Thursday, May 07, 2009

Banks Need Fewer Carrots and More Sticks

This is an interesting opinion piece by Glenn Hubbard, he offers a way to deal with the "bad assets". Its a reasonable plan and one that the FDIC has been utilizing for decades. At its core is the idea of splitting the bad assets from the good - essentially creating two banks where one existed - one bank gets the good assets, the other the bad assets. The bond holders and creditors are on the hook for the losses of the bad bank and in exchange receive significant equity ownership in the good bank.

This is essentially a combination of many of the ideas put forth on this blog (and others) over the past six months as it acknowledges that purchasing toxic assets is a bad idea as no price can be found and the discovery process is fraught with peril. Instead, no price is given to the assets - as those assets are worked out or sold off the gains or losses are absorbed first by the creditors.

I like this idea, though it requires legislation (thus another opportunity for congress to gouge us with pork).

The issue I have is that it still isn't a comprehensive plan for dealing with the bad underlying collateral that is literally owned by thousands of institutions. These pieces have to be put back together in order to deal with the collateral, or legislation has to be passed to allow this collateral to be dealt with (which will piss somebody off).

It also does not deal with Fannie and Freddie, who have been ignored but are completely insolvent institutions in need of bailouts for as far as the eye can see.

Until the underlying collateral is dealt with we will continue to have a difficult financial system.

Scott Dauenhauer CFP, MSFP, AIF