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Deliberate Policy to Stabilize the Economy
What to do with Problem Banks
Clarence Schwab, Former Harbus News Editor, HBS MBA '96
Issue date: 2/2/09 Section: News
The Federal Reserve chairman's view that the US government may have to infuse additional funds into banks and separate "bad" assets from banks is correct. Banks are not in a position to lend to all creditworthy borrowers, as they remain under-capitalized given the additional trillion dollars plus of estimated losses the financial system is yet to recognize (according to Goldman Sachs).
To help the economy stabilize, however, not only are additional equity infusions and the separation of "bad" assets required, on which regulators are now focusing; the U.S. must also promptly implement a deliberate policy to handle problem banks. Such a deliberate policy should be implemented by management professionals independent of partisan considerations. In this context, Congress and President Obama should seriously consider creating a separate, independent authority, similar to the Resolution Trust Corporation.
The authority would distinguish between problem banks that are systemically-important and those that are not. Only when a bank failure could have an impact on the payment system would the authority takeover that bank.
If a bank's failure would not affect the normal functioning of the payment system, the authority would permit that bank to fail. The Federal Deposit Insurance Corporation's expanded guarantees, now in place, would protect depositors and senior creditors of that failed bank.
After deciding to takeover a bank, the authority would remove board members, replace existing top management (generally with managers from the ranks of the bank itself), identify bad assets, place those assets into a separate entity and select outside experts to manage and sell them to maximize value to taxpayers. Existing management teams who destroyed shareholder value and existing shareholders would receive no benefit.
The authority would use taxpayer funds to buy non-performing assets at market prices if available or, otherwise, at reasonable prices determined by the authority. The authority would set expectations upfront with outside managers for liquidation timing and results, and give them incentives to exceed expectations. With a full and open accounting, the authority would also infuse sufficient capital into each rescued bank to make the rescued banks solvent. Taxpayers would receive substantially all upside as owners of the non-performing assets and the rescued banks.
To help the economy stabilize, however, not only are additional equity infusions and the separation of "bad" assets required, on which regulators are now focusing; the U.S. must also promptly implement a deliberate policy to handle problem banks. Such a deliberate policy should be implemented by management professionals independent of partisan considerations. In this context, Congress and President Obama should seriously consider creating a separate, independent authority, similar to the Resolution Trust Corporation.
The authority would distinguish between problem banks that are systemically-important and those that are not. Only when a bank failure could have an impact on the payment system would the authority takeover that bank.
If a bank's failure would not affect the normal functioning of the payment system, the authority would permit that bank to fail. The Federal Deposit Insurance Corporation's expanded guarantees, now in place, would protect depositors and senior creditors of that failed bank.
After deciding to takeover a bank, the authority would remove board members, replace existing top management (generally with managers from the ranks of the bank itself), identify bad assets, place those assets into a separate entity and select outside experts to manage and sell them to maximize value to taxpayers. Existing management teams who destroyed shareholder value and existing shareholders would receive no benefit.
The authority would use taxpayer funds to buy non-performing assets at market prices if available or, otherwise, at reasonable prices determined by the authority. The authority would set expectations upfront with outside managers for liquidation timing and results, and give them incentives to exceed expectations. With a full and open accounting, the authority would also infuse sufficient capital into each rescued bank to make the rescued banks solvent. Taxpayers would receive substantially all upside as owners of the non-performing assets and the rescued banks.
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