One Bank Two Bank Good Bank Bad Bank

Well my literary ability is not as well crafted as Dr. Seuss however you get the point. I need to vent on the proposal to take "toxic loans" off bank balance sheets. My point is very simple - what is the U.S. governement going to pay for these assets? Seems simple in theory but in reality it is anything but. Generally the assets we are talking about are collections of assets such as HELOC's, mortgages, student loans, credit card receivables etc. However the difficulty comes with valuation. The bank has all the incentive not to write down the value of the asset to the market value because it would impair (even further) their balance sheet. While a potential investor will look at the underlying assets and determine what they are willing to pay to take on such risk. Recently I was shown an example where a bank valued an asset at 97 cents on the dollars but a potential investor valued it at 38 cents on the dollar. Quite a difference. Who is right? Considering the price we are paying for risk these days the truth probably lies in the middle (but closer to 38 than 97).

Again what price does the government pay for the assets? Obama has two choices. First if he pays 97 cents the bank shareholders and management are happy but the taxpayer gets stuck with a bill as the actual value is much lower than they have just paid. Second if they pay 38 cents the bank is completely screwed and its capital base is eroded and in need of a capital injection to remain solvent while the taxpayer is made whole through its willingness to take on risk. In this situation the equity holders are either completely wiped our or are severly diluted and the bond holders are holding on for dear life.

I have a hard time supporting any plan that saves the banks without wiping out the management, equity holders and bond holders. I don't believe I am going to get my wish. It looks as if the U.S. taxpayer is going to be on the hook for this bill and only time will tell whether or not the banks have been cleansed. My feeling is they will be back to the trough a few more times before this is all over. I don't know where the "Law of Unintended Consequences" comes into play here but when I do I'll let you know.