February 3, 2009
The Hidden Issue in the "Bad Bank" Solution: Rotten "Good Banks"
The press is reporting that President IBM's advisor's are considering a good bank/bad bank solution to financial institution crisis. The government will buy the "toxic" illiquid assets held by banks, leaving a good bank, and put the assets in one or more "bad banks" run by the government. The press is worried about the price the government will pay for hard to value illiquid assets: Pay too high a price and the taxpayers lock in a loss and the bank's shareholder's get a windfall gain; pay too low a price and the banks will not sell their toxic assets. Banks have begun strategically delaying write downs to hold out for the government offer, hoping the government will pay current balance sheet prices. If the government does pay balance sheet prices the honest pay and the dishonest win. But all this hides a significant underlying problem assuming the prices paid are plus or minus ten percent of the toxic assets fundamental value (whatever that is). Geithner knows that paying even approximate prices for toxic assets will force many banks, several very large, to declare that they are effectively insolvent. In other words, the cash paid will not be enough to meet capital reserve requirements and there is no more hiding behind delayed write down policies on the balance sheet to conceal the problem. After the purchase of the toxic assets we will have banks that either need to be wound up or receive immediate cash grant infusions from the federal government. What do we do with those banks? Give them cash before the purchase of toxic assets to cover up their distress but then suffer the bleating of their shareholders who will not want to share their windfall with the government? Give them cash to bail them out after the purchase and take shareholder equity without a complaint but worry about the "insolvency" word? Or wind them up anyway, cashing out shareholders and firing management, without any sale of their toxic assets? I prefer the latter, but government will choose the first of the three, giving shareholders a windfall.
February 3, 2009 | Permalink
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