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Up Next: Good Bank / Bad Bank

The Street believes that "good bank/bad bank" is inevitable.

The horrible performance of the banks today (the Bank Index is down 13 percent today, down about 35 percent since the start of the year) indicates that the TARP, so far, is not working and some other approach needs to be taken.

The hot topic is the creation of a '' bad bank'', which would buy failed or failing assets from banks in exchange for equity. The hope is that a "bad bank'' will free-up capital that is being held as a reserve and improve credit.

The argument in favor of a "bad bank" is that:

1) It attacks the main problem, which is that toxic assets are weighing down the ability of banks to lend; and

2) There is ample precedence for this because it is essentially what the Resolution Trust Corporation successfully did in the 1980s and 1990s for the failed thrift assets.

The main argument against a "bad bank" is that it may be impossible to get an agreement on the price to be paid. Indeed, this is the main reason Treasury abandoned the idea for TARP 1.

If they buy assets at a premium, it would help the banks but be politically contentious. If they are bought at a discount many banks would likely find any way they could to avoid the capital hit.

The bet on the Street is that they will buy assets at a premium (or at least mark to market) to help the banks.

The other issues are, what would a bad bank do? Would it be able to engage in lending activities? Would it compete with private banks? Would it be empowered to modify the terms of its loans?

These questions will be answered quickly, since there is a belief that more aggressive action must be taken immediately.

    • US Bank Stocks Fall on Fears More Losses Ahead

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