Deliberate Policy to Stabilize the Economy

The Federal Reserve chairman’s view that the US government may have to infuse additional funds into banks and separate “bad” assets from banks is correct. Banks are not in a position to lend to all creditworthy borrowers, as they remain under-capitalized given the additional trillion dollars plus of estimated losses the financial system is yet to recognize (according to Goldman Sachs).

To help the economy stabilize, however, not only are additional equity infusions and the separation of “bad” assets required, on which regulators are now focusing; the U.S. must also promptly implement a deliberate policy to handle problem banks. Such a deliberate policy should be implemented by management professionals independent of partisan considerations In this context, Congress and President Obama should seriously consider creating a separate, independent authority, similar to the Resolution Trust Corporation.

The authority would distinguish between problem banks that are systemically-important and those that are not. Only when a bank failure could have an impact on the payment system would the authority takeover that bank.

If a bank’s failure would not affect the normal functioning of the payment system, the authority would permit that bank to fail. The Federal Deposit Insurance Corporation’s expanded guarantees, now in place, would protect depositors and senior creditors of that failed bank.

After deciding to takeover a bank, the authority would remove board members, replace existing top management (generally with managers from the ranks of the bank itself), identify bad assets, place those assets into a separate entity and select outside experts to manage and sell them to maximize value to taxpayers. Existing management teams who destroyed shareholder value and existing shareholders would receive no benefit.

The authority would use taxpayer funds to buy non-performing assets at market prices if available or, otherwise, at reasonable prices determined by the authority. The authority would set expectations upfront with outside managers for liquidation timing and results, and give them incentives to exceed expectations. With a full and open accounting, the authority would also infuse sufficient capital into each rescued bank to make the rescued banks solvent. Taxpayers would receive substantially all upside as owners of the non-performing assets and the rescued banks.

With adequate capitalization and a transparent, clean balance sheet, rescued banks would not be distracted managing problem assets and would focus all of their energies, instead, on making new loans to creditworthy borrowers and participating fully in the economy. Equity investors would likely be willing to invest in the rescued banks. The authority could then sell equity in these banks to investors, which would permit taxpayers to recoup part of their investment. Once the outside managers completed the sales of non-performing assets, which would also return capital to taxpayers, the authority itself tag heuer replica for sale , having achieved its objectives, would be terminated.

Congress and the president-elect hopefully now realize that half-measures will only lengthen the crisis and further undermine confidence and economic activity. If the U.S. has the political will to enact a deliberate policy to handle problem banks, in conjunction with comprehensive fiscal and monetary measures, the economy will be better positioned to achieve its growth potential.

“Mr. Schwab founded and manages Schwab Capital Management, an investment and advisory firm focused on making investments in alternative energy and other companies. Before starting his firm, he worked at TSG Consumer Partners, a private equity firm and Golub Capital, a junior debt firm, as a Principal, making growth-oriented investments in U.S. middle market companies. Before that, Mr. Schwab worked in Mergers and Acquisitions at Wasserstein Perella & Co and Enron Corporation, advising and investing in electric utilities, natural gas companies and software and hardware companies focused on energy efficiency.

He has published several pieces related to the credit crisis, including a letter the Financial Times published 1/15/09 which discusses a deliberate policy to handle problem banks; another letter the Financial Times published 9/24/08 which outlines reasons Congress needed to pass the $700 billion bill quickly breitling superocean replica; and an op-ed in the Columbia Spectator published 4/21/08 outlining ways the University could help students pay for school.”

February 2, 2009
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