BLOG VIEW: Is A Bad Bank A Good Idea?

Are you ready for another government agency to handle the current crisis? If the buzz out of Washington is correct, it appears there will be a new federal entity coming in the very near future. There's no official name for this entity just yet, but there is an unofficial term that defines its mission: ‘bad bank.’

In short, a bad bank is a government-owned agency that purchases the troubled assets from seriously at-risk financial institutions. This helps the financial institutions clean up their affairs and get back into a positive business operation. The toxic assets, in turn, are quarantined until it is determined how to dispose of them.

The bad bank strategy is one of several ideas being floated, and it currently appears to have the best chance of taking off. However, the Obama administration officials who are reportedly advocating this approach were not the first in Washington to consider it.

Henry Paulson, the outgoing Treasury secretary, considered the bad bank approach when he first took the steering wheel last year as the economy hit the skids. But that was one of a bundle of ideas that Paulson played with during the raucous period when he was busy improvising a solution to the crisis. Had it been incorporated into the bailout/rescue plan that was ultimately pushed through Congress, the current situation might not have been so acute.

The bad bank approach has a history in Europe, most notably in Sweden during the 1990s. Several European governments are already openly flirting with the idea, though none have made any commitment to taking this route.

Some industry veterans may get a sense of deja vu with the bank bad notion – remember the Resolution Trust Corp. (RTC)? That helped to clean up the mess left by the reckless thrifts, but that was a completely different crisis. RTC had to deal with the assets – both good and bad – of more than 1,000 thrifts that failed. Thanks to the hundreds of billions of dollars being pumped into the financial system through the Troubled Asset Recovery Program (TARP), the big banks at the crux of the crisis are able to stay in business under the "too big to fail" strategy.

But the bad bank strategy also has a double-edged unresolved problem that prevents me from giving any endorsement: How much is the government willing to spend for the purchase of the troubled assets, and what will become of these assets once the government assumes control? The idea that additional billions in taxpayer funds could be used to buy assets that have less value than a Tila Tequila calendar is more than a little bothersome.

A detailed plan for the ultimate disposal of these assets must be made clear if this strategy is to go forward. A reprise of last year's Henry Paulson-Ben Bernanke rush of ‘Quick, we need $700 billion – or else’ is not going find traction this year. Considering the Obama administration's approach to governing appears to be more detail oriented than the Bush administration's approach, I suspect that any solution being put forward will be extremely precise on what we can expect. After investing $700 billion in TARP with little measurable success, there will be a strong call from the American public for a strategy that actually works.

What is your opinion of the bad bank plan? Drop me a line and let's get a discussion going.

– Phil Hall, editor, Secondary Marketing Executive.

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