A Bad bank is set up to buy the bad and non performing loans of a bank with the significant amount of the collateral assets – being listed at market price.
Now the ‘market’ price is a mute point – as it is that value that a third party is willing to pay for the asset.
On a revaluation – when the market is under considerable stress – by whom is another issue entirely.
Therefore the ‘Bad Bank’ is set up by transferring the bad assets of an institution to the newly created bad bank, the Bank then clears their balance sheet of these toxic assets – but would be forced to take write downs.
Shareholders and bondholders stand to lose money from this solution (but not depositors).
Banks that become insolvent as a result of the process can be recapitalized, nationalized or liquidated. (1)
In a conversation I had with Jens, Tomy and few other gentleman I raised my opinion on why The Federal Reserve Bank of America (The Fed) is a ‘Bad Bank’. Well to describe it as a ‘Bad Bank’ may be an understatement and my reasoning was set out below.
But first I wish to remind my readers of a few points:-
1. The Fed Chairman Ben Bernanke proposed the idea of using a government-run ‘Bad Bank’ in the aftermath of the 2008 financial collapse and the recession following the subprime mortgage meltdown. This was so that the ‘To Big To Fail’ (TBTF) banks could clean up their balance sheets – alleviate the high levels of problematic assets and allow them to start lending again.
Please note that the shareholders of The Fed are these TBTF banks. The Fed very diligently refuses to post the shareholders names (2) but through Global Research’s diligence (3) they have established this fact – and no – they have no input into the operations – they only receive a 6 percent dividend annually.
2. The US Government passed a law – the Emergency Economic Stabilization Act in 2008 – on the treatment and ‘value’ on bank assets – Section 133 of the Act mandates that the assets are valued at cost. (4) So the assets are no longer valued at ‘market value’ – which would reduce the value of the assets but at cost.
In order to refinance the Banks – the Fed undertook through the Quantitive Easing programs – to buy theses assets at cost – and replace them with US Government securities.
The Fed acquired around U$D 3.5 trillion of toxic assets (5) from the TBTF banks – at cost – and gave the Banks in exchange US Government bonds to that value.
The bottom line is that the Fed now has a problem with the orderly disposal of these toxic assets – valued at the original Banks cost price – the actual market value of which is far in excess of the ‘cost’.
The Institute for Energy estimates that the Fed owns through established subsidiaries (Maiden Lane etal, TARP Llc and others):-
* More than 900,000 separate real assets covering more than 3 billion sq. ft.
* Mineral rights, on and offshore, covering 2.515 billion acres of land, more than the total surface land in Canada
* 45,190 underutilized buildings, the operating costs of which are $1.66 billion annually
* Oil and gas resources on and offshore. Mining tenements that have significant costs to bring online.
* Student Loans from the Federal Student Loan program of $948 billion.
As is the practice of the Fed – the funds are issued without any holding costs whatsoever. This being the Fed’s practice of issuing Bonds (liability) and obtaining (assets).
Photo courtesy of AmericaAction Forum
Photos courtesy of AmericaAction Forum.
The problem is though – is the underlying value of the assets are still valued at cost.
In essence the Fed is a ‘Bad Bank’ – Mr Bernanke in his wisdom utilized the resources of the Fed to undertake implicitly what congress denied him the right to do externally.
Profit from the Fed for the calendar years 2013 and 2014 were high – the residual income being transferred to the US Treasury – however this seems to ensure that no party looks at the underlying source of the income
Chart courtesy of CarpeDiem.
The Wall Street Journal did comment on these profits in early 2015 however the sale is at the discretion of the Bank itself.
“The entire federal budget deficit for fiscal 2014, which ended in September, was $483 billion. Without the Fed’s windfall, it would have been nearly $100 billion more. Corporate income tax revenue in 2014 was $321 billion, so the Fed turned over nearly 30% of the amount provided by every American corporation.
Treasury is spending the Fed’s windfall, naturally, which means that when the QE boom ends the country will have to spend that much less or find the revenue somewhere else. The danger is that politicians are getting used to the money, which is one more reason for the Fed to begin winding down its balance sheet sooner rather than later.”
Yes ‘winding down’ the Fed’s balance sheet. The crystallization of bad assets – the losses of which will be absorbed by the US taxpayer.
This Bad Bank has the ability to hold these toxic assets – as there are no underlying holding costs for the capital. There are expenses – but these are very easily absorbed by the overall profit of the Bank.
Any losses incurred will mean a suspension of payments to the US Treasury.