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Unwanted assets

By Steven Syre
Globe Columnist / January 30, 2009
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Two days ago, financial stocks actually shot up because the idea of establishing a government "bad bank" to buy toxic assets from real banks seemed to be gaining traction in Washington.

By yesterday, those same stocks had given up about half their gains from the previous session.

So what? It's true, the day-to-day movements of a group of stocks aren't very important on their own. But they do capture the desperate hopes for a plausible solution to the financial industry's crisis, and the sobering reality of just how hard it would be to make one work.

The idea of a bad bank, sometimes known as an aggregator bank, is nothing new. It would acquire the kind of troubled assets no one else seems to be willing to buy, the ones that are killing many big commercial banks and other lenders today. The bad bank would manage those assets for a period and sell the portfolio off over time, when hopefully, more stable markets would trade at better prices.

There are real-world examples of entities like bad banks working successfully in America. The Resolution Trust Corp., which managed assets from hundreds of savings and loans, is the most obvious case.

Another example much closer to home: Recoll Management, the Boston company created out of the failure of Bank of New England. Fleet Financial Group, which won the bidding for Bank of New England, operated Recoll and eventually disposed of billions of dollars of assets for the Federal Deposit Insurance Corp.

So it was no surprise when the idea of a bad bank popped up late last year. Then-Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke were floating new ideas to solve the financial crisis on a daily basis. The bad bank concept disappeared for the same reason that financial stocks slipped back again yesterday.

The critical problem facing a bad bank in today's world is about price. What would it pay for assets no one wants to own?

The government could demand banks mark those assets down to the kind of drastic discounts that come with a marketplace that has ceased to function. Most banks have reduced the value of distressed assets on their books, but not to those kinds of prices.

Transactions at those levels could be disastrous for the selling bank, the supposed tough-love beneficiary. It could also be very bad for other banks that own similar assets and might have to discount them to similar values because a new price had been established.

In the alternative, the government could pay more for those same assets. That would cut bankers slack at the potential expense of taxpayers, who wouldn't be getting anything in return for their generosity. How do you think that would go over politically?

Here's how the Resolution Trust Corp. and Recoll managed this problem: They didn't. They both took over assets from failed banks and thrifts, essentially acquiring them free of charge.

Those old "bad bankers" were carving up a financial corpse. The bad bank contemplated today would be working with a living patient that happens to be awake for the operation.

A third option - do nothing - poses another kind of problem. Zombie banks struggling with billions of bad assets could continue to exist, but do very little business for a long time. That's no solution for anyone.

The way out may be a combination of solutions. Some banks can truly improve on their own if given more time. Others are going to fail, and we ought just get to it sooner rather than later.

The rest could get a break selling assets to a government bad bank in return for real incentives. That might mean greater ownership interests for taxpayers. That would dilute existing shareholders and might look like nationalization in some cases, an unpopular thought.

Investors would complain about the dilution, but their holdings were already in big trouble. They would say the government was scaring private capital away from banks, but I'd bet on the opposite. Private capital would be happy to buy the government's shares in a newly revived bank with a profitable future.

A solution, whatever it turns out to be, is going to cost a fortune. That kind of money is going to come with more strings attached.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.

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