Proposed Solution for Toxic Assets Plaguing Banks

by: John Henderson

There is correctly much controversy over what to do with the toxic assets plaguing the banks. The famed Jim Rogers was on Bloomberg TV Saturday and he correctly brought up the issue of pricing the toxic assets that plague the banks. If the government takes the bad assets off of the balance sheet, what should the government pay? If the government pays too much, then the bankers will be making out. If the government pays too little then the banks will not sell.

Here is a potential solution: What if the government buys bad assets from an ailing bank at exactly what that bank has them marked at? A bank may ask why should it do that if the assets eventually go up in value? That would be a correct and logical answer by a bank. But if the government offered a profit-sharing arrangement for the assets that are bought, then the banks may participate.

It would work something like this: The bank in trouble sells the toxic asset marked-to-market at the mark-to-market value. The bank receives cash and the government receives the asset. Over time, the government will dispose of the asset with the intention of selling it at a minimum price, which would be the price it paid. In many cases, the assets over time will increase in value. The government then may be able to sell the assets at a profit.

This is the reason the banks do not want to part with the bad asset - the bank believes that with time the asset will be worth more. But what if the government offers the bank a profit sharing arrangement with a 50% - 50% split of the potential future profits? In that case, a bank may be more inclined to sell the toxic asset at the low marked-to-market fair value. So when the government later on sells the bad asset at a profit, it will then split the gain with the bank. The bank gets rid of the bad asset and then profits from an upside to that bad asset. The government does not overpay for bad assets and potentially gets a profit.

This seems like a win for all involved. For the bank it provides two things. First it allows the bank to shed bad assets, and then it provides a way for the bank to profit from the upside, if the toxic asset increases in value. For the government, it helps the bank by removing the bad assets, helps to restore credit flowing to the system, and gets its money back when the bad assets are sold and even potentially gets a profit. For the tax payer, it would help restore some lending, and it would not be on the hook for overpaying for toxic assets.

Maybe I am missing something and have oversimplified this but sometimes the best solutions are right in front of us. Also this would cost the government money up-front. But the TARP is there, it can be used for a purpose like this.

One last caveat: If the assets are sold to the government and the asset then drops in value, then the bank that sold the asset to the government would have to share in the loss with the government.