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Turning Bad Bank / Good Bank on its head (Update)

by BruceMcF Thu Mar 19th, 2009 at 04:24:53 AM EST

Normal disclaimer applies ... written for a US audience, I humbly apologize for all parochialism and of course for the non-Commenwealth English spelling

Burning the Midnight Oil for the Beauty Platform and Economic Populism

The problem with the "Good Bank / Bad Bank" (see also Dr. Seuss version) plan is, of course, ... {drum roll}

... in order to "rescue" banks that distributed a massive amount of contingency reserves as if it was income ... by pretending that massive downsides did not exist ...

... we "have to" reward the people who proved to be grossly incompetent in the core competency for senior executive management of a bank.

Except, as Joe Stiglitz points out, we don't have to at all.

In other words, there is good and bad in the Good Bank / Bad Bank plan. And if we reverse who ends up with the Good Assets and who ends up with the Bad Assets, we can have all of the Good, and avoid most of the Bad.

From the diaries - afew



UPDATE

Keith Olbermann cites "my" plan on the Tonight show ... posted at the Big Orange

The Good, the Bad, and, yes, its all Ugly

The good is the clearing up the mess, establishing going concerns that can lend when consumers and small and medium business demand for credit begins to ride, and the restoration of confidence in the banking system.

The bad is the rewarding of the incompetents who ran the banks into the ground, and the message that a big enough bank cannot fail if they fail alongside other big enough banks.

OK, now, suppose we do it this way. Bank examiners do "stress testing", which is to say, a real world audit instead of the fantasy audits that we have been doing in order to avoid official recognition of the depths of the problem. And banks that are in too much financial peril to be allowed to continue operating as they have been doing ... are put into receivership.

Now, the US government strips out the liabilities that we wish to protect ... the account liabilities ... and takes over the "good" assets. If that is a net plus, the government pays the original bank for the positive net assets. If that is a net minus, the government makes up the difference with the new Good Bank, and takes a compensating Senior claim in the old Bad Bank.

Then the residual of the old Bad Bank is run through ordinary Chapter 11 proceedings ... in most cases the shareholders will be zeroed out, the bondholders will become shareholders, the new shareholders are quite likely to sack the old senior executive management, and the old Bad Bank will see what they can do to recover whatever value can be had in the trash that forms their asset base.

In normal economic conditions, the government would sell this Good Bank to an existing sound bank ... but these are not normal economic conditions. And some Americans have been deeply indoctrinated in the idea that Government can't do something like banking as well as the Private Sector (presumably setting aside what the largest banks have been doing for over a decade under the category of "a few bad apples").

But there are ways to finesse that ... for example, ChrisCook at the European Tribune suggests a bank restructure on the basis of a Capital Partnership. In the context of a New Good Bank / Bad Old Bank system, a good bank could buy into a stake in the gross revenue of the Good Bank, and operate the bank for a fee as the managing partner.

Do pay attention to why this is cheaper ...

Why is this cheaper than Trash for Cash? Because what "we" - consumers and businesspeople - need from the banking system is for deposit liabilities to be backed up by sound assets, and for there to be sufficient confidence in the operational banking system so that banks with credit-worthy borrowers applying for loans can raise the funds to grant the loans.

To the extent that there is a shortfall between deposit liabilities and sound assets ... that shortfall must be made good.

But making good any other shortfall ... that is not first and foremost protecting the ability of the bank to provide depository services. Rather, it is about first and foremost protecting the senior executive management from the consequences of their gross incompetence and sheltering shareholders from the perils of buying shares in companies that have been distributing contingency reserves as if they were income.

And rather than being a long term service to the economy, that protection of senior executive management and shareholders from the consequences of grossly incompetent strategy is a long term disservice.

So, in short, pay what must be paid to keep the banking operations available in service to the real economy.

However, unlike the series of proposals coming out of the Finance Sector, don't pay a dime to shelter the senior management and shareholders from gross incompetence in strategic management. Strip out the good, and leave them with the trash.


Oh, and, yes, we can stop the damn Bonus money

Final point, since its a hot button issue at the moment ... doing this means that we no longer have to keep AIG alive as a zombie CDS writer in order to avoid toppling banks and wreaking  havoc on the economy. We will have an operational banking system that does not need Credit Default Swaps written by AIG to paper over their insolvency.

