Wednesday, January 28, 2009

Equity Futures Perk Up on "Bad Bank"

US equity futures are decidedly higher this morning.  Most of the rise, which occurred after the closing bell yesterday, can be attributed to news leaking out about plans to form a universal "bad bank", owned by US taxpayers, that will be managed by the FDIC.  The bad bank would purchase "toxic assets" from banks, manage them, limit losses to the taxpayer, and administer spankings whenever appropriate.  The market loves this idea because the banking system finally has a place to deposit all of that garbage that it didn't know what to do with.  The situation is remarkably similar to the Mobro 4000 giant garbage barge that floated around New York in 1987, that nobody was willing to take.  Congratulations Sheila Bair, you are officially commander of Mobro-Redux 2009.
My biggest and only issue with the bad bank is determining the prices on the toxic assets.  I really hate the idea of a large transference of risk from the capital markets to the taxpayer, particularly if the taxpayer is going to take assets off of the banks' balance sheets at prices equal to or higher than where the banks are carrying them on their books. It's handing a gift to shareholders and firms who, frankly, don't deserve it, given all of the mayhem the credit crisis has caused for the rest of the economy.  Alternatively, I would prefer it if the FDIC just prepared itself more fully for large scale banking liquidations like the RTC held in early 1990's.  The RTC did not pay to acquire those assets, consequently, the cost to the taxpayer was minimal.  I believe it's important to protect depositors and the financial system from more turmoil, but the burden of poor investment decisions made by many very highly compensated people should be borne by those who made those decisions as well as those who took the risks of investing without performing adequate due diligence on their investments.  It's the way the capital markets were created.  Equity loses first, then debt, in that order.  If the taxpayer needs to step in, it should take the losses last.  Granted the US taxpayer is already in bed with the banking system, so at this point it is merely protecting its own investments, but now we're just talking about shuffling money around from one money-losing entity to another.
I don't profess to have the answers to the complicated problem of the morass we are in.  But I prefer the idea of backing new banks that are not burdened by toxic assets and the lazy boards or crappy management that allowed some of these banks to get into so much trouble to begin with.  Something was rotten at the core of many of our largest financial institutions.  Helping to create new institutions rather than supporting the status quo is a plan I would support. 

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