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The assets cannot lose more than their face value.

The liabilities, on the other hand, can grow infinitely. But, in a climate of deflation and low interest rates, liabilities grow slowly.

So the problem is that some assets are maybe worth zero. All you need to do is add free cash to the assets until the assets are worth enough. Normally this would be done with an equity injection, which would mean a share of ownership. If the share of ownership becomes more than 50%... tough for the management!

This is the way to deal with this mess: Turning Bad Bank / Good Bank on its head (Update) by BruceMcF

OK, now, suppose we do it this way. Bank examiners do "stress testing", which is to say, a real world audit instead of the fantasy audits that we have been doing in order to avoid official recognition of the depths of the problem. And banks that are in too much financial peril to be allowed to continue operating as they have been doing ... are put into receivership.

Now, the US government strips out the liabilities that we wish to protect ... the account liabilities ... and takes over the "good" assets. If that is a net plus, the government pays the original bank for the positive net assets. If that is a net minus, the government makes up the difference with the new Good Bank, and takes a compensating Senior claim in the old Bad Bank.

Then the residual of the old Bad Bank is run through ordinary Chapter 11 proceedings ... in most cases the shareholders will be zeroed out, the bondholders will become shareholders, the new shareholders are quite likely to sack the old senior executive management, and the old Bad Bank will see what they can do to recover whatever value can be had in the trash that forms their asset base.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Fri Mar 20th, 2009 at 05:18:57 AM EST
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