Fallout: The Financial Crisis

‘Bad bank’ idea gaining steam

Marketplace Staff Jan 28, 2009
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Fallout: The Financial Crisis

‘Bad bank’ idea gaining steam

Marketplace Staff Jan 28, 2009
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TEXT OF STORY

KAI RYSSDAL: Banking stocks did pretty well in the market today, mostly because of increasing chatter about a “bad bank.” And yes, there is a case to be made that there are a lot of those out there nowadays. But I’m talking about one in particular. The idea that the government’s going to set up kind of an aggregator, a bank that would absorb all the bad debt the big commercial banks have on their books. If it works right, it could go a long way toward letting banks get back to the business of lending, and so help turn the economy around. But Ashley Milne-Tyte reports that’s a pretty big “if.”


ASHLEY MILNE-TYTE: FDIC head Sheila Bair has long wanted the government to focus more on helping home owners. David Easthope is senior analyst at consulting firm Celent. He says if the FDIC sets up a bad bank full of home loans Sheila Bair could get her wish.

DAVID EASTHOPE: So if someone has a particularly high interest rate or is unable to meet their obligations they can re-work these loans and it becomes a government program, rather than depending on the financial institutions to re-work these loans, which can often be very, very difficult.

Not that the government’s task would be easy. Easthope says given how many troubled loans are packaged into bonds there’d be a lot of unraveling to do. One big issue for a bad bank is valuing problem securities. Karen Shaw Petrou is managing partner of Federal Financial Analytics. She says setting the price is a delicate matter for the government. If it’s too low…

KAREN SHAW PETROU: …Then banks that are well enough capitalized to hold on to their troubled assets would be immediately penalized, essentially worsening an already bad situation.

Because they’d suddenly have to mark their loans down, making their books look even worse. David Easthope says the government could use today’s market as a guide.

EASTHOPE:For example, Merrill Lynch sold some of these securities at very, very few cents on the dollar. They could offer a slight premium to that. But any type of valuation is going to be a shot in the dark.

He says for many of these tainted bonds there is no market. Which raises the same question that came up when the Troubled Asset Relief Program was first introduced: how to put a price on something nobody wants to buy.

I’m Ashley Milne-Tyte for Marketplace.

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