We need good banks, not a bad one

You've asked people to give you ideas, so here's one: Don't recycle Bush's failed ideas and expect them to work. Each of those failed ideas has deep flaws. Instead, if you have to save the banking system -- and I would like to see how things would work if companies and people lived within their means rather than borrowing to pay for things that they can't afford -- then cull and capitalize or create new banks.

Here's what's wrong with the three recycled Bush ideas being floated:

  • Create a bad bank to buy toxic waste. Hank Paulson wanted to do this when he shoved TARP down Congress' throat. But he then figured out that there was no way to set a price for the toxic waste that would not either wipe out the banks' capital or stick the taxpayer with big losses. The pricing problem is still there, so there is no reason to think this will work. And what kind of signal does it send if taxpayer money is used to bail out bankers' bad investments?
  • Put capital into banks. The Treasury has already injected senior preferred stock into dozens of banks and they've used it to pay themselves $18.4 billion in bonuses (my wife is ready to throttle me because I said your comment yesterday afternoon about shameful bonuses sounded like it was inspired by my post). In the process, those government investments have left common shareholders with nearly worthless investments. Another problem is that putting money into banks that are saddled with toxic waste does not get them lending because those bankers believe that the new loans won't get paid back and they'll have to go raise more capital. And of course, if the purpose of the U.S. capital infusion was to boost lending, giving it to such zombie banks is a waste.
  • Insuring banks' assets. This idea has also been tried -- with the U.S. insuring hundreds of billions of dollars of assets at some of our biggest zombie banks. After the announcements of these guarantees, the common shares of these banks plunged further and they subsequently announced lousy results. To be fair, guarantees probably cost less then the other options, but there is no evidence that they're working so why bother.

Here are two different ideas to consider:

  • Cull and capitalize. As I posted, the idea here is to figure out which banks are viable and which aren't. We close or merge the ones that aren't viable and put enormous amounts of capital into the ones that are. The well-capitalized survivors will know that their fellow survivors are on solid financial footing and there is no longer a risk of the system being dragged down by zombie banks. The healthy survivors will lend to each other and eventually to businesses and people.
  • Create new banks. As I posted, creating new banks -- from a mixture of taxpayer and private capital -- would assure that there are banks with no toxic legacy assets that hold back banks from lending. With fresh capital, these new banks could hire some of the most talented bankers who have lost their jobs and surely they could hire companies to operate their computer systems and otherwise get back to lending quickly. Over time, customers would shift their business from the zombie banks to the new ones. And we could manage the failure of the zombie banks in an orderly manner.

The ideas being floated to fix the banking system have a proven track record of failure. That's why you should at least consider these two new ideas.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and is the author of You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.

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