The Economics Journal

With money flocking to Treasuries and public mistrust on tainted institutions, why not create a fresh bank from the scratch, booted with government money? It will not carry too much of baggage and can be innovative with its management and hierarchies, and can do the basic job the banks must do – pool risk by transferring money from retail investors to capital spending in corporation. Today’s WSJ has an article on this.

http://online.wsj.com/article/SB122757211390954799.html

Now, I have another proposal. Identify the small strong banks and give them the money. Surely, there are enough banks that have played within their means with shrewd management. Now, pay enough attention to them and see if you can help few of these smaller banks to grow big. Too much of attention is paid to the failing banks that we might need to switch gear.

Positives of focusing on strong banks:

1. Too much of bailout money is going to “idiots” – who pummeled their institutions to ground. This creates a moral hazard. By helping small successfully banks to grow big with public money, you are neutralizing the hazard.
2. It is time consuming to start a new management from scratch. If you have a concept already working it is relatively easier to expand that.
3. Many of the smaller/stronger banks are getting absorbed by the bigger banks with a bailout money, thereby killing their expertise. Maybe this will revert the tide and level field and allow the smaller banks to buy the bigger ones, if they show competence.

Sure, setting it up might take some time, but It might not take long, if government relaxes a lot of onerous requirements. Look at how fast they turned various institutions into banks overstepping all the rules. FDIC would already have data on strong banks, pick them up and call an emergency meeting with their executives and ask them how they can expand given a $10b capital infusion with very little strings attached. In a couple of weeks time, make them work 24/7 on their proposals and give them all the data they need. Pick a 100 of the best proposals, and make those banks grow to next level. This will not be an isolated thing and government should also work on fiscal and monetary policies. But, atleast this trillion might be put for productive use.

What is the guarantee that the smaller banks will continue lending, and not hoard money like how the bigger banks do?

1. Banks make money only by lending – there are not many other ways to make money, particularly for smaller banks.
2. The bigger ones don’t lend money because they are burnt enough and they don’t know what to do and using the money to cover the losses elsewhere. They are also over-leveraged and using the money to reduce leverage. We are looking at banks that don’t have too many losses or high leverage, for which they need money to hoard and cover.
3. Smaller banks have a lot of community links and would know about risks in their locality well, and thus might be able to get in their front foot in lending for good projects.
4. When Fed requests proposals, it can order the proposals on which of them will lend more to the corporations and capital spending. Since, most of these are already well-run banks, the risk of them getting on binge with poor lending is lower.
5. And the money injection is relatively smaller – a few billions at the max, and spread over a vast pool across the nation.

Header Image of a bank robber in LA: Colin Brown