Washington and Lee University
The nation’s banking crisis has no simple solutions, but a Washington and Lee University economist believes that the idea of a so-called “bad bank” is gaining traction because it is an easier concept to explain.
Banks that are unable to make loans because their bad loans are taking so much of their capital would charter a “bad bank,” also known as a “collection bank,” and would move all the non-performing assets into that bank in order to free up capital.
“Moving those bad loans out of the way is the key to clearing the market,” said Linda Hooks, the Canaan Professor of Economics at W&L who specializes in banking and bank failures. Hooks believes that the bad bank would be an easier sell to the public than other alternatives, including the prospect of nationalizing the banks.
“We do not have a history of nationalizing banks in the United States, and my sense is that the very idea just seems much worse from the public perspective, whether or not it made better economic sense,” said Hooks.
Hooks said that aside from the bad-bank or nationalizing alternatives, another possibility would be to re-create a government agency like the Resolution Trust Corp. (RTC), which the federal government established in the late 1980s in response to the savings and loan crisis. As Hooks explains, the RTC is a variant of the bad-bank idea, except that a government agency is created to buy all the bad loans so that commercial banks can avoid the legal expense of setting up their own bad banks.
“There was some virtue to the simplicity of the RTC, but it was slow and inconsistent in its handling of bad real estate,” Hooks said. “It was controversial enough that I doubt people are quickly going to adopt the same approach.”
Hooks is optimistic about the prospective of a quick recovery once the government identifies and adopts a program for dealing with the bad loans that are preventing banks from lending. She believes that in many respects, the current crisis looks far more like the S&L crisis of the late ’80s and early ’90s than it does the Great Depression.
“Even though the S&L crisis is, to my mind, the closest comparison, the scale seems so relatively small now. We really have never seen anything on this scale before,” said Hooks.
Comparisons between our current situation and the Depression are wrong on several levels, according to Hooks. On one hand, today’s problems are not as acute as they were during the Depression, when unemployment reached 25 percent.
“But comparisons to the Great Depression are also inapt because our problems now are far bigger than what was the case during the Great Depression, based on the complexity of our system today. Even though there was an equally dramatic collapse, we were not so interconnected then.”
Hooks disagrees with arguments that it will take the country a decade or more to recover from the economic collapse. She expects to see improvements within the next two years.
“I don’t think there is a reason for a gloom-and-doom forecast into the next decade,” she said. “Our economy, in the long run, has a very good foundation. At this point, I think we have begun to stabilize the market, which seems to be returning to a reasonable level of activity. Now the task is to make the banks healthy again. Then the long-term prospect is for the government to step back and rethink regulation and the structure of the financial institutions out there, because that structure has not served us well recently.”
