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Fixing nations' broken banking system will be costly
Toronto Globe and Mail


February 05, 2009
Thursday PM

Capping executive pay is the easy part.

But fixing the broken banking system remains as elusive a goal for President Obama and his new Treasury Secretary, Tim Geithner, as it was for the Bush administration.

Experts say it will take time, and a whole lot more taxpayers' money -- perhaps another $2-trillion. And maybe a few more false starts.

The administration will unveil what Geithner called "a comprehensive program for financial recovery" next week.

"We will have to do more -- substantially more -- to fix this crisis," Geithner said.

The plan is expected to include one or all of the following options: a giant "Bad Bank" to consolidate toxic loans, an orderly winding up of hobbled banks, federal guarantees to shore up the surviving banks and more aid for homeowners. Some experts are even advocating nationalizing key banks.

None of the options is perfect nor sufficient on its own to deal with the financial crisis, most experts agree.

"The financial system is in bad shape and so none of the options is a good option," agreed Douglas Elliott, a fellow in economic studies at the Brookings Institution in Washington. "We are looking for the least bad solution."

There is also a risk that whatever Obama does could make the situation worse, said economist Simon Johnson of the Peterson Institute for International Finance in Washington.

The ultimate goal is to get the major banks lending again, by relieving them of their bad assets and shoring up their balance sheets.

But it would be a serious mistake for the government to compel banks to lend or to lend to particular types of borrowers, argued Johnson, a former chief economist at the International Monetary Fund.

"This would be a recipe for more bad loans and further damage to the banking system, and more costs to the taxpayer," he said.

"It would also lead to corruption, scandal and reform fatigue."

There was overlending during the boom years and now banks must reduce their leverage to get healthy again, he said.

A key problem for the banking sector is the continued weakness in housing. U.S. home values have already fallen 25 percent from their peak in 2006, and economists expect prices to fall at least another 10 percent before the market bottoms out.

That means more foreclosures, and more homeowners owing more on their mortgages than their homes are worth.

So far, the U.S. Treasury has doled out roughly half of the $700-billion Troubled Asset Relief Program. That leaves just $350-billion left to deal with a much larger problem.

Johnson estimates that a Bad Bank would cost as much as $3-trillion to $4-trillion to set up. The net cost to taxpayers, after working out and selling the bad loans, would be $1-trillion to $2-trillion, or 5 to 10 per cent of U.S. gross domestic product.

The benefit of a Bad Bank is that it clears up the balance sheets of banks, allowing them to lend again.

The tricky part will be to figure out what prices the bank will pay for the assets this aggregator bank acquires. None of this is easy.

If the Bad Bank pays distressed prices, the banks selling the assets might become insolvent, as would other banks holding similar assets. So the government presumably will have to pay above-market rates, forcing taxpayers to take a heavy hit.

That's why some lawmakers, including Sen. Charles Schumer, D-N.Y., are urging the Obama administration to focus instead on insuring the banks bad debts.


E-mail Barrie McKenna at bmckenna(at)
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