Wednesday, January 28, 2009

Getting The 'Bad Bank' Solution To Work

The "aggregator bank" solution fits the strategy emerging for 2009 by both the Federal Reserve and the U.S. Treasury. In particular, both agencies appear interested in getting more bang for their buck, so to speak, in part because of public outcry over the use of the TARP. The goal now is to be more directly involved in getting money into the hands of those who want it.

For example, the Federal Reserve's upcoming $200 billion Term Asset-Backed Securities Loan Facility (TALF) will lend money to purchasers of asset-backed securities, money that will funnel through to consumers via credit card loans, car loans and leases, student loans and small business loans. The Fed said it could expand the program to include other areas of lending, including commercial mortgages.

The Fed has also been involved in the mortgage realm, having announced on Nov. 25 a plan to purchase up to $100 billion of agency securities and $500 billion of agency mortgage-backed securities. The plan, initiated in January, has resulted in a sharp decline in mortgage rates.

For its part, the Treasury could use the TARP in ways that are more likely to result in an increase in bank credit. One way is through the cordoning off of assets, which, as I said earlier today, would remove a barrier to the use of cash balances, whcih are now massive. Perhaps the Treasury can use its money to offer low-interest-rate mortgages and other loans.

One model aside from the FDIC's idea is for the Treasury to capitalize a special-purpose vehicle run by the Fed, a way of expanding the amount of assets that could be bought, thanks to the magic of the Fed's printing press. For example, the Treasury could inject $100 billion into the SPV, which could then purchase up to $1 trillion of assets. There are obviously many intricacies to such a plan that would have to be ironed out.

The FDIC has plenty of experience in handling bank crises, and under Sheila Bair it surely remains plenty capable. An FDIC paper written in 2000 and titled "The Cost of the Savings and Loan Crisis" put the number of failed thrifts at 1,043 for the years 1986-1995, with total assets for the failed banks at $500 billion. The cost to taxpayers was $124 billion.

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