Thursday, February 05, 2009
TARP and the Bad Bank - A Modest Proposal
One impediment has been the concern that the government will overpay for these assets - and this has essentially stalled the banks form cleaning up their balance sheets. This is a significant problem that, it seems to me, could be resolved quickly.
Rather than enter into some great debate about what the right price is, the government should buy the assets at their existing marks without negotiation. Keep in mind that these assets in aggregate are still producing very significant cash flow yields, despite increasing non-performers or chargeoffs. Furthermore, keep in mind that the US government finances cheaper than anybody on the planet. So the Treasury will generate a tremendous spread on these purchases. And in the end, the government could put in place a form of a true-up provision in 7-10 years in the event the taxpayer got picked off too much and didn't earn a sufficient yield after accounting for chargeoffs.
It's really not that hard to conjure up this solution. This would give the banks years to heal their balance sheets, and allow them to begin to deploy their now awesome amounts of liquidity.
5 Comments:
By 
Viking Kaj, at
Thu Feb 05, 12:19:00 PM:
This of course assumes that government can do a decent job of managing the loans and repayment schedules.
Given their record I'm not willing to trust them to run a post office, much less a large loan portfolio.
By Mrs. Davis, at
Thu Feb 05, 03:00:00 PM:
The government did a decent job with the Resolution Trust Company. But those were old fashioned mortgages, some of which were easily determined to be fraudulent, some underwater, and some OK.
This time the question is: Which assets?
Loans? Sure.
Mortgage Backed Securities? Hmm.
Credit Default Swaps? I don't buy things I don't understand.
And, I suspect, therein lies the problem. The banks have an awful lot of down right dreck (no offence intended) on their balance sheets that amount to no more than bets, that have no real security or economic value.
Bank examiners should be forcing a rigorous analysis of the balance sheets of the banks. Non-performing loans are relatively easy to value. MBS? If they're non-performing, mark to market. CDS? Mark to market. If the bank is insolvent, receivership and FDIC payout. If solvent, Good Housekeeping Seal of Approval. This could be finished in a year.
By 
, at
Thu Feb 05, 04:22:00 PM:
Sorry to be a nitpicker Tigerhawk but despite the attractive simplicity of your plan, here are two pretty big nits –
1) The system you propose penalizes/is unappealing to those institutions who have written down these assets to reflect market value whilst rewarding those who as still living in la-la land thinking Florida condos will return to 2006 prices if only we give it enough time. Judging by general competence, the latter banks probably have the worst assets yet we would probably buy the biggest proportion from them. We would hand the “bad” banks a future competitive advantage of a healthy balance sheet vs the “good”, well run banks that are just temporarily weakened by having taken the proper write downs.
2) The problem of taxpayers overpaying for bad assets is somewhat reduced by the potential clawback provision. But that very uncertainly will mean the institutions will still have a cloud hanging over their heads for 7-10years re potential paybacks to the government. This would be similar to how a company operates when there is a huge legal judgment out a few years with the good chance of a negative ruling. Not insurmountable but definitely not ideal and at the very least would add to their borrowing costs which I suppose might negate issue 1) above!
Personally I would much prefer we go the route Mrs Davis outlines above with appropriate safeguards to avoid depositor and investor panic.
However, if the “bad bank” is the route determined then doing reverse auctions as discussed here might be the best although would be interested in others views. http://www.npr.org/blogs/money/2008/10/the_biggest_auction_ever_1.html
By , at
Thu Feb 05, 06:47:00 PM:
The banks aren't turning loose of the mortgages. The cash flow is too good, and, thus, the assets are way undervalued.
By , at
Thu Feb 05, 06:53:00 PM:
If I may make a further modest proposal: could we perhaps set up a Bad Government to pay for the bad assets in the bad bank (along with all the stimuls pork), and so leave the credit of the regular government unimpaired?
