Banks want G20 to set up pricey bad bank
Critics say the financial sector is holding the economy hostage
By Greg Robb, MarketWatch
Last Update: 7:54 PM ET Mar 13, 2009
WASHINGTON (MarketWatch) -- The world's largest financial institutions urged the G20 financial leaders on Friday to endorse the "bad bank" approach to dealing with the credit crisis, an expensive model one expert likened to another ransom note.
The request came in a letter to U.K. Prime Minister Gordon Brown from the Institute of International Finance, a trade group of the world's largest global banks. The IIF wants Brown and his G20 colleagues to push the Obama administration in the direction of setting up a bad bank.
Under this approach, governments would buy toxic assets from banks at a price higher than the prevailing market rates. For the time being, private investors simply won't buy the assets at the prices that the banks want. As a result, banks have huge holes in their balance sheets.
Last month, Treasury Secretary Timothy Geithner seemed headed in the direction of establishing a bad bank, but veered off at the last minute.
Instead, Geithner has proposed a public-private fund to get toxic assets off banks' books. Details of the plan remain murky; Geithner's apparent change of heart also was greeted with a sharp sell-off in the stock market.
Vince Reinhart -- an outspoken former Federal Reserve official who's made no secret of his disappointment with the plans so far to end the crisis -- said what the Treasury secretary really was trying to do was avoid having to go back to Congress for more money.
Indeed, legislators have been signaling that they're not eager to receive a request for additional funds for banks on top of the 700 billion financial-rescue plan approved last fall.
Members from both parties believe that former Treasury Secretary Henry Paulson acted in bad faith when he completely changed the nature of the U.S. bank plan shortly after receiving the funds from Congress.
The public is frustrated that the 700 billion plan hasn't worked. They have a sense that bankers who made bad decisions are being rewarded, pollsters said.
The financial sector is holding the American economy hostage, according to Reinhart. "Until we dig them out of their capital hole, they will continue to hold the economy hostage," he said. "You don't like paying ransom, but at least you understand why you do it."
President Barack Obama seemed unwilling to spend political capital on the rescue plan, Reinhart commented. The Geithner plan was essentially "trying to figure out how to do it under the radar," he said. "But if you do it under the radar, you don't do enough and you certainly can't explain it well."
Officials from the IIF bristled at their proposal being called a ransom note. "This is about something totally different. This is about trying to clear away a cloud that hangs over the financial system," said Charles Dallara, managing director of the IIF.
The taxpayer will be much better off by staring this problem down squarely, because the economy will suffer without a bad-bank plan, he contended.
Obama had the power to push a bad-bank plan through Congress. "All of it depends upon leadership," said Dallara.
IIF officials said a global bad-bank approach wouldn't work, and that the best place to initiate the idea is the United States.
Dallara said that there had been "serious malpractice" in many bank boardrooms leading up to the financial crisis. The industry already has come up with new standards on risk management, he added. Compensation reform is now on the table. "Things are happening; the industry is trying to deal with these problems in a serious way.
"The industry has to prove itself and demonstrate that is serious," according to Dallara.