Book Reviews | Gordon Campbell | News Flashes | Scoop Features | Scoop Video | Strange & Bizarre | Search


Gerald Epstein: Bad Bank - Bad Idea

Bad Bank: Bad Idea

Tuesday 03 February 2009
by: Gerald Epstein, t r u t h o u t | Perspective

The irresponsible, and even fraudulent, behavior of bankers and the financial regulators we trusted to monitor them have left the rest of us in deep trouble with no good financial options. Major banks, including Citibank, Bank of America and others, are on the verge of bankruptcy, if not already insolvent, despite the commitment already made on behalf of US taxpayers to spend or guarantee billions of dollars to rescue them. Meanwhile, the economic vortex is dragging the rest of us down.

Something must be done to restructure the financial sector as part of the government's recovery program, and the Obama team will soon be announcing a new financial rescue plan. But the widely discussed "good bank, bad bank" option that Treasury Secretary Timothy Geithner, Federal Reserve Chair Ben Bernanke and White House economic adviser Lawrence Summers might be dishing up next week is among the worst of a bad lot.

The "good bank, bad bank" idea ("bad bank" for short) is to use US taxpayers' money to buy the toxic assets bankers created, put them in a nationalized "bad bank" and leave the bankers with the good assets to deploy as they wish, meanwhile, having to endure only a mild reprimand and quite modest face-saving restrictions on their pay and dividend payments. The bank managers, owners and creditors will be at least partially rescued, while "we the people" will be left holding the garbage, hoping someday to sell it to the financial scavengers for dimes (or pennies) on the dollar. As Paul Krugman, Dean Baker and others have pointed out, the plan socializes the costs of bankers' outrageous behavior, while privatizing the benefits, letting many of the bankers off the hook at our expense.

A much better approach is to turn the formula on its head. Let the taxpayers keep the good banks and leave the bad ones for the bankers.

The traditional "bad bank" idea is, in reality, a desperate attempt by Geithner and company to avoid the creeping "nationalization" of the banking system as more large banks become insolvent and taxpayers are being hit up to invest in them in an attempt to prevent a total breakdown of the financial system from leading to a catastrophic crash of the economy.

But, in fact, the "bad bank" approach IS a type of nationalization: it's just that we nationalize the bad stuff and virtually give away the good stuff. And we leave the bankers who caused this mess right there in the economy's driver's seat, just as before. Obama's economic team hopes the "bad bank" policy will allow the banks to raise private capital from the market, and to start lending again with the idea that this will contribute to an economic revival. But, more likely, it will prove to be a failed attempt to hit the financial "restart" button, to try to fix the banks up as they were before and hope their prosperity will "trickle down" to the rest of us.

So, what should be done instead? At the outset, let's be clear about the goals of a financial recovery program. Financial institutions must, first, write down the debt overhang that is suffocating American homeowners and credit card users. This means some combination of writing down the principal and reducing the monthly payments so that people can stay in their homes and begin to recover some of their equity. It also means restoring bank honesty and reasonable charges for credit card users so they can work themselves out of their consumer debt traps. Second, financial institutions must start lending to businesses - small and large - so they can create jobs; and to state and local governments so they can retain jobs, make investments and provide needed services. Third, the debt overhang that is weighing down the financial institutions themselves has to be resolved. This means the toxic assets that are clogging the arteries of the financial system have to be cleared out in the least costly and disruptive way possible and the banking system needs to be recapitalized. Finally, bank fraud and abuse must be rooted out and mechanisms put in place to prevent their return and to protect customers and investors.

This is a tall order, and there is no simple panacea. But trying to return to a broken and destructive system - which is the goal of the "bad bank" idea - will certainly fail.

Here is a better idea. Just REVERSE the traditional "good bank, bad bank" formula. The government should take over the "good assets" and leave the bad ones to the bankers. Here is how this "good bank" approach will work.

