(Paul) Romer: Start New Banks?

Paul Romer, husband and co-author to CEA head Christy Romer, has a suggestion that on the surface makes all kinds of sense.

Paul Romer Says Starting New Banks Would Keep TARP Money Away From Bad Banks - WSJ.com. Everyone agrees that the United States urgently needs a few good banks. Turning bad banks into good banks is a difficult and risky way to get them. It's simpler and safer to start entirely new banks. ... The government has $350 billion in Troubled Asset Relief Program (TARP) funds ... it could support $3.5 trillion in new lending with a modest 9-to-1 leverage.

Short story, government provides seed capital for new private banks that have clean balance sheets, and owns all the shares in those banks. Since they don't have toxic assets lurking, they don't need to hoard their cash, so they can provide the lending necessary for recovery, and give economic breathing room to let legacy banks take their hits.

Over time, private players buy the shares from the government, and the banks become completely private. It seems damned sensible.

The problems, pointed out by some of his commenters:

• You can't just flip a switch to create banks on the massive scale that Romer suggests. There are all those pesky details of thousands of employees, management and information systems, physical locations, etc.

• Cronyism, lobbying, and general corruption and malfeasance: who gets to start these new banks? Who decides?

Commenter BruceCopeland points to a much better option: government investment in solid banks with a proven track record of responsible management--mostly smaller, regional banks. The government could invest in these banks via new or existing share purchases, loans with options, or other well-established and transparent vehicles. Whatever the vehicle, it expands these banks' capital base so they can increase lending under traditional fractional-reserve policies.

As with Romer's proposal, those shares would eventually be sold to private investors, removing the government's ownership share in those banks.

Advantages:

• Less concentration and too-big-to-fail curses. Let a thousand flowers bloom.
• It’s far easier to evaluate an existing track record than to predict who will successfully launch and operate a new bank.
• The whole mechanism of investment is extant, transparent, and immediately available. (Though we should probably hire Warren Buffet to cut the deals for us.)
• Much faster effect. Existing banks can scale up internal operations, or farm out parts to the many existing shops, while retaining the crucial management control–deciding who to lend to at what rates–with more limited and judicious staff increases.
• The expanded lending from these juiced-up banks would provide the economic breathing room to let big legacy banks take their hits.
• It seems that selling government shares back to the public could/would happen more rapidly if those shares are in a company with a proven track record.

Others?

Comments

[Michael]

Just a correction -- David Romer is Christy's husband. Paul Romer is a separate (and I believe entirely unrelated) Romer.