How to "Reprivatize" the Bad Banks

In the midst of an accelerating economic contraction the financial viability of very large "Chimera" banks (combinations of investment banks, brokerages, and genuine banking institutions) which were created after the Clinton Presidency failed to veto Gramm-Leach-Biley, seem to some to be only a side issue. That may be so, at least compared to the need to recreate the money supply that vanished when the derivatives based assets those institutions (or their non-bank parts and partners) became of uncertain value.

But the existence of these banking chimeras as probably insolvent insititutions is imposing significant constraints in the policy options which we have available to deal with the problems of the real economy. Doubts about these giant "banking" institutions' solvency and and long term viability, and about when and whether they will be willing to lend at reasonable rates again, create confusion about the source of the problem with the real economy. Is it still "only" a "credit" crisis, with banking - mortgage and derivitive instruments - at its heart? Or must it be addressed as a much larger and more pervasive problem of a general failure of the money supply, and treated with measures appropriate to that very different problem?

Clearing the problems faced by these suspect financial institutions out of the way is going to be necessary before we can see and get agreement about the real character of the current economic contraction. That must be accomplished swiftly, and with clarity, and in a way that does not leave a lot of the fog of war on the field after it is accomplished.

Once the banks which should be taken into receivership by the government are identified (stress testing by the Treasury Department will accomplish that) those banks can be swiftly taken into receivership, reorganized, and--most essentially--promptly reprivatized.

But for this to be seen as both an effective and an appropriate way of dealing with these banks, we must have a means of accomplishing. This must assure that the necessary reorganization and reprivatization can be accomplished without incurring the political costs associated with the notion of "nationalization" by announcing it as a temporary and short term action; without requiring liquidation of the assets of the institutions or interrupting the operations of their true "bank" banking activities; without charging costs of recapitalization of the banks to the taxpayer; and without relieving the owner/shareholders and bondholders of the bank of the risk they assumed when they took their investment in the institution.

This process cannot require the establishment of a government owned or run "bad bank." It cannot require the siezure or long-term control of the equity of the shareholders. It cannot leave the taxpayers with responsibility for sorting out any "bad bank" investment assets. Those risks must stay with the shareholders.

How can this be accomplished? I believe that a process based on the article "The right way to create a good bank and a bad bank" by Susan Woodward and Robert Hall | Feb 23, 2009 | (based on an idea from Jeremy Bulow) just might do the trick. The process is described at both
http://woodwardhall.wordpress.com/2009/02/23/the-right-way-to-create-a-good-bank-and-a-bad-bank/
and
http://www.rgemonitor.com/financemarkets-monitor/255689/the_right_way_to_create_a_good_bank_and_a_bad_bank

A comment at Nouriel Roubini's site by "By 2cents on 2009-02-23 10:12:13" indicates that there will be resistance to such treatment within both government and the banking industry, and that it will be necessary to account for (recoup) government funds already given to these banks.

Can't disagree on these points. But this approach is the most concrete, least subject to misconstruction, resistance and misrepresentaton--and likely to be the most generally acceptable and produce the best results, that is available to us.

Speaking as a simple private citizen I think these hurdles should not stand in our way but should be overcome. And that those who are in a position to cause movement in this direction by players in banking and government should carefully consider throwing their weight behind it.

(edited for clarity and title change. 10:41 AM ET Feb. 24, 2009)