How’s the US banking crisis going to end? Nouriel Roubini, of New York University, has taken the lead in urging the Swedish solution, namely government receivership: take ’em over, clean ’em up and sell ’em back to the private sector, preferably in pieces. Others, including Chris Whalen, of Institutional Risk Manager, argue that bankruptcy, like Lehman Brothers, is the best procedure. Kill ’em all and let the Bankruptcy Court of the Southern District of New York sort ’em out.

 

Former Federal Reserve chairman Alan Greenspan and Sen. Sen. Lindsey Graham of South Carolina went out of their way last week to signal to their fellow Republicans that government receivership must be an option. “You should not get hung up on a word [nationalization],” Lindsey told the Financial Times.

 

Meanwhile, Citibank and Bank of America are fighting tooth and nail to preserve their hegemony. Indeed, Citibank wants more taxpayer money.

 

How about this instead?  Capitalize half a dozen start-up wholesale banks with government money – call them Hamilton, Jefferson, Franklin, Madison, Adams and Washington. Get them borrowing and lending freely, purchasing assets from legacy banks, and then, equally swiftly, sell them off – privatize them.

 

This “good bank” plan was broached independently and more or less simultaneously a month ago  by Willem Buiter, of the London School of Economics, and Paul Romer, of the Stanford Institute for Economic Policy Research, and discussed last week to good effect by James Kwak in BaselineScenario.

 

Both Buiter and Romer make the case that creating such good banks, unburdened by suspicion of hard-to-value assets, would be both cheaper and more expeditious than taking over existing banks and sorting through their questionable assets, segregating some and insuring others. Bankrolling some smart guys and sending them into the market figures to achieve better results in the end, they say, than any purely administrative procedure the government can devise.

 

In fact, the Treasury Department still has $350 billion from the Troubled Asset Relief Program (TARP). Deposited as paid-in capital in new banks, then levered at a conservative ratio of nine to one, the money would support $3.5 trillion in new lending – enough, probably, to kick the securitization markets back into gear.

 

The details are hazy. Who would put the new banks together? Private equity firms willing to work for the government, in expectation of being able to buy their banks in due course?  Banking industry entrepreneurs signed into government service? Look for a growing discussion in the blogosphere, the trade press and mainstream media about how a few “good banks” could be created and put to work. Expect the proposal to get a good going over at Treasury as well.

 

For once they were commissioned, the new banks presumably would become the storm that tossed the ocean. Legacy banks would be driven to sell good assets to improve their balance sheets or enter Federal Deposit Insurance Corp. receivership (or both). Existing smaller “good” banks, those with no balance sheet problems (of which there are many), might elect to bulk up and enter the fray.

 

In this scenario, the troubled legacy banks mostly would sizzle and snap and wither away, something like the Wicked Witch of the West in that well-known financial allegory The Wizard of Oz. The mere announcement of a “good bank” plan probably would cause their share prices to drop to zero (as anticipation of receivership has already driven it most of the way:  Bank of America shares closed under $4 Friday, and Citibank under $2).

 

Since the depositors would be protected; the action would then shift to the banks’ creditors, including funds, magnates and foreign governments, who hold something like $1 trillion in bonds (at least at face value).  For a sight gag that conveys the mood of financial markets, and an incisive graphic depicting the isolation of the megabanks, see Take a Little Off the Top, by mortgage trader-turned-analyst Ira Artman.

 

In a response to Kwak’s discussion, Romer noted that Treasury Secretary Timothy Geithner has gone a certain distance toward dedicating TARP funds to new institutions that can increase credit quickly. “The additional $80 billion from TARP that he proposed as support for the TALF (Term Asset-backed Securities Loan Facility) program is designed to support a large and rapidly growing new wholesale bank that is being created inside the Fed…. The Fed is doing just what a private bank would do, treating the TARP funds as capital and borrowing to buy assets worth about 10 times the capital. The Fed’s experience also shows how quickly one could build up a new wholesale bank.”

 

Both Buiter and Romer have some experience in these matters. Buiter served five years as chief economist for the European Bank for Reconstruction and Development. Romer wrote “Looting,” an influential paper on various mechanisms at work in the savings and loan crisis (including, in particular, the enterprising role played by Michael Milken), with George Akerlof, of the University of California at Berkeley. Later, Romer devised the Justice Department’s proposal to break Microsoft into two separate companies, operating systems and applications, initially ordered but later abandoned.

 

Events are moving very swiftly now. It is hard to believe that there is any sympathy for keeping the current arrangement intact. The last thing the Obama administration can afford to do is marry the existing order on Wall Street.