Harvard’s Lucian Bebchuk: Competing ‘bad banks’ could hold down the cost of financial recovery

Harvard Law professor Lucian Bebchuk has come up with a brilliant idea to speed up the processing of banks’ troubled assets and ensure that the clean-up is done at the lowest possible cost: Competition.

Instead of setting up one “bad bank,” as envisioned by the Treasury Department to handle the bad debts, establish several “bad banks” (also called aggregator banks) to compete for those high-risk mortgages and other dubious assets.

Why is this idea better than the single “bad bank” now under consideration? First, keep in mind that any “bad bank” will be a public-private partnership, and the ratio of tax money to private money placed at risk will have to be negotiated. Each private investor will have to estimate how much the devalued assets currently are worth, and then calculate how much cash he is willing to risk.

Invisible hand. If there were only one “bad bank,” its private managers could demand that the government commit more tax money than really is necessary, and there’d be no way to know if a smaller public stake would have been enough. However, if 25 “bad banks” were established, their competition for the troubled assets would maximize the private share of the risk, and minimize the burden on taxpayers.

Professor Bebchuk, this is a great idea.

This concept is so well-thought-out that

(1) if passed, it is 100 times more likely to repair the economy than the new $787 billion “stimulus” program; and

(2) it probably won’t pass.

But here’s hoping.

Frank Warner

Comments

[jj mollo]

Sounds interesting, but all the bad banks would be playing with government money so they will be inclined to overbid. They are competing, but have nothing to lose.

[Frank Warner]

The "bad banks" would involve private investors' money, too. The 25 "bad banks" would be bidding not only on the price of the dubious assets, but on the percentage of private money that must be invested. And they would be bidding against one another.

Those 24 other banks (or funds) would take the assets by bidding the highest prices and highest percentage of private investment. They wouldn't want to bid too high, because those private investors want a reasonable return.