Monday, 19 January 2009

Bad banks

Not bad as in `bad girl'. Bad as in non-performing. Paul Krugman makes the point that bad banks are not the answer to banking system problem, they are a tool for recovering more for the taxpayer after the banks have been nationalised, cleaned up, and sold on. In other words, wiping out existing shareholders is the first step. Let's begin with RBS shall we?

Update. Interfluidity has a nice post on full nationalisation and the Swedish model. The importance of excluding shareholders from future participation is clearly made:
Suppose that a bank whose true book equity is $0 has failed to mark down some assets, and shows a position of $10B. The bank receives a $90B capital injection, valuing existing shares at book. Then the old equity whose true value was precisely zero prior to the recapitalization suddenly has a real book value of $9B. That is, old shareholders reap an immediate windfall from the recapitalization, and the size of the windfall increases in direct proportion with the amount to which management had lied about the banks losses!

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