FDIC's Bair pushes to detox banks

When TARP was first passed, the plan was to buy the toxic assets of banks so they could recognize their losses, clean their books and move on. However, the Bush administration stepped back from that plan, calling it too costly and difficult. Instead they just infused cash into the sick system.

FDIC Chairman Sheila Bair wants to revisit the original plan. As she told the Washington Post, "This takes courage to do, but if we don't do it, history shows that this kind of mechanism -- recognize the losses, get at the root of it and move on -- this is how you jump start the economy. The other option, just to park those assets on the balance sheet, I don't think gets us very far."

The plan is still taking shape inside the Obama administration. You may not hear the official announcement for about two weeks. Bair calls it an "aggregator bank." Treasury officials want to call it "public-private investment funds." But, I doubt the public really cares what's its called as long as it does the job of cleaning out the problem and jump starting the economy.

Basically the way the plan will work is that both the government and private equity funds would put up a small portion of the money needed. Then the Federal Reserve will put up the rest. The theoretical example the Washington Post gave was to raise $10 million, $1 million would be contributed by the government, $1 million would be contributed by a private fund and then they would leverage that $2 million by taking a $8 million loan from the Federal Reserve. This may not turn out to be a 50/50 proposition. The actual ratios could be different when the plans are announced. But, the numbers need to solve the problem will be a lot bigger than those in this example.

These public-private investment funds would then create a market to buy toxic assets from the banks. The funds would be managed by private investors, who would determine what to pay for the assets. Based on what Warren Buffet said yesterday on CNBC, "I'd rather buy those assets from the bank than anything else they've got. I can make more money on those assets." He's clearly ready to get on board this train. I wouldn't be surprised to find out he's going to run one of the private investment groups.

The net result of this plan could be that banks forced to take large losses might need more money from the government to survive, but they can now move forward with a clean set of books. Without these toxic assets on their books they would have a better chance to raise private capital and pay off the government TARP funds. Some banks may need to take losses so large that they can't survive, but isn't it better to identify those banks now rather than let the problems continue to fester. Building trust in our banking system is critical to getting the credit markets flowing again.

The big question is how many banks are ready to show the depth of their losses. So far the cash infusions have let them limp along without having to fully admit to their problems. But, those banks that truly want the government off their backs can only do that by cleansing their books, so even though the medicine won't feel or taste good, it's likely most will take it.

Lita Epstein has written more than 25 books, including Reading Financial Reports for Dummies and the Complete Idiot's Guide to Value Investing.

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