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Here’s what TPM Reader PS says I’m missing about the wisdom of the ‘bad bank’ model …

What you are missing is that the new “bad bank” structure that has been reported has a way to deal with the uncertainty surrounding the value of many of the suspect assets. The new bank will buy these assets at some estimate of current fair market value, but if the assets ultimately turn out to be worth less, then the new bank will receive common equity (not debt) in the existing banks, potentially massively diluting existing shareholders but not jeopardizing the soundness of the bank.

This proposed transaction thus achieves two things:

1) Uncertainty as to the capital sufficiency of existing banks will be much reduced. This has to achieved before robust bank lending can resume.

2) Nationalization gets postponed and may not ultimately prove necessary. If the assets transferred prove to be really bad, then the government may indeed end up as the majority holder in some banks. But this will occur many years down the road, in what can only hope will be calmer waters. If that is the case then the majority stake can be disposed of that that point.

So the key point here is that this structure finesses the current valuation of the bad assets. Nobody really knows what these assets are worth currently, but in a few years all will become clear.

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Josh Marshall is editor and publisher of TalkingPointsMemo.com.
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