Do We Really Need More Bad Banks?

The Obama administration is reportedly considering the establishment of a so-called “Bad Bank” under the management of the FDIC.  Other plans are also on the table, and it appears no final decisions have been made.

If it happens, the Bad Bank (more polite commentators are calling it the “Aggregator Bank”) will use your money to buy all the “troubled assets” that are currently cluttering the balance sheets of otherwise Good Banks.  That is the theory, at least.  How it will work in practice is unknown.

This sounds remarkably like Hank Paulson’s $700 billion Troubled Asset Relief Program from last fall, you may be saying.  You’re right.  Congress gave Paulson the money he wanted but, for reasons that remain murky to this day, he decided to spend it on other things.  So the Bad Bank is really just TARP 2.0.

The key question is this: how much will the bad bank pay for the paper it buys?  The market price for most of the stuff is nil.  That is why it is called “troubled.”  The bankers and politicians are trying to convince us that these assets are really quite valuable if we will all just wait.  Sorry, I’m calling B.S. on that argument.  If it is really so valuable, why do the banks not want to keep it?  In fact, why have they had to be forced into acknowledging its very existence?

The bottom line on the Bad Bank plan is that somebody will win, and somebody else will lose.  The debate is about who will be on which side.  If the government pays too much for the assets, the bankers will win while the taxpayers will have wasted billions or trillions of dollars.  Moreover, it will be more than taxpayers: since the purchases will be financed with borrowed money that will eventually drive up inflation, everyone will lose.

If, on the other hand, the Bad Bank gobbles up the toxic assets and pays only what they are really worth, which is approximately nothing, the problems of the banking system will remain unsolved.  So why are we even talking about this?  Because the politicians need to look like they are “doing something.”  Whether it actually works is not their main concern. They know their pensions are secure.

Disclosure: no positions

photo credit: Sarabbit