How good would the creation of a "bad bank? To overcome the crisis?

How good would the creation of a "bad bank? to overcome the crisis?

Buenos Aires, Argentina

January 29, 2009

Yesterday, after some time, the euphoria turned to markets in the hand of a good news from the United States and could accelerate global economy out of recession in the situation you are.

Is that, beyond maintaining the benchmark interest rate by the Fed and the stimulus plan approved by the House of Representatives, has gained strength the possibility of creation by the U.S. government of a "bad bank? or entity that acquires most of the toxic assets of banks, which cleanse the balance sheets of banks and thus underpin the stability of putting themselves in position to start to revive the credit circuit.

It is worth remembering that this idea of ​​creating a "bad bank? to acquire toxic assets from banks was used by the Scandinavian authorities in resolving the banking crisis of 1991.

This "bad bank? in the proposal to the U.S. be managed by the Federal Deposit Insurance Corporation (FDIC in its acronym in English), a body chaired by Sheila Bair, who would be responsible for purchase of U.S. financial institutions affected by the assets 'subprime mortgages'.

Once purchased these toxic assets, the FDIC will insure it by a bond issue guaranteed by the institution itself. Thus the FDIC would cleanse toxic assets entities thereby eliminating the risk of crisis to those who are currently undergoing U.S. financial institutions.

But to realize this "cleaning? financial institutions, one of the key issues that should be analyzed carefully, and will be essential to make the initiative work, is the way the FDIC will assess the banks' toxic assets at the time of purchase. Regarding this issue, the Treasury secretary, Timothy Geithner, has three options under consideration: value as the market is valuing similar assets using valuation models used by independent firms or seek a review by the financial supervisors.

Considering the valuation methodology and its relationship to the true market value of toxic assets, identifies two variants to this type of bad bank: the bad and the good bank bad bank evil. The first alternative is to generate lower costs and is more aligned with the goals of seeking a safe behavior of financial institutions for risk. This variant is that the bad bank acquires the assets at market value forcing banks to write off those assets and clean up their balance sheets. The result, those banks that are insolvent are being recapitalized, nationalized or liquidated by the State.

In the variant of bad bad bank, bad bank would buy the toxic assets at inflated prices (above market value) so that banks can start as soon as possible to lend money again. This alternative appears to be attractive to governments because it would accelerate the economic recovery (to revive the credit channel), but would create perverse incentives for banks in the future also involve a higher tax cost (and even by the big questions of the population).

About these alternatives, in the view of David Roche, who has been for many years chief strategist at Morgan Stanley and now president of independent firm, "If not adopted good bad bank solution, the system remains as corrupt as before . The bad assets will suck resources from the economic system as a zombie borrowers, misallocation and distorted price of capital, public debt and budget deficits?.

But beyond the modality adopted this proposal (although this is not a minor issue), the fact is that the creation of the entity increases the chances of faster recovery of the U.S. economy and that would bring the U.S. financial system of the struggle to consolidate their financial statements and put him in a position to generate credit for consumption and productive investment.

With a financial system recovered and historically low interest rates, the U.S. economy, highly dependent on domestic consumption, you can speed your recovery and represents a more than good news for the rest of the world economy.

The positive impact of creating such a bad bank will encourage other policy makers to adopt the proposed resolution of the crisis. Thus, a positive result in the application of the methodology of resolution in the U.S. could induce the European Central Bank to take a similar measure that would benefit the financial system of the eurozone.

In the meantime, what can be said is that this proposal has brought some hope for economies to confront the crisis and accelerate out of the crisis.

But be aware that both the new proposed resolution as the previous actions taken by governments, perverse incentives to produce future behavior of financial institutions on which we must work seriously.

The other issue that we must work is about the strength of macroeconomics mainly in developed countries. Among other consequences, the crisis has forced the developed economies incur large fiscal costs to mitigate its impact, which will entail a greater debt burden in the future. These economies will emerge from the crisis hit and require urgent action to prevent the continued deterioration of the macroeconomic variables that may make them vulnerable to adverse shocks again.