triggers a shift towards a “government bank” alternative, it will be this lending intransigence.
The banks argue, with only limited justification, that they’ve been asked to loosen their lending criteria, while at the same time being told to tighten reserve requirements and risk oversight.
But this “you can’t tell us what to do” attitude has frustrated authorities to the point where alternatives are being sought.
For instance – why not simply create a cleanskin bank, capable of channelling new lending to the market. Mortgages, business loans and consumer credit. This can be Treasury-funded or securitised under government-guaranteed bond issuance.
It would provide a more focused conduit that could offer far greater bang for the buck on any “financial aid” dollar provided.
Such an entity would compete head-to-head with the commercial and retail banks. We’d invariably see enhanced competition as banks relaxed lending criteria to compete with the state-controlled alternative lender.
So is this going to happen? Possibly, though initially not on any grand scale. We may instead see more examples of government-sponsored special purpose vehicles providing alternative sources of funding.
In the UK, the government has the option of creating something new, or simply expanding its two wholly owned financial “orphans” – Northern Rock and Bradford & Bingley.
In the United States, this could involve enhancements and expansions of the two existing government agencies, the Small Business Administration and the Federal Housing Administration. Given the chronic problems facing the housing market, the FHA is an obvious early candidate for president-elect Barack Obama.
So prepare for a change. To date banking sector support has been akin to shuffling an already dog-eared deck of cards. It may be time for authorities to deal themselves a fresh hand – from a new pack.
I will try to make here few more logic points:
a) if we agree that some banks ended up being “too big to fail”, it is logic to me that we have to break them up in smaller ones. In this respect I do not see why we should go for a wholesale or centralized bank model. We do not want a centralized credit system we want a decentralized one, more democratic and more accountable. Wholesale banking means also concentration of assets and we do not want it, don’t we?
b) about nationalization, I have not yet read the compelling case for a state ownership. As far as possible ownership should be public but not necessarily state. If funds come from Treasury, that is taxpayers, it could make sens that taxpayers are allotted some shares. We can then work out the details on how represent the best interests of the new taxpayers shareholders.
c) about what is going to happen to bondholders, it also depends on how the markets will react to the proposal of new good banks. There is scope to restructure those loans and see who hold them while also offering them a refinancing deal in which a debt holder gets an equity or loan position in the new banks. Alternately bondholders could stay in the insolvent banks and see what it comes out from their liquidation.
d) under the above circumstances, I do not see the run on bad banks, although their stock prices may have already reflected that scenario. Depositors could be moved in good order and gradually. If they prefer the new good banks let it be, that’s market…
In the FT article that reported Greenspan supported nationalization it said he felt it was necessary to spare senior debt. If they are senior unsecured why would he feel they should be spared? Bondholders make certain choices about investing just as equity investors.
Ideological stances have led to this avoidable crisis. India was relatively unhurt by the crisis because of well regulated finance markets.
However, it is now emerging that even children in rural India are becoming victims of the crisis: http://bigotblog.wordpress.com/2009/02/19/the-global-slowdown-affects-education-in-rural-india/
And it is India’s much criticised nature of hoarding gold that’s coming o the rescue
Why make new banks? There are already many small banks and credit unions invested in their communities, this is where the money needs to go. This is where the money is needed most and where it needs to go.
Government created banks, with the government already owned by the criminal banks just opens it up for more criminal banks that they can market as “new…and improved.” Corporate slime is slippery, yes?
Larger businesses should create their own business to business currencies. Saying they can’t do anything is nonsense, the materials and labor are still there so nothing is stopping it except their irrational belief in the religion of the FED. Its just like the building crew showing up to a well supplied site and saying they can’t build because they’re out of inches. Time for a reality check, let’s turn our brains on, unplug from the matrix, whatever term you prefer but essential action is required to at least balance our rhetorical blather.
I like the idea of a good bank, but rather than privatizing it, I’d prefer it be socialized. Let the citizens take the profits for a change… sort of like the credit unions.
Comments are closed.