Stiglitz: Let's create "good banks"

Nobel Prize-winning economist Joe Stiglitz reiterates and elaborates his long-standing view that government must temporarily seize failed banks:

It has been obvious for some time that a government takeover of our banking system—perhaps along the lines of what Norway and Sweden did in the ‘90s—is the only solution. It should be done, and done quickly, before even more bailout money is wasted.

Stiglitz also explains another sensible approach (that is apparently receiving no consideration from the banking industry insiders running the bailout show):

One innovative proposal (variants of which have been floated by Willem Buiter at the London School of Economics and by George Soros) entails the creation of a Good Bank. Rather than dump the bad assets on the government, we would strip out the good assets—those that can be easily priced. If the value of claims by depositors and other claims that we decide need to be protected is less than the value of the assets, then the government would write a check to the Old Bank (we could call it the Bad Bank). If the reverse is true, then the government would have a senior claim on the Old Bank. In normal times, it would be easy to recapitalize the Good Bank privately. These are not normal times, so the government might have to run the bank for a while.

Meanwhile, the Old Bank would be left with the task of disposing of its toxic assets as best it can. Because the Old Bank’s capital is inadequate, it couldn’t take deposits, unless it found enough capital privately to recapitalize itself. How much shareholders and bondholders got would depend on how well management did in disposing of these assets—and how well they did in ensuring that management didn’t overpay itself.

Posted by James on Monday, March 09, 2009