Good Bank vs. Bad Bank: Segregating Toxic Assets Might Help U.S. Economy Rebound

Same thing today. Banks made bad loans, in current lingo, troubled or toxic assets, the "T" in TARP, the Troubled Assets Relief Program, last year's big bailout designed to buy up those assets, but transformed instead into just giving the banks more money to keep lending.

Despite the fancy acronym, though, the trouble is that these loans are unlikely to be paid back, toxic in that, if the loans go bad, the banks would only be able to pay back the depositors, much less the investors, when pigs fly.

SIMON JOHNSON, Massachusetts Institute of Technology: Nobody wants to own the stock in these big banks right now because they're so afraid of these toxic holdings that they have.

PAUL SOLMAN: MIT economist Simon Johnson, who helps write the crisis blog at BaselineScenario.com.

SIMON JOHNSON: So you want to split the banks, put the toxic bad stuff in some entity -- let's call it the bad bank -- and keep the good part of the business in the good bank. The good bank, you say, "Congratulations, you now run a bank without any of the toxic assets, without any of the holdover problems. Your job is to run this as a bank that makes money in a good, old-fashioned banking way."

PAUL SOLMAN: This is old-fashioned banking that many banks have not been doing, even though they took the bailout money, for fear of making more loans that might turn toxic. So the proposal has been split the system in two, good bank, bad bank, the latter, at least, owned by the government, which hires folks to sell the bad loans.

SIMON JOHNSON: You put some guys in, and you say, "Guys, sell stuff off. Get us out of this position. Don't do it overnight, because that'll probably mean even bigger losses, but over a five year period we want to exit. So find buyers, negotiate as best a deal as you can." And we also hope the economy's going to rise, and that'll help them to some degree.

OK, here we actually are in Sweden with good bank, bad bank, because that's how the Swedes solved their cataclysmic bank crisis back in the early 1990s. Our expect, Swedish economist Anders Aslund.

ANDERS ASLUND, Peterson Institute for International Economics: What Sweden did was, first, to make sure that they knew all the losses in the banks. And the second thing was to take out the bad debts from the normal banks and put them into bad debt banks. And then the good banks started giving loans again.

PAUL SOLMAN: But if the idea is to take all these toxic assets and put them in a bad bank, aren't you simply relieving the banks, at taxpayer expense, of all the bad loans they've made?

ANDERS ASLUND: This is rather likely to be a big asset in the future. The Swedish government funded a bad debt bank, was sold off gradually, and actually made a slight profit.

PAUL SOLMAN: You mean more money than the Swedish government actually paid in total?

ANDERS ASLUND: Yes.

PAUL SOLMAN: In other words, the bad loans put into the bad bank turned out to be worth more than the fire-sale prices the government paid for them at the bleakest stretch of the downturn.

As for the good banks, Sweden had nationalized them and, rid of their toxic assets, they were turned around and, in a few years, re-sold to private investors. But Sweden is a lot smaller than the U.S. and a lot more homogeneous.

The argument in favor, according to Simon Johnson.

SIMON JOHNSON: You can have the president go on TV and, in 30 seconds, or maybe two minutes, he can explain to you what we've done and say, "OK, fine, we've made a clean break." Right, so the concept of break is a very easy one to communicate. The con or the problem is the valuation. So what price are you paying?

PAUL SOLMAN: Paying to the private banks, that is, for the toxic assets. If the price is too high, taxpayers get hosed; too low, and the banks won't go along with the deal. If the government forces their hand, that is nationalization.

SIMON JOHNSON: And so that is a very thorny political issue, because the U.S. doesn't want to end up with a nationalized banking system at this point.

PAUL SOLMAN: But perhaps it should want that?

SIMON JOHNSON: We're not comfortable with that yet. Maybe in three months we'll have to become comfortable.

PAUL SOLMAN: If, that is, we haven't already split the system into good banks and bad banks, both types owned by the U.S. government, what you might call the Swedification of the U.S. banking system, for better or worse.