Opinion: A Plan to Resolve the Banking Crisis

By Richard T. Pratt, Chairman of the Federal Home Loan Bank Board 1981-1983; R. Dan Brumbaugh, Jr., Deputy Chief Economist 1983-1986; and Bowers W. Espy, Deputy Director of the Office of Economic and Policy Research 1981-1983, the Federal Home Loan Bank Board.

The Current Debate: Expand the Troubled Asset Relief Program (TARP) versus Nationalization

The Administration, the Federal Reserve System, and the Federal Deposit Insurance Corporation (FDIC) are addressing many critical elements necessary to resuscitate credit markets and facilitate economic stabilization and recovery. They understand that a fully functioning banking system is essential to that end. The initiatives announced by the Secretary of the Treasury on February 10, 2009 take important steps toward that goal.

A key initiative, the Capital Assistance Plan (CAP), would provide needed capital from the TARP to the banking system via the government purchase of convertible preferred securities from institutions deemed viable. Based on most estimates of future bank losses, however, available funding through the TARP is woefully inadequate to meet the capital needs of banks and substantial additional congressional funding will be required at a time when our federal deficit is soaring.

Concern over the Administration's plan has given rise to a growing call for massive bank nationalization. Nationalization should not be viewed as an overall solution to the banking crisis, but reserved for select institutions that have no hope of recovery. The FDIC already has a long history of closing -- in effect nationalizing -- failing banks on a case-by-case basis, and that process will continue.

The wholesale nationalization of a large segment of the banking industry based on current market conditions is not feasible. The primary problems affecting the banking system today are a function of system-wide de-leveraging, dysfunctional markets, and uncertainty about the scale of the current recession. They have caused a major disconnect between the so-called "fair value" and the fundamental value of bank assets based on expected cash flows. A government takeover of any or all of the banking system will not resolve these problems. These issues can only be resolved over time, as economic conditions stabilize.