Bad Bank – Another Rabbit Out Of The Hat

| February 2, 2009

Citibank Front.jpg

Now that they are beginning to see that the original bailouts and TARP is not working, your government is preparing yet another exotic scheme to try and rescue the financial industry. From the Financial Times:

US set for ‘big bang’ financial clean-up

Barack Obama is gearing up for a “big bang” announcement next week that will combine a bank clean-up with measures to reduce home foreclosures and probably steps to kick-start credit markets.

The US president’s plan will include an overhaul of the troubled asset relief programme – the $700bn bail-out fund – including curbs on executive compensation at banks receiving public aid.

The Tarp overhaul is intended to restore public confidence in what is a deeply unpopular programme and ensure that public money is not used to fund excessive pay, bonuses and dividends to shareholders.

For those of you playing at home, this article is long on promise and short of details. What you are likely to see is the creation of a “bad bank” that insolvent companies like Citibank and Bank of America would “sell” their tier 3 assets to. Tier 3 assets are not typically tracked with the same kind of rigor that things like cash deposits, and banks are more or less allowed to value them to whatever they imagine they might be worth. This is the core of the problem for these banks, as they are holding massive amounts of speculative credit instruments in these tier 3 accounts. Back in the day, the bank could imagine that these assets would pay a healthy reward. In reality of the current age, those billions of worthless credit instruments are worthless.

The notion of the “bad bank” would be to allow Citi and Bank of America to sell these turkeys to the government for some amount of money, and the us taxpaying Americans would be the proud owners of billions or trillions in worthless debt that will never be made whole.

As we have seen from TARP1, the banks are perfectly happy to take the government dole and do with it as they please. They also feel free to not report what they are doing with the money to their creditors (that would be us), and to even squander the paltry million or so here and there to make sure that the executives never have to leave the lap of luxury to which they are so accustomed.

The hope (and it’s only a fools hope) is that if they free the banks from their mistakes, they will turn on the lending spigot again, and we will return to the happy go lucky days of free money with McMansions for everyone. This won’t work because there has been a fundamental shift in outlook. Banks no longer think it is safe to lend, no matter what, and people think it is no longer safe to borrow, no matter what.

This credit aversion is a natural reaction to the systemic imbalances of the past 10 years. By offering these bailouts, the government is trying to restore the “old order” rather than accepting that the American people have shifted mood. The government would be well served to use the money to close down the insolvent banks, as it would be more fitting and more popular with the voters. No one should ever be considered too big to fail.

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Category: Credit Backlash, Economics, Main, Recession Watch

About the Author ()

Bruce Henderson is a former Marine who focuses custom data mining and visualization technologies on the economy and other disasters.

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