The government should buy the good assets from the banks. The government will be able to buy these relatively cheaply, as the banks' stock values have plummeted. The government can then put in a good management team, perhaps including many of the competent and honest bank staff who are now being laid off, but certainly at an initially lower pay. To succeed, the government will have to create a completely different banking environment, one with a completely different mandate and incentives. The bankers will still have to be concerned about efficiency and the bottom line, but pay, promotion and bonuses will be tied to the ability to profitably and efficiently achieve the long-term goals outlined above, rather than minimizing tax payments and maximizing fees, short-term capital gains and executive compensation. Many of the top dealmakers will still try to go elsewhere in search of multimillion-dollar pay and the excitement of living on the edge. But many bank employees will want to stay and make the new bank work to help salvage the economy, and restore their self-respect and social standing.

If banks do not want to sell the good bank to the government, of course, they do not have to. But if, later, they are not able to survive on their own, then the government will simply take the bank over for much less, or for nothing at all.

But what about fears of government incompetence, of political control over banking, of government corruption? Won't this sink this "good bank" plan? These are genuine concerns. The government must hire competent experienced staff, as I have suggested. But this is just the start. There must also be accountability and transparency. One idea is to establish an independent Public Banking Authority to manage these institutions. This authority must be governed democratically, with stakeholder groups - workers, small business owners, professional experts - serving on the governing board.

As for the "bad assets," they can be spun off into separate entities - bad banks - still owned by the original bank owners. The banks will try to salvage what they can, as best they can. They know better than anyone what their assets are, where the skeletons are hidden, what is salvageable and what isn't. They might have to sell them for pennies on the dollar, but at least, these bad assets will no longer be clogging up the system. And the bankers will have to deal with their own mess, rather the foisting it off on the rest of us.

Of course, this plan will fail unless the overall Obama recovery program based on fiscal spending and reversing the fortunes of the majority of Americans works. If the economic recovery takes hold, then the value of both the public good banks' and even the private bad banks' assets will go up. This is a "bubble-up" approach to restoring both financial and economic health to the US economy, and it is one that gives the rest of the world a fighting chance as well.


Gerald Epstein is Professor of Economics and co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts, Amherst, and Visiting Scholar, Université, Paris NORD (Paris XIII).

© Scoop Media

Top Scoops Headlines


Werewolf: ‘Disruption’ Is For Losers

Disruption – anarchic, dynamic, table-tipping, mould-breaking, consensus-shattering disruption – has become part of every corporate bout of auto-hype to the faddish point where the term has lost any useful meaning it might once have had. More>>


Werewolf: Coney Island (And The Trumps), Baby

Like much of that part of the coast, and given the storm surges of Hurricane Sandy, Coney Island should be occupied only by clumps of grass and seabirds. Instead there are 60,000 people in multi-storey apartment buildings living among the faded remnants of a once-spectacular fantasyland.. More>>


Gordon Campbell:
On Corbyn, Trump And Outsider Politics

Jeremy Corbyn elevated to the leadership of Britain’s Labour Party! Donald Trump and Bernie Sanders on the rise in the US… On both sides of the Atlantic, these are dark days for the political Establishment. More>>


Operation Chrysalis: A New Beginning For Scoop

On December 19th 2014 the Scoop Team set out on a project called "Operation Chrysalis". We decided to turn Scoop's 16 year old online news publishing business into a new kind of news business, one connected directly to its readers, owned by a not-for-profit and based on a new business model. More>>


Keith Rankin: The Economy - What's It For?

I re-watched the Q+A 'immigration debate' screenedon 23 August. In light of recent events, the discussion already seems very dated. The underlying assumptions were that the economy is a system in which production growth is pretty much the sole objective, and that migration policy must serve this end of output maximisation... More>>

Until Dawn: Pick Your Own Horrible Adventure

Suppermassive Games’ Until Dawn sees a group of dumb sexy teenagers take a trip to a spooky mansion atop a mountain. It is, obviously, a horror game. However, the game is so ridiculous it turns out to be more of a comedy. Until Dawn begins with ... More>>

Get More From Scoop

Top Scoops
Search Scoop  
Powered by Vodafone
NZ independent news