What to do with the troubled banks?

Simon Johnson is a professor of economics at MIT.

TEXT OF INTERVIEW

KAI RYSSDAL: All the political pomp and circumstance in Washington today didn't amount to a hill of beans on Wall Street. In case you took the day off from the financial crisis to celebrate the inauguration, here's the update:

Bank of America lost almost a third of its value today. Citigroup can be had for $3.50 a share. The rumors of nationalization or some kind of uber-bailout known as a "bad bank" are getting stronger. The British government has already taken huge ownership stakes in some of it's biggest banks.

Economist Simon Johnson teaches at MIT. He also used to work at the International Monetary Fund. Good to have you with us.

SIMON JOHNSON: Nice to be with you.

RYSSDAL: What's your sense of the banking industry in the United States? Specifically, the big ones -- Citigroup and Bank of America -- that have been in so much trouble?

JOHNSON: Well, I'm worried. But that's not the issue. The markets are very worried. And they're very worried on a sort of an immediate, pressing basis. And that's a huge issue for the incoming administration.

RYSSDAL: One of the things that's been talked about as a solution is this thing called a "bad bank" that would absorb some of these bad assets that the banks have on their books. What, exactly, would that entail?

JOHNSON: Well, the basic notion of a "bad bank" is that you split the assets of these banks. You let the banks determine, maybe with some government help, which parts they should hive off into the bad banking. And you split what the shareholders get. So they get part of the good bank and part of the bad bank. And then you hope that the good bank can go on and make loans and go about its business. There's a wall between that and the bad bank. And anything that goes further wrong in the bad bank, or any massive uncertainty about the holdings of the bad bank, shouldn't affect the good bank.

RYSSDAL: All right. But wait a minute. Didn't we go down this road a little bit back in October when Secretary Paulson came up with this plan known as the TARP, the Trouble Assets Relief Plan? That we would just take all those bad things and the good banks would be fine?

JOHNSON: Well, there was an idea -- it was actually back in September. The original idea was that the government would buy these so-called troubled assets. That never actually happened. The government switched course in mid-October and went into the business of recapitalizing the banks. And it left the troubled assets on the balance sheets of the banks. So, in a sense, we are coming full circle. But I think the sense is now that you come full circle in a much bigger, more decisive way. And, you combine toxic-waste clean-up -- that's getting rid of the bad debt -- with big recapitalization of the banks, whether they like it or not.

RYSSDAL: And this recapitalization, if you do it on a large enough scale, that in essence becomes nationalization, doesn't it?

JOHNSON: Well, no, I don't think it does. Nationalization is something that's going to happen in some European countries. The government will take 100 percent ownership stake and it'll run the banks. In the U.S., I really don't believe that is going to happen, or that that would be a good idea. I think what will happen, the government will inject capital, the government will get some claims on the banks -- let's call it warrants, so the option is to buy shares in the banks -- and then the government will manage those stakes through a Resolution Trust Corporation-kind of structure. That's what we used after the savings & loans debacle in the 1980s. And this RTC will get rid of the stakes. It will sell them, for example, to private equity, which we know is waiting with deep pockets on the sidelines. So, sell it to private equity, private equity can buy these banks, and I would think break them up into smaller, more sensible, manageable units. Oh, and I think they would also fire a lot of the managers, top managers, along the way.

RYSSDAL: What a shock. . . . Would this then . . . If we do this, if we get all these bad assets into one bad bank, would that simplify things?

JOHNSON: What it should do is simplify the business of banking. So, it should allow banks to move on and to make their own decisions about who to lend to, without worrying about this sort of overhang of this bad debt and the various kinds of problems that it brings with it. So it separates the problems between banking on the one side and fiscal on the other side. And at this stage, I think we need it.

RYSSDAL: What's your sense of how much time we have to figure this out. I mean, Bank of America and Citigroup aren't getting any richer by the day, are they?

JOHNSON: Yes, well, if it was just about the United States, I would say we would have a bit of time. Unfortunately, the global situation is not cooperating at all. The situation in Europe is dramatically worsened over the past week. And I think this may force the new administration's hand rather sooner than they may wish.

RYSSDAL: Simon Johnson at MIT, the Peterson Institute, and the blog, Baseline Scenario. Professor, thanks a lot for your time.

JOHNSON: My pleasure.

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