Crisis Diary as it unfolds ….

Bad ‘Bad Bank’

Bad bank? Hmmm .. bad bank! How good can it be, when they name it bad bank?

What is Bad bank?

‘Bad Bank’ is the new gimmick tossed around by the same people who came up with but could not work out TARP – Troubled Assets Relief Program. The same set of intellientia has rebranded TARP as ‘Bad Bank’ and is running around proselytizing people to their newly formed faith – born again TARP.
“Bad Bank’ aims at isolating toxic trash from banks’ assets and create a new giant bad bank to carry only this toxic junk. This will improve the quality of asset book of all the banks and they will be back in their usual business of lending again. Good thought. So where is the problem?
The problem is, who will provide the capital for ‘Bad Bank’? Since most of the assets that are going to end up on the balance sheet of Bad Bank are worth nothing, they are essentially going to eat up most of the capital. So in the name of which crazy f*ing variant of capitalism, is it fair to ask taxpayers to cough up the capital for ‘Bad Bank’? They call it Lemon Socialism. I am no fan of socialism, but pure socialism is million times better than this Lemon Socialism.
The idea of ‘Bad Bank’ is going to fail for exact same reason the original idea of TARP failed. How to price the Toxic Assets? If they are priced at what they are worth i.e. zero, no bank will be willing to part them from their balance sheets. If they are priced anywhere near their book value, it is really bad deal for taxpayers.

Let’s look at what are the general perspectives we get to hear about Bad Bank.

The smart ones …

These people are the founding fathers of Bad Bank initiatives – the shrewd class of diplomats in cahoots with nation’s bankers. They have their own interests in getting things running again – even if it comes at the cost of taxpayer dollars. They want to sell this idea of Bad Bank somehow, because it is one perfect medicine that will mop up all the dirt from balance sheets of all banks. the ultimate cleansing of body and soul, you see.

The naive ones …

There are always few who fall for such cunning ideas of political craft. They say that toxic assets are in reality worth more than what they sell for in the market. So if gov’t sits over these assets for long duration, taxpayers will end up making profit on in. Okay. So markets don’t know how to price these assets, eh? But wait a minute, markets are supposed to know the best, isn’t it? Yes, and they do. These assets are really worth nothing.

The wise ones …

This includes economists like Joe Stglitz , Paul Krugman and Yves Smith, who openly criticized the idea of Bad Bank in its current form – just because it is exactly what it says it is .. Bad.

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February 7, 2009 - Posted by | Opinions | , ,

2 Comments »

  1. The Bad Bank and the 2 Ton Elephant in the Room

    Under the “Bad Bank” scenario, the taxpayers will own these “Troubled Assets” which are comprised of “Toxic” mortgages. I believe that we must address another issue at the same time, in order to maximize the success and mitigate the losses of this approach

    In effect, the US government (taxpayers) will be bearing the loss on these “toxic” mortgages. The growing concern is that these losses will continue to materialize as defaults increase with the projected 8 million foreclosures expected over the next four years. It seems that the key to this crisis IS THE BORROWER!

    Everyone is ignoring the “2 Ton Elephant in the Room”. Many agree that the contributing factor to most of our problems is the consumer’s lack of financial understanding. He is like a “Boat without a Paddle” when it comes to managing money and making money choices. Everyone is betting that the Borrower will default and foreclosures will follow. The high rate of foreclosure and RE-DEFAULT should have been expected because the Borrower has no concept of managing money.

    It can be argued that the Borrower’s lack of knowledge in financial management was the primary cause of the Subprime Mortgage Crisis which precipitated the Credit Crunch and our current economic woes.

    Loan modifications on these Troubled mortgages will not save the Borrowers. The fact is that these measures will fail because the Borrower will fail unless he has guidance. The evidence is that Re-default is occurring anyway at a rate of 60% within 6-8 months.

    Let’s finally address the real issue which requires developing a program of “Immediate and Specific Financial Guidance” to help the Borrower understand how to manage his financial affairs.

    The Borrower is in desperate need of “Financial Guidance” in this complex economic environment that requires “informed” financial decision-making. The Subprime Mortgage Crisis, out-of-control consumer spending and credit card usage, and the spike in foreclosures and bankruptcies provide evidence of that fact.

    We must develop a program of “Immediate and Specific Financial Guidance” that will help the Borrower “naturally” be able to make the monthly mortgage payment. This program is NOT the so-called Financial Literacy initiative that simply disseminates “information” and takes forever to complete, but rather it is a program that will help the Borrower “understand” how to manage money in the shortest possible time and avoid the pitfalls that have previously caused financial
    distress.

    As the Borrower is successfully guided to avoid default, the financial and housing markets will respond favorably. The result will be a reversal of the downward trend in the valuation of the “troubled assets”.

    If we are successful, we can turn this crisis “all around” and stimulate the economy “naturally” rather than by “bailout” which does not guarantee success.

    Instead of the expected losses, the US government (taxpayers) will benefit from the unexpected gains that will result as these investments grow in value.

    Samuel D. Bornstein
    Professor of Accounting & Taxation
    Kean University, School of Business, Union, NJ
    Tel: (732) 493 – 4799
    Email: bornsteinsong@aol.com

    Comment by Prof. Samuel D. Bornstein | February 7, 2009

  2. Thanks for your comment and insightful thoughts!

    But with regards to following lines

    We must develop a program of “Immediate and Specific Financial Guidance” that will help the Borrower “naturally” be able to make the monthly mortgage payment. This program is NOT the so-called Financial Literacy initiative that simply disseminates “information” and takes forever to complete, but rather it is a program that will help the Borrower “understand” how to manage money in the shortest possible time and avoid the pitfalls that have previously caused financial distress.
    —–

    This will be a good long-term initiative.

    But in short-term, this suggestion will work assuming people default because they do not know how to manage their finances wisely. Whereas, in many cases I think they just don’t have any money to pay for their mortgages any more. Also, there is an ‘incentive to default’ at work here. When home equity falls below mortgage principal, there is always an incentive to default. Is it not that this incentive is also driving several defaults?
    Also, banking, by its very nature, tends to be highly levered. So even few defaults cut into banks’ capital heavily.

    Comment by Aniket | February 7, 2009


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