Government Plans On Building The Bad Bank

It looks like the Obama administration’s first huge financial reform will involve a government funded “bad bank” to take over the financial system’s troubled assets. It’s got support from the most powerful person in the Obama administration, it’s got a new name, it’s probably the secret plan hinted at by Obama’s Treasury Secretary nominee, and it may be the reason Jamie Dimon and Ken Lewis started buying shares of their banks yesterday.

  • Sheila Bair supports the bad bank idea. Bair may be the most powerful economic regulator in the world right now. Ben Bernanke’s decision making is constrained by colleagues on the Federal Reserve. Everyone else is still transitioning into office. Bair is in place, she’s staying there, and she has her long-serving team of advisers by her side. And it’s become obvious that she is convinced that mortgage backed securities are being systematically underpriced. She believes the government could see a positive return if it bought up these assets.
  • They’ve given the bad bank a new name. You’ll never get lawmakers or the public to support the government creation of a bad bank. The solution is to give it a better name: The Aggregator Bank. This is purely a marketing move…and it’s a good one. It actually describes what the bank will do, aggregating the troubled assets from across the financial system.
  • Geithner hinted at it yesterday. In his Treasury Secretary confirmation hearing yesterday, Tim Geithner indicated that the Obama administration was working on a financial rescue but wouldn’t say exactly what it was. Clearly, something new is in the works. That means they aren’t going to follow the Paulson plan of injecting capital into banks by purchasing preferred shares. We’re betting this big new idea is exactly the one that the Obama administration has been anonymously leaking to the press: the bad bank.
  • Top banking officials are buying. The recent spurt of buying by the heads of JP Morgan and Bank of America could indicate that these guys think–or maybe actually know–that the bad bank will be created. Why would this be bullish news? Because the bad bank won’t dillute shareholders of their banks and won’t subordinate common beneath preferred equities. Instead, it will buy the troubled assets at values higher than the market believes they are worth. This means the banks will get to hand over their junk for cash. Also, buying now seems to be a bet that Obama will not wipeout shareholders by nationalizing either institution. (Side note: if the government officials have been consulting with banking heads about the bad bank, and we hope they have been, does it count as insider trading when the banking chiefs buy their own stock?)

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