The Parallax Brief

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Unrepentant Subjectivity on Economics, Politics, Defence, Foreign Policy, and Russia

Toxic Bank a Supine Move to Avoid N-Word.

Britain has become the first nation to attempt to resuscitate its banking system through the creation of a so-called ‘toxic’ or ‘bad bank’. The government hopes to transfer to an ‘aggregator’ those assets which are dragging the banks down, leaving the banks free to perform their usual economic duties, and, fingers crossed, leaving the tax payer with a nice profit once the world economy recovers from its economic heart attack.

The business community breathed a sigh of relief when it learned of the government’s plan, but is it a really good idea?

I’m afraid the obvious answer is no, it is not a good idea. The government should have bitten the bullet and nationalized all banks of systemic importance. It should have nationalized them back in October instead its of original bailout. And it should have nationalized them instead of this latest bailout. Ultimately, it’ll probably have to nationalize the banks anyway.

The government’s chosen alternative, the ‘bad bank’, in effect argues “even though the market says these assets are worth X, we are willing to pay Y,” because the only way the government can make these banks solvent again is by paying more than the market would. Of course, it hopes prays that in doing this it will finally purge the financial arsenic from the banking system’s blood stream, allowing for recovery, while getting valuable assets at an ultimately profitable price. But how likely is the government to be able to successfully second guess the market? And will this really prepare the ground for recovery?

Nobel Laureate Paul Krugman is skeptical:

“Now, maybe private buyers aren’t willing to pay what toxic waste is really worth… But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make [the banks] solvent again?”

Krugman believes that the government, in effect, is handing the banks a huge stack of tax payers’ cash, while taking risks that the banks cannot.

“What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.”

Clearly, something had to be done. The banking system is currently on life support, breathing only through the mechanisms the government provides. Last time things were this bad we tried turning off the machines, causing the Great Depression. Doing nothing, therefore, was not an option. But gifting the shareholders and management of the banks should not have been the first course of action.

Of course, a Labour government nationalizing banks is a public relations open goal for the Conservative Party, and this government is nothing if not supine, so perhaps we should have expected Brown and Co. to writhe and thrash a bit before succumbing to the inevitable.

But the sooner the government plucks up enough courage to use the N-word, and makes an announcement that it is nationalizing the British banking system for a strictly limited period of time, the better it will be for everyone.

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