Remember What A 'Bad Bank' Really Is

The latest way to pay up for bad assets.

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Second verse, same as the first. The idea to create a "bad bank" to buy up those pesky billions worth of bad assets still on the books at big banks is the latest twist in our long bailout saga. Estimates for what it might cost ( up to $4 billion) and whether creating such an institution to sort out those assets would even work are unclear, mostly because nobody is sure how to go about setting prices. The idea is reportedly meeting some dissent, and reactions have been harsh given the usual lack of clarity.

As the WSJ's David Gaffen puts it:

The current proposal combines purchases of the assets on the balance sheets of the nation’s largest institutions, along with the guarantee against future losses on other assets, and once again, it leaves investors grappling for specifics as the wheels turn slowly.

The frustrating thing is that this is exactly the problem we've had all along. Six months into the worst credit crisis in memory, and we're still facing precise dilemma the first $700 billion bailout was designed to fix (remember: the super-rushed first version of the TARP was going to buy those assets).

So there's no reason to get excited by the plan, other than the likelihood we'll get to watch policymakers get anxious and aggressive in pushing through a new, expensive idea that might or might not get to the heart of the problem. That's because the one thing we do know about these assets is that banks haven't really been working all that hard to figure out how to price them until they see a plan from the government that might get them more money than they'd otherwise be paid if they sold the assets on the open market. In the meantime, the economy suffers as bankers hope for a sweeter deal.

So keep that in mind. What a 'bad bank' would most likely do is over-pay for bad assets.

In an interview with Fortune today, Oppenheimer analyst Meredith Whitney says as much. If this idea gains traction, just remember this quote:

"The bad bank is a covert way to recapitalize banks by paying more for the assets than the market would, she said. "Then the banks might be able to write up the value of the securities. This would give them, on paper, more tangible equity. In theory they would look stronger."

Bankers seem to think if they wait long enough, they'll still get to dictate price. They might be right.

  • Kirk Shinkle

    Kirk Shinkle is a senior editor for U.S. News Money and manages the Best Funds portal. Follow him on Twitter @KirkS or email him at kshinkle@usnews.com.

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