Could new “good banks” solve the bad-bank problem?
As I discuss in today’s column, the talk about possible bank nationalization is roiling financial markets. If you forswear the possibility of nationalizing banks, though, you have to come up with a credible alternative. Some experts have found flaws in the Treasury’s plan, which includes a “bad bank” that would buy up problem assets.
Willem Buiter, a professor at the London School of Economics, thinks he has a better idea. Instead of funneling taxpayer money into a “bad bank,” he says, we should use it to set up brand-new “good banks.” Banks that are insolvent, Buiter proposes, should lose their banking licenses and be left to their own devices. New, taxpayer-assisted institutions would take over the bad banks’ deposits and could buy some of their good assets. Buiter writes in the Wall Street Journal:
When public resources are scarce, they should be concentrated not on supporting the valuations of existing impaired or toxic assets — representing yesterday’s mistakes — but on encouraging new flows of lending and borrowing, for which success or failure is still to be determined. To decouple flows of new lending from existing stocks of bad and toxic assets, a legal and institutional separation between the owners of the bad assets and the investors in the new assets is necessary.
The idea sounds promising. It brings market discipline back to the banking sector, and it would end the political tug-of-war over bankers’ pay, perks and dividends. A bank could either stand on its own, and make its own decisions about such things, or it would be left to liquidate itself.
However, Buiter’s solution doesn’t address the idea of systemic risk. Could our system withstand the failure of a big institution like Citigroup, even with a new bank waiting in the wings? Most of us would rather not find out the answer to that question.
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David Nicklaus has covered St. Louis business for more than 25 years. His column appears three days a week on the Post-Dispatch business page. 
Someone put the question in terms that is much easier to understand on NPR’s Diane Rheam show this morning. How do you liquidate such a massive bank like Citigroup that is about to topple (also worth noting that their is 8500 banks for which most are in good shape. However, asking a small healthy bank to take on Citigroup is like asking a minnow to swallow a whale)? It is too big for the FDIC as things are structured now. It doesn’t have assets that people would rush in for nor is any of other big banks capable of taking on anymore stress. BofA went from healthy to questionable ever since Countrywide and Morgan Stanley acquisition. Getting rid of a tangible asset like a laptop from a defunct Circiut City is a heck of a lot easier then getting rid of an underwater mortgage.
In the end, I think the government is going to secure the assets and make the slow painful effort to try to recover something for the taxpayer over time. For housing it might require the Feds to hold assets for the foreseeable future considering the latest housing report this morning.
Good post Tp.
The idea of setting up a “good bank” seems shaky to me. Simply setting it up doesn’t mean people would use it, and no one in the government could run something like that. Banking is like a lot of other industries in that they have tens of thousands of regulation they have to comply with (despite the recent articles suggesting deregulation caused all this buy the way, banking remains one of the most heavily regulated industries in America), so who is going to make sure that happens? David makes the most important point, which is that a failure the size of Citi would have economic repercussions regardless of how good the “good bank” is…
This sounds like a disaster in the making if you ask me.