Aggregator Bank – A Brief Note
Sheila Bair, Chairperson of the FDIC, indicated in the January 16 interview by the Wall Street Journal ( WSJ Interview: FDIC's Bair Fleshes Out 'Aggregator Bank' Idea) that the Aggregator Bank is “beyond hypothetical.” In other words, there will soon be a new government banking agency created to ameliorate the shaky path of the economy. The main thrust of this proposal is to set up an independent banking entity, Aggregator Bank, which will be capitalized by a portion of TARP funds. This entity would buy troubled assets from financial institutions. Sheila Bair indicated that troubled assets would be priced at “fair value,” but the methodology of pricing is not available, as yet. Sellers of troubled assets would be paid partly in cash and partly in equity of the new Aggregator Bank. The new bank would hold on to the troubled assets, securitize them, or do a covered bond issue. At the core of the economic crisis is the persistent credit crunch. The game plan behind the Aggregator Bank is that a cleansing of balance sheets should thaw frozen credit markets and the Aggregator Bank is supposedly the conduit to make this happen. All is well so far, except that the operational details, particularly the pricing of the toxic assets, raise questions.
The camp which shuns mark-to-market accounting during a period of crisis reasons that it would lead to a liquidation of several financial institutions and reducing leverage simultaneously would be destabilizing. There is no doubt marking-to-market would be painful. On the other hand, if troubled assets are valued at non-market inflated prices, the immediate benefit is that we will smell roses again. Isn’t this the sort of wishful thinking that has led the global economy to the current juncture? The crisis is now on track to mark its second anniversary. Creative pricing of toxic assets will only postpone the pain, extend the duration of the crisis, and present a bigger bill.
The resolution of the Swedish banking crisis of the 1990s is often cited as the model to emulate. The methodology Sweden followed is appealing but there is an important detail that will need to be fixed to adapt the model today – pricing of toxic assets. An expert on the Swedish crisis educated yours truly that Sweden was dealing with traditional real estate and consumer loans which enabled the approach it adopted. The real estate loans and commercial paper were all held in Sweden. The credit exposure in the current crisis is beyond the shores of the U.S and the toxic securities are significantly more complex than what Swedish financial authorities faced during their banking crisis. We will leave it to experts at the FDIC and other professionals to solve the problem of pricing, with the only requirement that toxic assets should not be “marked-to-myth” because it will postpone the day of reckoning. Enhanced transparency and disclosure are necessary for credit markets to thaw. Banks need to resume the old-fashioned business of lending on a clean slate. Even if the toxic assets are entirely off the balance sheets of troubled banks, if they are priced incorrectly the taxpayer will bear the brunt when losses have to be realized. It is therefore more prudent to start the workout with a firm hand and face the true cost of clean-up now as opposed to later.
At the cost of repeating the obvious, the balance sheet of a firm provides signals to the market, which implies that consistency is a necessity. Mark-to-market accounting enabled phenomenal profits and astounding compensation in the financial sector during the upswing of the business cycle. Switching to a different methodology midstream because it is less suitable is beset with issues because consistency in marking assets is essential to retain credibility in the global marketplace. Therefore, caution is advised before marking these assets using non-market guidelines.
The 2008 tax rebate is behind us, the first tranche of the Economic Emergency Stabilization Act of 2008 has been largely used to recapitalize banks and some who were holding on to these toxic assets came back for more. The Fed is operating in a zero interest rate environment and has instituted many creative programs to support the working of the financial system. The second tranche of TARP will be spent soon and Congress is considering an $825 billion fiscal stimulus package. Essentially, economic ideology has been set aside and a string of remedies have been applied but the banking system, the backbone of economy, is still ill. We remain hopeful that the new bank will restore the health of the economy.
