Given the limited scope U.S. authorities have for increasing the public debt burden without adverse asset market responses, it is best to forget about tax cuts or public spending increases. Instead, the available fiscal resources should be focused on restoring the flow of credit to nonfinancial enterprises and, to a lesser extent, to households (most of which are already over-indebted and should not be encouraged to spend more).
Rather than wasting the $1.4 trillion of public funds it would take to restore (according to NYU economist Nouriel Roubini's estimate) the capitalization of the U.S. banking sector to its fall 2008 level, it would be better to use public money to capitalize new banks that don't suffer from an overhang of past bad investments and loans -- and to guarantee new borrowing or new loans and investment by these banks. This "good bank" model achieves this by identifying the systemically important banks that are kept afloat only by past, present and anticipated future public financial support ("bad banks") and taking their banking licenses away.
The "stress test" proposed by Mr. Geithner for major banks (assets in excess of $100 billion) could be used to gather the necessary information to identify the bad banks. New banks, capitalized by the government (possibly with private co-financing) would take the deposits of the bad banks and purchase the good assets from the bad banks. Future government support, through guarantees or other means, would be focused exclusively on new lending and new borrowing by the new good banks and those old banks that passed the stress test.
The legacy bad banks would not be allowed to make new investments or new loans and would simply manage the inherited stocks of assets in the interest of their owners. They sink or swim on their own. If they fail, their unsecured creditors can figure out what to do with the bad assets
I have several issues with nationalization: who do you nationalize, how do you do it to minimize market disruption and how do you prevent political corruption from entering into the picture after you do it. The above plan comes much closer to addressing my concerns.
First, I always liked the stress test idea. The Treasury has to go into all of the big banks and take a look at all their books in detail. And no party involved can pull any punches. In addition, the more a party tries to obfuscate the truth, the more trouble they are in. I've always thought this was the best way to figure out who gets help. In other words -- we know how to find out who.
How is a big issue. The markets are already reeling from the threat of nationalization. Every time it gets brought up, the markets tank. This was cited as a primary reason for last week's market instability. In other words, the actual process of shifting from private to public ownership is an issue.
Now enter the above plan. I would personally use the remaining TARP money to make one big bank. Then I would stress test all the money center banks at the same time and come out with a report on all of them at the same time. Force them to sell their good assets to the one good bank and let the dregs remain in the old banks. If you do this over a short time period -- say 2-4 weeks -- you can end this problem pretty quickly.
The main reason I like the idea of one big bank is there is only one bank to monitor. That's been a huge issue for me with the idea of nationalizing the banks -- the idea that we would still have all of these banks to perform oversight on. With one big bank we just have one bank to monitor which is a much easier task. For me, it makes much more sense.