Creating a "bad"/aggregator bank organized by the government to hoover up the bad assets from bank balance sheets sounds like it could be an excellent step toward restoring confidence in the financial system and freeing up credit.
Unfortunately, where the rubber meets the road, there is a rather fiendish question that needs to be ironed out - price.
The answer is in the price, my dear Watson
Transfer the assets to the government bank at too low a price and it could spark another round of bank losses and produce insolvencies. Too high a price, and the operation amounts to a transfer of wealth from taxpayers to financial institutions.
The intuitive answer is that assets should be transferred at fair value. That might get full credit in an academic setting, but if the fair value for these assets was known and widely accepted, we wouldn’t be facing a crisis of this magnitude. The market for these assets only provides scant clues -- it’s highly illiquid.
A banker’s proposal
All that would remain at the original holding company would be the units holding the bad assets -- some of which would be insolvent. The government would acquire the holding companies and liquidate them over time.
That still leaves open questions regarding whether such a plan is voluntary and who will participate. The government has already implemented loss guarantees on over $400 billion in assets with Citigroup
Beyond these elephants ...
... the government should focus on redressing or shuttering ailing regional and local lenders. I’m not a fan of state intervention, but we need a catalyst to deal with a banking sector that has pockets of insolvency. In January, bank failures accelerated to the fastest pace since the start of the crisis, but at only 6 in 2009 and 27 since Indy Mac kicked off, we are far from the number required to "clear the system."
We don’t want to go through the next few years with "zombie" banks, the way the Japanese did in the 1990s, and I think we want to avoid bank nationalizations on the scale of the U.K. with Royal Bank of Scotland
Prudent by nature, Motley Fool Inside Value gave banks a wide berth in 2008. However, there are numerous sectors in which the bear market could spell opportunity in 2009 and beyond. Lower equity prices mean better future returns for those who have the conviction to invest in straightforward, outstanding businesses now. The team at Inside Value can help you find those businesses. To find out their latest picks now, sign up for a 30-day free trial.
Fool contributor Alex Dumortier, CFA, has a beneficial interest in Wells Fargo, but not in any of the other companies mentioned in this article. JPMorgan Chase is a Motley Fool Income Investor pick. Lloyds Banking Group is a Motley Fool Inside Value recommendation. Bank of America is a former Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.