Banks and Bad Asset Resolution

In an article by Paul Krugman he presents an easy to follow analysis of what is wrong with the current thinking on bailing out what he refers to as either "dead banks walking" or "zombie banks", banks that have actually gone bust but are continuing to operate. In doing so he refers back to the 1989 Resolution Trust Corporation (RTC) used during the real estate crisis in the 1980s.

I recommend reading Mr. Krugman's article, Wall Street Voodoo, however I do not think that Dr. Krugman's article goes far enough in describing the differences between the RTC solution and the current proposals. I will make my pitiful attempt the do so here.

The major difference between the RTC and what is being proposed now is that under the RTC, the banks were first nationalized, the bad assets were taken over by the RTC to be sold off at some future day, and then the bank was sold to new owners sans bad assets. The current proposal is to give the banks enough money to make them solvent and have the bad assets taken over by the government through what is being called a "bad bank".

What is the difference in outcome? Under the RTC program, the bank management is replaced by the management that purchases the bank at "fair market value" with the bad assets gone and the original stockholders are left holding an empty bag. The proposed plan would ensure that the management remains unchanged and lets the original stockholders reap the "benefit" of holding a bag of some undetermined value at the cost of the government.

The supposed added value of the proposed plan is that the banks, with an infusion of cash, usually in excess of the current market value of the unloaded bad assets, then will be enabled immediately to make loans again.

I have problems with the outcome of the proposed plan. First, although the banks may be enabled to start making loans, there is no guarantee that they will. Look at the results of the first $350 billion handout to the banks.

Second, there is no consequence to the misconduct by the current bank management and since they have already demonstrated a level of incompetence or skulduggery, doesn't the concept of accountability apply here? As for the stockholders, doesn't the conservative principle of risk taking apply to them? Invest to make a financial gain and either reap the benefits or suffer the losses.

With respect to the two issues above, doesn't the argument being made by the conservatives apply here? Doesn't bailing them out only encourage them to be reckless in the future? Or at least less diligent in their responsibilities.

And my final point is that none of these plans offer any direct help to those who are suffering the most, the homeowners being foreclosed upon. If we are going to violate the principles of the free marketeers, shouldn't we first take care of the least well off rather than the wealthy bankers and investors? And in so doing, wont rescuing them have a bigger payoff for economic recovery?

I would love to hear from you. Let me know what your thoughts are and if you agree or disagree with my thinking. It is time for all of us to let the president and our legislators know what we want. As Obama says, it will have to come from the bottom up.

For those who agree with what I have written, please pass this email along to others.

This is the link to inform Obama of your thoughts:

Office of Public Liaison

The Whitehouse web site has been redone by the Obama team. It is worth a visit:

The Whitehouse.gov

Michael