Good bank, bad bank: Woodward and Hall have the solution

Let the “bad bank” own the stock in the good bank, and be responsible for the non-deposit liabilities.

Susan Woodward and Robert Hall propose a version (which they credit to Jeremy Bulow) of the “good bank/bad bank” approach:

The “bad bank” holds the equity in the “good bank” plus the bad assets, and owes the non-deposit creditors. The “good bank” continues to hold the good assets and be responsible for the deposits.

If the the “bad bank” can’t keep rolling over its credit, then it gets reorganized: the stockholders are wiped out and the bondholders and other creditors get so-and-so-many cents on the dollar depending on their seniority, just as in any other bankruptcy. But there’s no pressure on the Treasury or the Fed to bail out the “bad bank,” because the depositors’ money is safely in the hands of the well-capitalized “good bank,” which continues doing business just as before, whatever happens to its parent.

This seems obviously right to me, and &#8212 more significantly &#8212 to Brad DeLong, who calls it “the cleverest plan I have yet seen.” It’s obviously bad for the stockholders and creditors of the banks, compared to being bailed out by the taxpayers, but that looks to me like a feature rather than a bug. I have no objection in principle to temporary nationalization Swedish-style, but this looks like the right way to avoid having to do it.

Technical question: Since the “good bank” equity has actual market value, could the “bad bank” do a quick underwriting of a partial stake in the “good bank” to generate cash with which to pay off its short-term creditors?

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: