Is a 'bad bank' for risky assets the solution to the financial mess?
The Obama administration is considering it as a way to avoid outright nationalization of the banking industry.
(Page 2 of 2)
These banks are all in the camp considered by many to be "too big to fail," but some analysts say that doesn't mean that one or more of them couldn't be temporarily taken over by the government, if conditions warrant.Skip to next paragraph
Subscribe Today to the Monitor
"I don't think there's any stigma associated with nationalizing a bank, if it opens the next day as a sound institution," Mr. Kyle says.
Nationalization wouldn't necessarily disrupt day-to-day operations at banks. Bad assets could be stripped out, new capital put in, and the bank could continue to operate with its current staff.
After a time the company – as a whole or in parts – could be sold to other banks or refloated with a new public stock offering, with the proceeds helping to cover the costs of government assistance. Similarly, the bad assets could be gradually sold off over time.
If the Obama team decides that these big banks must not go that route, part of the reason may be the fallout from last fall's failure of the investment bank Lehman Brothers.
The tide of fear that rippled through financial markets after Lehman's bankruptcy – in part the fear of who might be next – is something that officials don't want to repeat. The economy worsened dramatically in the wake of that event.
It's possible that fear would spread among investors in other banks if shareholders of a big bank were wiped out in a nationalization.
This risk highlights the difficult choices facing Obama and his advisers.
At this point, fixing banks is a vital part of any economic recovery, but it is just part of an overall revival plan.
Claims for new unemployment benefits came in higher than expected in a weekly report Thursday, and new-home sales hit a historic low. This explains why Obama is also pushing an overall government spending and tax-cut package to support the job market, and why he's preparing special proposals to ease pressures on the housing market.
In this environment, some observers say separating good assets from bad in the banking industry is no simple task.
Meredith Whitney, a bank-industry analyst at Oppenheimer & Co., writes in a new report that losses from the troubled assets – structured securities largely tied to the housing market – are "only one challenge related to the commercial banks." The banks also face rising losses this year on everything from credit cards to business loans because of the recession.
A bad bank would not constitute Obama's entire plan for restoring a healthy financial system. But it could play a central role.
That means facing the question of how to acquire troubled assets. If the government pays too high a price, taxpayers are effectively subsidizing bank shareholders. If the price is too small, Ms. Whitney says it will be hard to attract enough assets to relieve uncertainty about banks' health.