So the last institution we can put through the process is AIG itself. And then the nonsense of "we have to pay millions of dollars in 'Performance Bonuses' to the people who brought us to the point that we are insolvent except for government assistance" goes away. Those idiots who did the idiocy as a group of mythical lemmings jumping over the same cliff, one after the other, thinking they were getting a free ride until they hit the mythical coastal rocks below ... they are "creditors" of an insolvent institution, and can get in line with the other creditors to get pennies on a dollar if that. But the insolvent institution won't be doing their business any more ... the CDS division can just collapse, and the actual insurance divisions will be perfectly solvent firms once stripped out from under the AIG senior management ... they the "brightest men in the room" in the sense of being the biggest bunch of flaming idiots around would also be redundant employees and can be sacked, at which point their golden parachutes become ... yes ... a creditors claim on an insolvent institution.

And they can get their penny stock in the "Bad American International Group", and stand in line with the other stakeholders in the Finance Sector Created and Government Supported Financial Stupidity of the Reagan EraTM ... without being in line to get any of the money from the actual "Good American Insurance Group" still in operation.

Display:
Personally I'd say to the AIG guys.

"We are going to "run off" this operation and liquidate it.

We will not pay you your bonus in dollars, and you may sue us and take your place in the queue of creditors when we wind this thing up.

But if you stay and help out we are prepared to pay you a proportional share of the crap assets you left us with, and you may share in any recoveries you assist in making.

Your choice is?"

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 17th, 2009 at 03:09:08 PM EST
Once we no longer care whether the CDS liabilities become as officially worthless as they are in effect, why in the hell would we need those people to hang around? We don't need that branch of the AIG financial conglomerate to actually exist, so let them be creditors to an insolvent rump.

Ditto the AIG conglomerate Senior Executives who thought it was a brilliant idea and the shareholders who were happy to have the paper gains while the income was coming in on the good old "California earthquake insurance plan ... if the earthquake happens, leave the country".

My impression is that most of the other divisions of AIG are sound businesses used by Senior Executive Management as cash cows to play irresponsible games ... as opposed to chocolate frosting on a pile of crap, they are more in the situation of real chocolate cake with a crap frosting courtesy a rogue senior management that found regular insurance too damn boring.

It may well be that simply stripping them out of the AIG conglomerate shell will be enough to right the ship, unless they have been pushed into holding too much "AAA trash" to juice their cash flow for the senior management to play games with. And even then, they will certainly be in much better shape unshackled from the CDS obligations of the parent company.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Mar 17th, 2009 at 03:25:04 PM EST
[ Parent ]
BruceMcF:
My impression is that most of the other divisions of AIG are sound businesses used by Senior Executive Management as cash cows to play irresponsible games ... as opposed to chocolate frosting on a pile of crap, they are more in the situation of real chocolate cake with a crap frosting courtesy a rogue senior management that found regular insurance too damn boring.

Then hand over the shares in these businesses in trust to the staff like the UK's very successful

John Lewis Partnership

This is Venture Communism, Comrade...the Unions should love it.

Then provide the Capital the Workers need on the basis that for as long as they use it they share their gross revenues with the Investor/Capital Partner.

There is no reason why the government shouldn't then sell off its proportional "Units" of entitlements to long term investors who like the idea of getting their hands on revenues before the management does. This structure is very much parallel to Income Trusts

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 17th, 2009 at 04:38:30 PM EST
[ Parent ]
Why I included the link to the LLC plan is because it offers a political wedge, since the firms that are in good enough shape to buy in as managing partner (without necessarily being able to acquire the bank in the present financial climate) are placed on the political side of, "yeah, dump the crap with the idiots that bought it, and set up a working firm with the sound part of the balance sheet", since the better job is done of separating the wheat from the chaff, the better the reward of being a managing partner of the "New Good Bank".

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue Mar 17th, 2009 at 06:43:43 PM EST
[ Parent ]
Brilliant.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Tue Mar 17th, 2009 at 04:44:33 PM EST
Thank you.

Diversity is the key to economic and political evolution.
by Cat on Wed Mar 18th, 2009 at 02:25:29 AM EST
I am very glad that an economist has posted this diary on so many sites.  I have wondered why such approaches could not be followed, but given my own lack of "expert" status in this area, my own wonder was unexceptional.

