Paul Romer's "New" Bank Scheme

Stanford Institute for Economic Policy Research senior fellow Paul Romer wrote a succinct piece in Friday's Wall Street Journal arguing for the the creation of new banks, rather than allocating Federal assets to shore up existing, crippled banks. It is reminscent of the Journal's similar article by Dennis Berman back in November, about which I posted here.

I didn't think much of Berman's idea then, and I don't feel Romer's prescription is actually any better. Or different, for that matter.

But Romer points out why a new bank might be better than Federal support for a crippled one, i.e., no messy valuation problems going forward.

That brought me to Anna Schwartz' comments in the interview with her in the Journal back in October, which elicited this post.

Schwartz asserted, correctly, I believe, that the current problem, unlike the Depression, is not liquidity, but discerning which banks are healthy. Investors won't buy into banks whose assets are of questionable value.

Thus, putting the two streams of thought together, one arrives at the unmistakable conclusion that, whether by straightforward write-offs, or modified mark-to-market policies reflecting actual economc value, impaired assets should be properly valued, insolvent banks closed and/or merged, and the results allowed to either decrease excess banking capacity, or allow existing, healthy banks to take up the slack.

Either way, it's really unclear now why we need Federal investment in banks, short of an explicit nationalization policy. Having had time, since September's bank panics, to see that the largest US commercial banks now fall into one of two groups.

Citi and BofA sell at as much as a 70% discount to their values back in September of last year. Wachovia and WaMu don't even exist now.

Chase and Wells Fargo track the S&P fairly closely, indicating less concern over their viability and asset valuations.

Doesn't this indicate that banking, in general, is not at risk. Just the two most problematic commercial banks.

If the Feds simply enforced sensible valuation at Citi and BofA, then determined capital adequacy, and closed either or both, if necessary, we'd probably be out of the woods, with respect to commercial banking stability, right now.

If more capacity is required in the sector, we'll know by growing loan profit margins and growth rates. And fresh capital will naturally seek out these businesses and compete the excess profits away. Without undue goverment manipulation and interference.