We, the People: Good Bank, Bad Bank, OUR BANK

With the news that the U.S. Government is on the cusp of striking a Good Bank/Bad Bank restructuring deal with Citigroup, I am left with the following question: what took so long? And notwithstanding my brainy friend Paul Kedrosky’s contention that one couldn’t have known whether direct bank injections and/or Good Bank/Bad Bank restructurings would work, and that likely both were needed, I say: we should have known. The key to the puzzle is that of understanding complex financial exposures – how they work, how they impact other constituencies and how investor confidence is rebuilt and won. It is in this regard, I’m afraid, that most within both public and private sectors missed the boat, that in the absence of clarity around these complex exposures investors would wait on the sidelines, and bank managements’ would hoard any and all liquidity provided them until they got a grip on how their complex asset portfolios would ultimately perform.

Alas, we’ve shelled out $125 billion with nary a thing to show for it, except a handful of banks with billions in stranded liquidity and a bunch of uneducated writers and politicos spouting “We should have compelled the banks to lend.” Sure, just like Congress compelled Fannie Mae and Freddie Mac to lend. That was an egregious error and exactly the wrong thing to do. The way to get banks to lend is to provide them with good lending opportunities. And good lending opportunities come from clean banks, a stable banking sector and attractive risk-adjusted opportunities to invest in the real economy. As of now we have precious few clean banks, a fundamentally unstable banking sector and a real economy in tatters. And we can’t get clean banks that are able to lend without Good Bank/Bad Bank restructurings, which require transparency in on and off-balance sheet exposures and a commitment to offloading bad assets and recapitalizing the healthy assets that remain.

Banks given the opportunity to claim TARP funds are doing exactly what rational bank managements should do for their shareholders: take the money and sit on it. The strings many wanted attached to TARP funds – the requirement to lend – are the wrong strings. The right strings are: if you want TARP funds you need to agree to a Good Bank/Bad Bank restructuring, with troubled assets marked down and sold at market value to a Government-sponsored “liquidation trust,” after which the gap between hard book capital and BIS regulatory-mandated capital is made up by either public or private investment. What then emerges is a healthy, well-capitalized bank without the legacy burden of toxic, illiquid assets. Private capital will be attracted to such a bank, and this bank has the ability to lend without the fear that it is spending capital on new business when it should be stockpiling it to deal with legacy problems.

Lehman should have been handled in such a way: Good Bank/Bad Bank would have meted out pain to those who deserved it, common shareholders and unsecured bondholders, while adding stability in how the hundreds of billions in complex exposures were wound down. AIG should have been handled this way from the outset; how many tens of billions more have taxpayers borne that was necessary had this approach been used? Hard to calculate, but you can bet the number is quite large. The first $25 billion that was injected into Citigroup? Let’s just call that the cost of education. As long as we do it right now, it will be a small price to pay compared to a rolling series of injections into a still-troubled bank that continues to be laden with tens of billions of toxic assets both on and off-balance sheet. We as taxpayers and as rational investors have a right to know what we are investing in, and as of now the picture couldn’t be more opaque. This is not ok.

• We, the people, are the owners of the Treasury, the Fed and the full faith and credit of the U.S. Government;

• We, the people, should benefit from the monies spent to reclaim our financial sector, that is merely a precursor to reclaiming the health of our economy;

• We, the people, need to know that our representative in Washington, D.C., are thinking clearly about this issue, free from lobbyists, conflicts of interests and other distractions;

• We, the people, need transparency from our Government, our financial institutions, and the process for restoring the health of our financial sector;

• We, the people, cannot see any more of our money squandered on short-term, patchwork solutions to painful and seemingly intractable problems that require radical thinking and even more radical actions; and

• We, the people, showed our desire for change at the polls and want to begin seeing these changes among our elected representatives, RIGHT NOW.

NB: For those interested in reading more on my views concerning the Good Bank/Bad Bank concept, I’ve written many posts dating back more than a year. This link provides the output of a Good Bank/Bad Bank keyword search on my blog.