Of Toxic Treatments

4th June 09 - Of toxic treatments

Is it possible to take an overview of how the big world economies have decided to deal with the mountain of toxic debt racked up by their major banks? The first move was Britain that, in effect, launched a take-over bid. In pumped in money in exchange for equity and purchased preference shares with such a high coupon that the swap of those for more equity was only a matter of time. It ended up owning the two big domestic banks and driving a third to middle-eastern saviours. In addition, the UK Government guaranteed assets held by a number of financial institutions. Therefore, the government manages the toxic assets and the taxpayer takes the risk. There is no separate "bad bank".

The US took a different route. It announced the formation of such a separate entity (TARP) - one of the very first entries in this diary and the subject of a separate article on this website. But, such a central pool seems not to have taken off (it did not help that meantime the administration has changed from Republican to Democrat). Instead the US is trying to entice private investors using generous public financing terms to buy troubled assets from banks. Again, like the UK, there would be no separate bad bank. The problem with this approach is that banks may well be unwilling to sell such assets if a loss would result.

A bad bank approach has been adopted by Germany, Switzerland and Ireland but "approach" is the operative word. The entry yesterday emphasises that the German way is an off-balance-sheet way and not really a bad bank at all and could lead to zombie status for affected banks. And as for Ireland - Brian Lenihan, the Irish finance minister said it was impossible to put a value on the troubled property loans that it  planned to transfer to the newly created National Asset Management Agency (NAMA). He told a parliamentary hearing that any transfer pricing mechanism would include a "long-term economic valuation" as well as an estimate of the current market valuation. Small snags are that property developers may have pledged a single security on multiple properties and given personal guarantees to numerous banks that could be used only once.

Is there a solution? A report by Pricewaterhousecoopers thinks that government guarantees could be sold to private investors and via large mutual funds that participate in the auction. It is a sort of US approach but widened. Worth some thought.