I’ve written here before about my puzzlement over the widespread international enthusiasm for “bad bank” proposals and I haven’t changed my mind since.
A more attractive proposal, which is getting less attention, is the idea of establishing new banks. It could be argued that this directly addresses the problems being created by the weak capitalization of the international banking system, without the extreme moral hazard problem associated with TARP-style over-paying for bad assets. The financial intermediation function performed by banks is crucial to the efficient functioning of the economy and, for a number of reasons, undercapitalized banks do not perform this function well. Understanding this, the approach of govenments everywhere has been to use taxpayers money to prop up undercapitalized banks. But while banks play a crucial role that doesn’t mean that we necessarily need the current set of banks to perform this role.
Kevin already posted a link to Willem Buiter proposing something like this but the idea is now being given wider prominence. Here for instance is a nice clearly-written piece from today’s Wall Street Journal by Stanford’s Paul Romer. An important benefit of this type of plan, as Romer notes, is that it seems more likely to attract additional private sector equity capital relative to the various plans to attract new investors for existing banks with failed management and murky balance sheets. Indeed, I first read about the idea of new banks in this 2009 predictions piece from celebrity uber-bear bank analyst Meredith Whitney and she was focusing purely on the private sector opportunities. She said: “I think you’ll see more new banks created. We’ve already seen more applications. And it’s a great idea: You start with a clean balance sheet and make loans today with today’s information. Plus, right now you’ve got a yield curve that’s good for lending.”
Skeptics could point out that these new banks will lack the branch network or knowledge capital of existing banks. However, branch networks could be purchased pretty cheaply these days and the newly-minted banks could be attractive places for those bankers with good track records to work. Perhaps the best argument against this idea is the time lags involved in getting new banks set up. But the problems in the international banking system seem likely to be with us for some time so useful long-term solutions may be called for.
No doubt I’m being wide-eyed and innocent here. Perhaps our trusty band of loyal commenters can give me a word to the wise.