Here’s the details on the FDIC deal with Bank of America. Wonder would this work in Ireland?

http://www.fdic.gov/news/news/press/2009/pr09004.html

On the other hand, a similar suggestion for the UK has been met with a less than positive response by some:

http://burningourmoney.blogspot.com/2009/01/toxic-spin.html

More on the bad bank

OK, I’ve been doing more homework on the “bad” or “aggregator” bank idea that seems to be gaining ground. And here’s what I think: it’s mainly based on a false analogy.

What people are thinking about, it’s pretty clear, is the Resolution Trust Corporation, which cleaned up the savings and loan mess. That’s a good role model, as far as it goes. But the creation of the RTC did not rescue the S&Ls. The S&Ls were rescued by (1) having FSLIC seize them, cleaning out the stockholders (2) having FSLIC pay down enough debt to make them viable (3) reselling them to new investors. The RTC’s takeover of the bad assets was just a way for taxpayers to reclaim some of the cost of recapitalizing the banks.

What’s being contemplated now, if Sheila Bair’s interview is any indication, is the creation of an RTC-like entity without the rest of the process. The “bad bank” will pay “fair value”, whatever that is, for the assets. But how does that help the situation?

It looks as if we’re back to the idea that toxic waste is really, truly worth much more than anyone is willing to pay for it — and that if only we get the price “right”, the banks will turn out to be solvent after all. In other words, we’re still in Super-SIV territory, the belief that fancy financial engineering can create value out of nothing.

Color me skeptical. I hope the buzz is wrong, and that something more substantive is being planned. Otherwise, we’re looking at Hankie Pankie II: Paulson may be gone, but officials are still determined to believe in financial magic.

Karl asks, Why not provide additional capital to cover the implicit losses and thus increase the government’s equity share? Presumably the banks will need more capital to plug the hole resulting from selling the bad loans to the AMC. Transferring them to a specialist distressed asset company has two advantages: (1) bankers have little expertise and experience in managing distressed assets, and (2) bankers who made the bad loans face perverse incentives in dealing with those loans. Folks at the AMC face better incentives.

There’s one obvious solution, canvassed by myself last September in the comment section of ft.com (see my posting at http://blogs.ft.com/wolfforum/2008/09/the-price-of-salvation/#comments).

The essence of my idea is that, in return for the toxic assets, the AMC pitches in enough government money to make the bank whole, but the government gets warrants for the bank shares whose exercise price rises with the recovery performance of the toxic assets.

The schemes subsequently used for the recapitalization of the Swiss bank UBS and also more recently for Citi contain similar features.

It is crucial to be very clear in advance as to who is bearing upside and downside risk in any financial restructuring arrangements if the taxpayer’s interests are to be protected — as I spelled out for the Anglo case in my comment to Kevin’s posting on Buiter’s idea yesterday.

This would be a floor, a pretty high floor, on the price of these dodgy loans. There would certainly have to be massive payouts by the state and the state would lose money in my humble opinion, but some free money is going to have to be handed out at some stage.

The difficulty is in setting the premium that will be paid to the state by the bank. Is there a market based mechanism that could set the premiums or guide the state as to which loan books are riskiest?