Is the 'Bad Bank' a Good Idea? (Morningstar)

Mathew: Hi, I'm Mathew Warren. I'm the associate director of Equity Research for the bank team here at Morning Star. Hitting the news, we’re seeing more rumors of a bad bank being formed up by the governments. Perhaps next week, we might get some more details, with me today to help flush this is Jamie Peters our senior analyst on the Bank Team and Jamie, isn’t this just the original tarp kind of reformulated with less money? Jamie: Or they might not be less money actually, we have a $350 billion left to the tarp. They have been approved for release but they are suggestions that they’ll be the $350 billion quest more in order to try to form this bad bank. Mathew: Very good, and in similar to the resolution trust back in savings and loan debacle except in that case, the assets and the bad bank loans were aggregated after the bank has failed. This time they’re trying to do it before the banks into further trouble and before they fail so, what do you think the invocation to that is? Jamie: I think it’s going to help the big banks especially because those type of banks, the Bank of America, City Group, JP Morgan really feel too large to fail. If they would go under, we would have systemic crisis so the government looks like they’re trying to find a way to sure up investor confidence and customer confidence in these large banks by trying to remove some of the toxic assets, however, I can't see any possible way how the government s going to get all of them off those balance sheets. Mathew: Well, they wont be able to take necessarily all the liquidated assets but you have the whole loans and the rest of the balance sheet that we still have to contend with and that’s when the trouble’s are really brimming right now. Is that fair to say? Jamie: I agree. 2008 was really the story of security loses, 2009 is about loan loses which is why you are seeing the major problem go down from just being the big banks into the mid-sized and even smaller banks. Mathew: The other issue that I see and we’ve talked about this before is that, the actual pricing in these securities, how do you determine a price when you’re going to help these banks out? Do you underpay for them? Do you overpay for them? And how do you even come to that answer? Jamie: Everybody and their brother has this suggestion for this, the reality is you can't do fire sale prices with the banks because they don’t have enough capital to be able to sell the assets at the fire sale price without going and failing anyway. So, then, you have to pay something above fire sale prices because that means book values, that means a premium to book value. a premium to book value is even book values is going to tax payer havoc because they’re going to argue that the government is taking the loses and that endowing bad banks with free gift money but at the same time you can't, there are the opposites that you don’t want then to fail. So, the government’s really going to have a tough problem and I really wish I have the answer on what’s the best way to do it but I don’t. Mathew: Yes, there could be a political back lash there that seems clear if they do overpay. And then, so once you’ve taken the liquid securities or at least the majority of them from a variety of large banks, what are we left with? What is the landscape looked like after you’ve done that? Jamie: Well, we have a lot of capital of those banks for the most part and so they are going to now have a capital base to be able to absorb loan loses which is really that is sure to drop and that the capital still needs to be there which means the banks are probably still going to be very hesitant to do a lot of lending. What that means again, we don’t have an effective solution for this credit crisis but what we have is we’re taking care of one issue and leaving more issues on the table and that also means that someday, we could get back right to where are right now. Mathew: Just from loan loses but at least we’d take that X-factor off the table. Well, thanks for walking me through that Jamie and thanks for joining us.