I have a 1/2" stack of various faxes I have sent to various senators and congressmen and e-mails to those who directly represent me predicting that the "Paulson Plan" was doomed to failure, explaining why, (correctly, as it turns out), and urging that a substantial sum of the "bail-out" money be devoted to creation of "new banks," or to buffing up known good banks, to get credit flowing.  The best I can hope is that some part, perhaps that in bold caps, was read and remembered by some low level staffer prior to filing in the circular file.  

The abject deference to Wall Street and wealth shown by so many in Congress stands as eloquent testimony to the need for campaign finance reform involving generous public financing of federal campaigns.  Perhaps the AIG outrage will nudge a few in that direction.  Perhaps LTEs on that subject will now be received favorably by more readers.

It is entirely fitting that the reluctant US pioneers of Chris Cooks' "not for loss" capital partnerships should be those who have so notably contributed to the current mess.  It is certainly better than being shipped to the New World as indentured servants, as could have been their fates in the 17th and 18th centuries.  Many will succeed.  That will be good for their own net worth and will demonstrate the viability of an approach that, otherwise, they would have preferred to smother in the cradle.  Fitting indeed!

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Mar 18th, 2009 at 09:53:20 AM EST
Putting the valueless assets into a bad bank would cascade to many parts of the economy. Many of these loans are held by state and local government and pension funds. Anything which lowers their ratings makes them ineligible to remain in these funds.

The funds would then have to make up the loss of asset value by contributing more money into the funds to meet the statutory minimums. Most of these fund owners don't have the resources to do this at present and this would just make things worse.

It is the same issue with AIG, insurance substituted for a high credit rating. If the insurance defaults then the assets are devalued and the retirement funds are below their asset minimums.

I have no sympathy for the traders who were obviously greedy, but they aren't incompetent. The traders at AIG are still the best ones to unravel many of the deals which are no longer viable. They know what they are and have the contacts with the counter parties. This has nothing to do with the bonuses, which is really just a distraction.

People are so frustrated that they have focused all their anger on the one area they can easily understand and the pols and press are delighted to play along since they don't have to explore the harder issues while everyone is distracted.

Two changes yesterday show that the gov't understands the tangled web. First congress is voting to relax the mark to market rules for assets. This will allow the banks to fudge the values of the "toxic" assets, but make it impossible for others to assess the viability of the banks themselves.

So the Fed is going to pump $1.1 trillion into the market in the hopes that banks will then lend this out and get money circulating again. This is also supposed to lower interest rates, but I feel that it will lead to runaway inflation down the line. Of course, by then the present crew will have moved on to other things and a new group of pols will be left to clean up the mess.

One only has to look at the parallel situation with LBJ. The US fought (and lost) a war without paying for it and then was subject to an oil crisis. After LBJ left it was Carter and Nixon that got stuck with 17% interest rates and the like.

We are now fighting (and losing) two wars without paying for them and I'm pretty sure the oil situation will return as the realization that supplies really are running out sinks in.

Printing money causes inflation, despite the assurances that this time will be different.  

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Thu Mar 19th, 2009 at 10:21:55 AM EST
... held by a bank, how can they be valueless assets held by a pension fund?

Your more normal financial relationship is something is an asset to one party and a liability to another.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Mar 19th, 2009 at 11:39:19 AM EST
[ Parent ]
Many of these loans are held by state and local government and pension funds. Anything which lowers their ratings makes them ineligible to remain in these funds.

There is nothing wrong with that which cannot be fixed by direct federal transfers and better public pensions, respectively.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 19th, 2009 at 04:44:18 PM EST
[ Parent ]
... will be good for the rest of their portfolio, beyond any stock and bonds they may hold in the bad banks.

Waving a magic wand and pretending that insolvent firms are solvent in order to protect some minority fraction of their shareholders and bondholders is grossly inefficient. It is, indeed, more of the same "come any closer and we are going to blow our head off" form of threat ... "we cannot go bankrupt because widows and orphans depend on income from our stocks and bonds".

Better a social safety net and getting banking operations in a shape so that they are in a position to respond if a recovery should threaten to flicker into life.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Mar 19th, 2009 at 11:11:53 PM EST
[ Parent ]


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