A better way to fix the banks
Here’s a plan that could solve the toxic-asset pricing problem
voluntarily—without requiring Uncle Sam to nationalize the whole industry—
and make (pretty much) everyone a winner.
Lowell Bryan and Toos Daruvala
F E B R U A R Y 2 0 0 9
f i n a n c i a l s e r v i c e s
In recent speeches, President Obama and Fed Chairman Ben Bernanke have said clearly
that the United States will provide whatever capital is needed to keep US banks solvent and that
they do not plan to nationalize even deeply troubled banks. This is good news, because economic
recovery requires a healthy, profit-motivated US banking system.
However, there has largely been silence from the administration on taking any action to remove
bad loans from bank balance sheets. Until the hundreds of billions of dollars of impaired assets
that currently weigh down bank balance sheets are removed, credit flows will be restricted. If we
wait for the banks to absorb the losses from these loans (net of recoveries), we will wait a long time,
and the economic turnaround will be very slow in coming.
To date, plans to remove these bad assets have foundered on precisely how to do so—specifically,
on how best to value the assets. Details matter. The Treasury has launched a program to use
“stress tests” to identify, proactively, the bad assets on bank balance sheets, using financial models
to project future loan values and loss rates under different economic scenarios. The intent is to get
better answers about the extent of future losses and to better understand which banks are healthy.
But what happens next? Which valuation method will be used to buy the bad assets? If prices are
set too low, banks won’t sell the assets unless forced to do so. If prices are too high, the existing
shareholders would be “unjustly enriched.” This dilemma is what stopped the first Paulson plan to
remove toxic assets, and no amount of stress testing gets you around it.
Our aim is not to plunge into those political debates but rather to p