An article in Saturday's Wall Street Journal points out that passed credit crises generally ended when investors could see that banks had read their books of toxic assets. This is exactly what is not happening now and this is what worries me. Remember when Treasury Secretary Paul Sun first went to Congress and ask them for $700 billion? It was supposed to be a buy a bad mortgage-based assets from the banks to clean up their books. What happened to that plan?
Recently, federal banking regulators provide a massive bailout to Citibank. "But actions have fallen short of actively moving problem assets off bank balance sheets."
"Let's Encourage Banks to Dump Bad Assets," Wall Street Journal, Saturday/Sunday, December 20-21, 2008, p. A15
Without such movements, an important claim on capital will not be removed, as the banks typically must allocate a sizable portion of their equity capital to support their problematic assets. Until banks substantially cleanse their balance sheets of nonperforming loans and other impaired assets, potential new equity investors will have little confidence that the banking industry can get back to the business of putting fresh capital to work profitably.
Had the bank regulators set a relatively short term expiration date--- perhaps a year--- on the assets guarantee, Citigroup would have a strong incentive to dump the assets at whatever price it would take to find a buyer, or else face the real possibility of additional shareholder losses once the guarantee expired.
Skeptics might respond that there would be no certainty that buyers would emerge no matter how low the price. But here's where creative tax incentives could make the difference. For instance, suppose the Treasury Department offered a one-year program where buyers of distressed real estate assets received a 50% tax credit on any purchase. This would provide buyers with a powerful incentive to act quickly. In short, the US government has the power to play or more constructive role than it has in incentivizing buyers and sellers of troubled assets to strike deals with a sense of urgency.
The US banking industry has had to confront credit cycles of one sort or another every few years -- whether the problems arose from excessive lending to real estate, leveraged buyouts, and/or developing countries. One thing has been clear: almost every credit crunch came to an end once investors detected that the banks were decisively ridding their balance sheets of toxic assets.