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In Portugal, a ‘bad bank’ saves the day

Mark Garrison Aug 4, 2014
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In Portugal, a ‘bad bank’ saves the day

Mark Garrison Aug 4, 2014
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A multi-billion dollar rescue is underway for a European bank, and global economy watchers are hopeful the fix will keep the problem from spreading beyond Portugal.

Banco Espirito Santo is getting chopped in two. Its toxic assets will be held in a so-called “bad bank,” a concept that drew attention during the worst of the global financial crisis.

The idea is that with bad loans and other toxic assets segregated from strong assets, the “good bank” can go on with the regular business of taking deposits and lending, without worries that customers will freak out and withdraw all their money, causing chaos.

When the bad bank tries to sell off the bad stuff, lots of money will be lost. But unlike previous bank bailouts, the burden doesn’t all land on taxpayers.

“The losses are gonna be borne by some of the creditors to that bank and the people that own stock in that bank, the shareholders,” explains Matt Slaughter, associate dean at Dartmouth’s Tuck School of Business. “That’s a good move.”

Slaughter says banks will manage risk better, if they don’t assume taxpayers will ultimately pay the bills for their screw-ups.

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