A "Bad Bank" is Brilliant - With an OOTB Proposal

While the country's politicians and economists are debating the fiscal stimulus package, the idea of fixing the financial system has stayed on the back burner, but many people are scratching their heads and wondering whether or not we need to create a "bad bank" as a way of removing "toxic assets" from our banking system. There is something about that term that captures the imagination of people, a seeming oxymoron. How can a bad bank be any good? There is also something a little wicked in the term. like, "Oooh, that's bad!" In fact in current young generation usage, bad actually has come to mean good. My 26 year old son Andrew, even created a fictional personality in New York City by the name of "Bad Brilliance," a funny, zoot-suited, balloon headed creature, described in Time Out New York magazine as a "highly entertaining conceptual art oddity" whose motto is "One bad idea after another" (http://www.badbrilliance.com/).

So the idea of this posting is to advocate in favor of a Bad Bank. A Bad Bank is a Good Bank, and here is the reason. The real crux of the current economic crisis is largely financial. Banks are not lending money to those who need it and credit is the grease on the skids of the economy, the plumbing that makes the system function, whatever metaphor you choose. For the banks to start lending again they need to dump their toxic assets, that will free them to loan again. All economists agree. What they do not agree upon is how such a bad bank would work and they have problems with applying the idea. Mostly--and this includes Nobel-prize-winning economists like Paul Krugman--they do not see how a Bad Bank would be able to properly or equitably price bad assets. If the Bad Bank pays the face value or too high a price on these bad assets, then the American public will pay a big price. If they pay current market value, then the banks will take a big hit, because it is generally agreed that these assets are currently undervalued by the market.

OK so here is the OOTB solution to this dilemma. Remember the term "trusteeship"? Well we need to create a Bad Bank that does not buy the toxic assets but which agrees to hold them in trust. Sound familiar? The banks would be able also to loan enough money from the Fed at reasonable interest rates to recapitalize, so the public would be paid back. The Bad Bank would hold the bad assets for a total of 5 years (or more if necessary) doing everything possible to manage them into health. At the end of the 5 years, they would be sold and any profit from them would be split with the banks 50/50. Any losses would be absorbed by the banks, which would be at a considerably reduced loss than if they had to give them up now. The public would not take any losses. This overcomes all objections to such a proposal. Even if done by outright purchase, the possible cost to the public has been estimated to be about $500 billion, considerably less than the stimulus package being debated. But a $0 loss potential would go down even better with the American public, whose patience has been worn thin by the failure of the TARP program to deliver on its promises of unfreezing credit. The TARP, remember, is a Bush Administration failure. The BB can be an Obama Administration success.

P.S. I am not an economist. If anybody has a better idea, please let me know.