A Bad Bank is a Bad Idea

I've shied away from bitching about the budget - at least here. That was before Brian Lenihan's appearance on Prime Time last night to discuss the 'bad bank' proposal. Never mind the fact that the Government have committed to buying assets without making any effort to ascertain their value - their 'bad bank' plan as proposed is doomed to failure if history and common sense are any guides.

Charles Wallace and Swedish Economist Stefan Karlsson go in-depth elsewhere,but the reasons are simple. In the two recent examples of successful 'bad bank' proposals - the American response to the 1989 Savings-and-Loan scandal and the (oft-cited) Swedish response to the 1990s banking crisis - the institutions being rescued were nationalised. Government officials objectively set the value of bad assets that the banks couldn't offload, and the state purchased them. When the banks had traded for a bit and found their feet, off they went again into the Private Sector, and normality was restored. 

In Japan, they took a different approach between 1999 and 2005, with the Resolution and Collection Group: the barely-solvent or insolvent banks continued as independent entities, and tried to negotiate the sale price of the  with the RCC. Predictably, they thought their assets - many of them ludicrously overvalued Zombie companies - were worth more than the State was prepared to pay. The result? The RCC only purchased 858 loans, with a nominal value of $38 billion, and Japan's economic stagnation continued right up to the present crisis.

The Government's plan (and, whisper it, Obama's) is doomed to failure for the very reasons that hobbled the Japanese approach. With bankers trying to extract maximum value for their worthless assets and Government officials trying not to get shafted, the result will be a "stalemate" - that's the analysis of William Seidman, who headed up the American response and advised the Japanese on theirs. 

Moral outrage over the proposal is a blind alley - there are no good choices in the current crisis. However, if we're going to bail out bankers, the bailout strategy should at least work. This plan, quite simply, won't.

UPDATE: Lenihan on RTE Radio has said that the Government may 'part nationalise' banks if the bad debts are big enough. Are they making it up as they go along?