Modern communications technology is amazing. Earlier today I sat at my computer with two windows open simultaneously. In one, I watched the inauguration of President Obama on a live video feed from Washington, D.C. while millions of onlookers crammed the National Mall. In the other window, I watched a live feed from New York showing the movement of the stock market as millions of shares traded hands in a series of free exchanges worth billions of dollars. Both events were remarkable by any standard.
The fact that the markets didn't seem to notice the remarkable event happening just a short flight south of Wall Street was indicative of our current problem. The financial world has become so preoccupied with its own internal woes that it can't see anything else. It is frozen, like a deer in the headlights, unable to comprehend that its danger grows every moment, the danger increased by its own lack of action. Every day the financial markets remain frozen sinks us deeper into a recession which, in turn, causes the overall credit worthiness of our economy to drop another notch. With every slip in credit quality, the outlook for banks becomes bleaker and the viscious cycle goes on and on.
The way out of this mess is for banks to accept the fact that they have to make some significant changes. Banks need to act now to move toxic assets off their balance sheets and into a separate entity where those who want to take those risks can do so. This strategy, called "good bank/bad bank" is not new. It was a core element of the process that allowed us to work our way out of the S&L crisis of the late 1980's.
Implementing this strategy will cause existing bank shareholders to take a big hit. After all, banks would need to write down the value of their toxic assets to a level that would attract investment in the "bad banks." Unfortunately, it may be banks no longer have a choice. The market action in bank stocks over the past couple of weeks makes it clear that they are running out of time. The good news is that such a restructuring would relieve the owners of the remaining banks (the so-called "good banks") of an albatross that has been around their necks for a long time and would allow them to concentrate on the future, to raise capital and to begin lending again. The sad reality is that if this course had been followed six months ago, the cost would have been significantly less than is will be now. If we don't do it now, it will cost even more in another six months.
There is now easy way out of this mess. There is no simple, clean, or fair way to set this right. But if the Obama Administration really is going to stand for "hope and change," we need to start right now in the beleagured financial sector.