An idea being floated around at the moment is that of a “bad bank”. This would be a financial vehicle set up by each individual country whereby the “toxic” assets of the banks would be placed. These toxic assets are so called, not because they can give you Ebola or are made of Asbestos, but simply because nobody knows how to value them. In a capitalist economy, to have an asset that cannot be properly valued sitting on your balance sheet is the equivalent of not knowing your true exposure to risk. In financial terms, Ebola is far easier to deal with.
In creating the financial “bad bank”, the toxic assets would be placed in isolation where their value can be worked out over time and at leisure by the government, assuming it has the wherewithal to do so. The risks of having them in the governments’ hands are far outweighed by the fact they once in the Bad Bank (BB), they are off the normal (let’s just call Screwed) banks’ balance sheets. They are then now free to act and trade normally freed from the uncertainty caused by having the toxic assets on their books. So far, so good.
Governments have so far avoided biting the bullet, offering instead a whole load of market reassuring measures such as part nationalisations and insurance guarantees, but these have not really stemmed the losses or removed the uncertainty. For example, how can you insure something that you cannot truly value? Also the fact that this insurance is being provided to bankers (seen as innately profligate) by taxpayers (seen as innately innocent) is difficult to sell politically to restive populations which, by virtue of us living in democracies, can show their discontent by voting you out. Ah, Obama and Brown must secretly envy Mr Putin…
The biggest obstacle to a Bad Bank, however is that Screwed Banks (i.e. RBS, Citibank, and every bank that got a handout) have not gotten wind of that expression that “beggars can’t be choosers”. They did however apply that other one, you know, “beggars can’t be lenders”, which is why our economies are stalled. So they are not keen on a Bad Bank because they would have to sell their assets to the government to put into the BB but don’t want to shortchanged. And as these assets are toxic, i.e. you cannot value them definition, then you cannot know how much to ask for them. Catch 22. You cannot value them, so you cannot sell them, and you cannot sell them till you can value them. So everybody procrastinates. You know, replace Nero with Brown or Obama, and Rome can be The City or Wall Street. The fiddling is what we’re all doing at the moment.
When Michael Jackson said "BAAAD", He Meant "GOOD", And So It Is With Sameh's Bank
SAMEH’S SOLUTION
It is my belief that the longer we go without a Bad Bank, the more the uncertainty, the losses, and the greater the possibility of ourtright nationalisation and threat to our capitalist (and now sadly socialist-looking) system. Sameh’s Solution is based on totally avoiding the need to value the toxic assets in any precise way. It is case of make Bad Bank now, sort out valuation later, and no immediate payments will be made by the government if ever. It will be understood that the facilities provided by the government to the banks, in the form of loans and liquidity to the markets, as well as the future avoided risk of having toxic assets on your balance sheet are more than enough immediate payment to the banking sector. Sameh’s solution will be applied over a financial week.
- Governments Pass A Law To Create Bad Bank Which Acquires ALL Toxic Assets. This will be done quickly as an emergency law. We are in an emergency. We apply a state of emergency in a natural disaster, this is a far bigger disaster and in any case a far bigger threat to our democracies than terrorism.
- All Toxic Assets are transferred to the Bad Bank on Monday, say. All banks, whether they got government help or not will be required by law to transfer all toxic assets off their balance sheets by close of business Monday, without any payment in return. Any bank that refuses will be forcibly nationalised. Get out of that one!
- The law that was passed to create the Bad Bank would have made provision for the formation of an independent committee of valuers, a mixture of quant-types, actuarial and accounting agencies that would have been given full access to the banks’ toxic assets in the weeks prior to TRANSFER WEEK. These guys will be required to act independent of both the government and the banks, and would carry out all their deliberations behind closed doors, not unlike a jury. Screw transparency, as we haven’t really had it for some time now. This independent Comittee will be known as the Bad Bank Independent Board (BBIB). They will be expected to work out a system to roughly - roughly is all we need - evaluate the toxic assets of each bank.
- Once the assets are transferred the BBIB will work out an average price of the assets over the 5 business days of the Transfer Week, to try to smooth out any craziness out of the valuations that could be created by the increased volatilities in the markets created by the formation of the Bad Bank.
- On Friday, an average rough valuation of each bank’s assets over the week will be worked out from data accumulated over the week. Each bank’s toxic asset position will be roughly estimated, as a mere snapshot in time, but it will have to do.
- The government will need to pay the banks for the assets, but not immediately, if at all. It will do so by deciding that 20%, say, of the shares of the Bad Bank will be awarded to the banks in lieu of payment. These shares will pay no dividend and are non-voting shares, and cannot be sold till a law is passed in the future to dissolve the Bad Bank. The 20% will be divided pro-rata between the banks according to the rough estimates of the size of each bank’s exposure. The more toxic assets they have, the more shares they get. I know it sounds counter-intuitive because there is a belief that we should punish those with more of these assets. But these things are worth something, sadly we’re not too sure how much, and the more of them you have, the more you should be getting paid. A bank that did not get government help will be given a relatively bigger proportion of the 20% of the Bad Bank than a bank with the same amount of toxic assets that received government help according to a conversion factor. That is fair.
- Now the government is the majority owner of the toxic assets. The tax payer will wait, as it would have waited anyway if all these banks got nationalised, to get its money back. But at least we would have a competitive financial system, and the financial system would have been back to semi-normal operaion, and far more regulated, from the day they toxic assets left their balance sheets on the first day of Transfer Week. An entirely nationalised system is not good for anyone. Also we would draw a line under the issue of the toxic assets once and for all.
- Once the initial secret valuation and sharing out of the 20%has been done by the BBIB and the banks accepted them, all BBIB future deliberations andvaluations will be made public as the Bad Bank is a publicly held entity.The BBIB will continue to advise the owners of the BB, but they reserve the right not accept its valuations, and seek other market valuations. The government as majority shareholder will have to manage its own risk, together with advice from the banks who own the remaining 20%. The Bad Bank will exist until all toxic assets have been valued and the positions unwound. The monies can be split, and the government may reserve the right to include added costs of maintaining the financial system as a liability to the bad bank, before paying out using the 20-80% split. This provision would also be in the law that was used to incorporate the Bad Bank, and the banks would have no right to challenge this in the future. The banks may end up with nothing, but the possibility of them possibly getting paid sometime in the future needs to be included to maintain the pretence that we are still living in capitalist societies.
- Just in case Obama or Brown want to give me a job to create the Bad Bank after reading this, save your breath. I am after a Nobel Prize!
No Resurrections Promised With A Bad Bank, Sadly For Some, But Less Future Deaths...
4 Responses
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First of all what is a Toxic Asset? Who gets to decide what has to be sold to the BB? Assets may be deemed toxic for reasons other than underlying value, not to mention the fact that since the sale price would not be up for discussion everybody would try very hard to only offload assets that they assumed had a true value at or below the value that they assume the BBIB would set.
The second issue I have with the above idea is that if all such Toxic Assets are placed in the BB, banks will be no more solvent than they are today. Their capital adequacy will not be in doubt any longer - in many cases they will simply be nonexistent. Furthermore, the value of the BB shares that are awarded in lieu of payment will be even less certain than the value of the Toxic Assets themselves adding another layer of uncertainty.
Lastly, I feel that having a committee of a workable size, say less than a few thousand, would simply not be able to value the assets in the time provided. Banks and their auditors have been trying and failing for over a year now to put a price on assets that are so far removed from real world processes and assets that they would be hard pressed to understand some of them in the time allotted let alone value them. It can be argued that this is simply dithering by the stakeholders to avoid the horrible naked truth about the erosion of the banks assets, however, I would argue that in many cases they are simply unable to attain the vaunted fair value.
The real question is if there would not be riots by the former Investment Bakers in gucci shoes, outside of the bunker, in order to preassure the BBIB.
Cheers!
I agree with Arthur: a key issue is the incestuous relationship of banking with politics. That is probably why no government has come up with Sameh’s BB solution - as yet.
Miklos, regarding defining a toxic asset it may difficult but not impossible, it is a question of where you put the “junk” threshold, no? A point that can be learnt from the Swedes back in the 90s is that it is easier to create one BB for each bank that applies to the saving plan. This is because it is easier “not to cope with the burdens of rationalizing and coordinating a variety of computer systems, filing systems, and information retrieval systems…documents were more uniform than they would have been if they had come from a variety of sources….it was possible for the BB to pattern its organizational structure after that of the supposedly good bank” (Are Bad Banks the Solution to a Banking Crisis?, JR Macey, June 1999).
I disagree on your second point. A lot of the chaos we are in now comes from high uncertainty and lack of confidence that translate in a stall of interbank mkt and increasing costs of funding. Once you take off toxic assets from a bank’s balance sheet, this should be able to get money at a lower costs on the mkt (note that government have already injected a lot of capital in the sector anyways).
Let me go in reverse order.
Surely once the balance sheets of the largest 50 banks in the US and UK have been “cleaned up” and the Toxic assets swapped for shares in the BB we will be faced with a situation that these banks will have very little or no equity left. I agree that in that situation we will have clarity, however the stark reality of their capitalisation - or lack thereof - will cause all partners to stop trading with them. Average Joe hasn’t as yet closed his accounts at RBS or Citi, until now only those wholesale partners have withdrawn their confidence from them that understand the gravity of the situation, namely that they are in all likelihood insolvent (actually I am not sure that is the right word for it but it makes my point nonetheless). Just look at what happened to Northern Rock. A run on these institutions would be crippling. What would follow is nationalisation. I am afraid that the clarity we would get is no more conducive to building confidence then the current situation.
Maybe the solution would be to nationalise all the banks, thus avoiding the above scenario. The nagging question I have is if we are willing to accept that the “Government” will be able to repay these ungodly sums in the future. Some countries such as Poland and Hungary are already having a very hard time convincing their respective creditors of this. At what point will we say the same about the US?
Maybe I am a romantic but even now I feel that the worst possible owner for a financial institution is the State. They would always err on the side of caution and would invariably be politicised no matter what they would claim.
I have no idea whatsoever how many items are on the assets side of one of these banks. I assume by the number of their customers it would be millions. How do you draw that line of what is Toxic? By the number of days that they are late on their home loans or by secondary market data for the asset backed security? The task is obviously possible, I am just claiming that it would take a very long time and would involve making a lot of assumptions that are in the long run likely to be unfair.
Once we set up the BB we will have two new issues that will have to be dealt with. Recapitalisation will be easy enough, we will just have to accept that our children will pay the bill (praying for Zimbabwe style inflation is also possible :D). Inept or criminal pricing of Toxic assets will make a selected few richer than Croesus and the public will loose confidence in the state once and for all.
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