Dennis Berman's Bad Banking Idea In Yeseterday's WSJ

Dennis Berman, a writer for the Wall Street Journal, typically pens thoughtful, well-reasoned articles. A search of his name on this blog will provide several mentions, most notably this post on his excellent editorial concerning online social networking websites, here, from September of last year. When Berman and I agree, which is more rather than less often, he's usually confirming my earlier insights and conclusions.

Berman's piece in yesterday's Journal is an unusual exception. Entitled, "One Cure for Financial Mistrust: Create New Banks," is one of the worst columns I've ever read. By anyone. Frankly, coming from Berman, I am shocked. Here are the salient portions of his article,

"The financial system is in tatters. It is time to build from scratch.

One provocative, and perhaps inevitable, path is for the government to directly fund the formation of new banks. It could give incentives to private investors to form banks free from the taint of the old economic order.

The benefits of new banks are immediate. They could begin lending at once, freed from the worries of coming write-offs and off-balance-sheet shenanigans that have paralyzed Citigroup and others. They also would represent a psychological turning point, separating the future from our current period of panic. It is the kind of step that seems custom-made for President-elect Obama.

"What we need are new bankers, not new banks," says economic historian Richard Sylla of New York University.

It would, of course, be impossible to instantly duplicate the deposit base and infrastructure of large banks such as Citi or Bank of America. A new bank -- let's call it Hamilton Bank -- could take as long as a year to get off the ground, say bankers.

And there would be plenty of room for Andrew Jackson-style worry about new institutions, especially leverage ratios and management. Perhaps the best path would be to start with two or three government grubstakes of $10 billion, with the hope that private investors would push the capital base to $50 billion each. Leveraging that at a conservative ratio of six or seven times would form a group of solid medium-size banks for attracting deposits. The next step would be to provide incentives to private investors -- with, say, dollar-for-dollar matching sums or tax credits -- to start their own institutions.

Strict deadlines would be necessary to get the banks started quickly. And much like its recent preferred-stock investments, the government would sell its bank stakes over time, eventually returning the banks to private hands."

There are, in my opinion, several serious errors of fact, analysis and judgment in Berman's piece.

Let's begin with the simplest one. It's not at all difficult to start a commercial bank. The sheer number of small and medium-sized banks currently existing, and the large number of financial service consulting and software firms is all the evidence you need to understand this point.

Perhaps the most time-consuming task in beginning a bank from scratch is common to all retail businesses; choosing a site, building the structure, hiring and training employees. Everything else can basically be outsourced and bought turnkey or off the shelf- software, hardware, furnishings, etc. This alone tells you our problem is too many undifferentiated, badly-run banks, not too few.

As for new banks being free of old, bad loans and other purchased toxic waste, new banks are far from necessary to achieve this end. Treasury just used the TARP on Monday to do this for Citigroup, backstopping $306B of asset value. Whether it is formally spun into a separate entity now, or not, hardly matters. What does matter is that the Federal government, as the representative of our entire society, has begun to take possession of hundreds of billions of dollars of questionable assets, the better to free the inept banks which ended up with these assets to continue business without the burdens of their prior, enormous mistakes.

But the most important reason why Berman's idea is flawed involves management. Look at the collapse of Wachovia, Washington Mutual, and Citigroup. These were highly-regarded, large, seemingly-unassailable commercial banks.

If asset concentrations of such size were, in fact, susceptible to inept (mis)management and poor leadership, where are we to magically find new, green executives now suddenly capable of doing a better job? And with taxpayer money, to boot?

If anything, you should worry that Berman's new, small banks will run into massive trouble as the senior executives hurry to grow their new institutions as quickly as possible. This is precisely what led to our current troubles.

Instead, we need, if anything, to simplify the existing banking structures, without government backing, or encourage further concentration of them, with explicit governmental ownership, heavier regulation, and effective conversion of them to financial utilities.

In neither case does Berman's vision of pristine, newly-minted banks run by mystery CEOs with sterling credentials, experience and qualifications, fit the needs of an effective future US banking system.