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"Bad Bank" Proposal   January 28th, 2009
Administration looking at setting up "bad bank" to buy up toxic assets       


More observations...

It appears the Obama administration is considering an idea similar to the original idea behind TARP. The original idea for the $700 bailout was that the federal government would buy up all the "toxic" assets from banks so that the banks' balance sheets would be in better shape and they could resume normal lending activities. Ultimately the Treasury Department ended up investing in banks without doing anything about the underlying toxic assets.


Now the Obama administration is going back to the drawing board to craft a new plan to save the banking system, get credit flowing again and try to pull the economy out of a deepening recession. The new plan could be announced as early as next week.

In his confirmation hearing last week, Treasury Secretary Tim Geithner said the White House is working on a new bank rescue plan. He was short on details, but the massive scope of the problem has prompted talk that the administration may be planning to "nationalize" a large portion of the banking industry.

In its most extreme form, nationalization would mean that the government buys (or takes) all the shares of stock and takes over operations of the company, keeping the profits. Such state ownership is typically a form of socialism; major oil producing countries, for example, have set up state-owned companies to produce and sell oil, using the proceeds to pay for government services.

It's encouraging that the mainstream media is finally using words such as "socialism" in articles that describe things that the administration is considering doing, albeit a little too late since the election was last November.

But the idea of a "bad bank" generally is along the lines of what legislators were considering back when they passed the $700 billion TARP bailout. And, as Republicans suggested back then, if the government is going to get involved in the industry, wouldn't it be cheaper and require less government meddling if the government just insured the toxic assets?

Banks with these "toxic assets" (which really just means "assets that are hard to estimate a value") could pay an ongoing premium to the government for these assets and the government could use those premiums to pay the banks when someone defaults on the underlying loan. Thus the banks themselves would be, in large part, funding their own protection. Sure, the government would probably end up having to pay out some money beyond those premiums, but the government would end up with the foreclosed homes and eventually be able to sell them and recover most of the loss. Meanwhile, the banks would be able to value their assets since they'd be insured of the underlying loans being paid. And the federal government wouldn't have to spend hundreds of billions or trillions of dollars to buy "toxic assets" that won't all go bad. Rather, the government would just have to spend money as the assets actually went bad--and the government would make those payouts from the premiums, and make up any losses from the eventual sale of the foreclosed home.

This was the Republican plan back in September and it was included in TARP as an option; but it wasn't acted upon. If we assume that the government needs to be involved in sorting out the "toxic asset" mess, this is an FDIC-like solution that would minimize government's meddling in the market and also minimize the amount of taxpayer money necessary to implement the solution.

So why are we discussing socializing the banking industry? Or, barring that, why are we considering spending hundreds of billions more dollars in taxpayer dollars unnecessarily? The "government insurance" solution would be far cheaper, more certain to work, and minimize government intrusion in the industry,

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