Government Bad Bank?
To help banks regain strength, the Federal Deposit Insurance Company (FDIC) proposes using a 'bad bank' plan. Bad banks are used to accept risky assets from otherwise good banks. By diverting risky assets to bad banks, banks can improve their financial strength and stay in business.
The main point of contention will be how much is paid for troubled assets. By paying too little, a bad bank won't help - the banks will still be insolvent. What if we pay too much? Of course, the issue of moral hazard comes up: the taxpayers get ripped off and the banks are rewarded for making big bets.
If the bad bank plan moves forward, regulators need to find the fine line between doing too little and doing too much.
According to hedge fund manager George Soros, the United States needs to recapitalize its banks but should consider the creation of a "good bank" when considering how to deal with the toxic assets. Speaking to Reuters Television at the World Economic Forum in Davos, Soros said the planned U.S. fiscal stimulus and proposals for creating a "bad bank" to pool banks' bad loans and assets may help ease the economic crisis stateside.
Soros said these were "only palliatives" and they need a thorough reorganization of the mortgage system and to replenish the equity of the banks. That now would require an injection of about a trillion and half dollars... much more than if they had done it previously under the TARP (the $700 billion Troubled Asset Relief Program agreed by Congress last year).
Soros claims the well has been poisoned by the way the TARP money was used.
"It needs a good bank/bad bank solution, but I would do it differently than what is proposed," he said. "I would keep the capital of the banks together with the bad assets in the bad bank and then create a new bank with the good assets of the bank and the recapitalise that, giving the shareholders the right to put in more money. Without this the banks will not lend, because they know there is a lot of deterioration coming."
Earlier Soros told a press lunch that the "financial structure we used to take for granted has collapsed" and everyone was in a "state of shock" as the financial storm spread internationally and into the real economy.
He said the bankruptcy of Lehman Brothers investment bank last September was a "watershed event" and the financial system was now on "artificial life support."
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