'Bad Bank' Plan Has Pitfalls, Analysts Say

As support builds on Wall Street and Capitol Hill for a "bad bank" that would help financial institutions free their balance sheets of illiquid assets, two prominent analysts on Thursday noted significant stumbling blocks in the way of the plan's success.

Oppenheimer analyst Meredith Whitney and FBR Capital Markets analysts led by Paul Miller questioned the impact that the bad bank concept that helped buoy financial stocks on Wednesday may have on the earnings power of financial companies.

The Obama administration is formulating the next phase of the federal government's response to the banking crisis and have expressed a willingness to consider using the remaining $350 million of the $700 billion Troubled Asset Relief Program, or TARP -- and possibly much more -- to buy up bad assets weighing down the banks.

Such a move would be a return to TARP's original intention, before then Treasury Secretary Henry Paulson turned his attention to making preferred equity investments in banks as a means to deliver much-needed capital. But Whitney -- who won acclaim for her early calls on Citigroup's (C Quote) need to cut its dividend and the insufficient capital levels at many major banks - said the bad bank plan did not address the "root cause" of the problem.

"If a bank were to sell its 'bad' assets into a 'bad bank,' it would still be left with lower earnings power from higher losses on 'good loans' and the requirement to build reserves," Whitney wrote in a note Thursday.