Is It Good Not To Be "Bad"?

While a formal announcement is still a day away, it appears the Obama Administration is backing away from the concept of a "bad bank" to take control of the bad assets of US banks. Instead, they will propose that price floors on assets would be set by the federal government as a means of inducing private investors to take control of the assets, manage them, and eventually sell them back into the marketplace.

In explaining the outlines of the proposal on Sunday, Lawrence Summers, the top White House economic adviser, indicated the administration had received a number of proposals from private equity firms, hedge funds, and insurance companies interested in asset management. He said that bringing private equity into the process would help limit the exposure of the taxpayer.

This approach—perhaps best described as a "mixed model"—puts the federal government in the guarantor position and would most likely involve federal oversight of the private firms' activities under the program. Some requirements might flow to the new asset managers as well. For example, a mandate or strong encouragement to restructure mortgage loans could well be a part of the deal for them.

The new approach has the benefit of being more market driven than a bad bank. It may well result in better asset management and a quicker return to market for the troubled assets. However, there is a legitimate question as to how well it will address one of the central goals of the program, which is spurring the banks to increase lending. In a bad bank scenario, one can see a construct where part of the agreement under which assets are removed from a bank's balance sheet is that it will take certain actions to step-up its lending activity. Under the "mixed model" it appears the transaction would be between the federal government and the asset manager. So it comes back to the question posed by the Bush Administration last fall (and never really answered):

Will removing "toxic" assets from banks' balance sheets cause them to resume lending?

Treasury Secretary Geithner is expected to announce the new ”Financial Stability and Recovery Plan" tomorrow at 11:00 a.m. It is unclear how much detail will be included in the announcement. The Secretary is also scheduled to testify before the Senate Banking Committee at 2:30 p.m. tomorrow, which may bring forth additional details. All those interested in being part of the asset management program should be paying close attention in the next several days. We, of course, will do likewise.

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