Silicon Valley Bank Fails After Run on Deposits

 Silicon Valley Bank Fails After Run on Deposits

The Federal Deposit Insurance Corporation took control of the bank’s assets on Friday. The failure raised concerns that other banks could face problems, too.

Silicon Valley Bank’s headquarters in Santa Clara, Calif., on Friday. Founded in 1983, Silicon Valley Bank was a big lender to tech start-ups.

By Emily Flitter and Rob Copeland

Emily Flitter and Rob Copeland cover Wall Street and finance.

March 10, 2023

Updated 9:42 p.m. ET

One of the most prominent lenders in the world of technology start-ups, struggling under the weight of ill-fated decisions and panicked customers, collapsed on Friday, forcing the federal government to step in.

The Federal Deposit Insurance Corporation said on Friday that it would take over Silicon Valley Bank, a 40-year-old institution based in Santa Clara, Calif. The bank’s failure is the second-largest in U.S. history, and the largest since the financial crisis of 2008.

The move put nearly $175 billion in customer deposits under the regulator’s control. While the swift downfall of the nation’s 16th largest bank evoked memories of the global financial panic of a decade and a half ago, it did not immediately touch off fears of widespread destruction in the financial industry or the global economy.

Silicon Valley Bank’s failure came two days after its emergency moves to handle withdrawal requests and a precipitous decline in the value of its investment holdings shocked Wall Street and depositors, sending its stock careening. The bank, which had $209 billion in assets at the end of 2022, had been working with financial advisers until Friday morning to find a buyer, a person with knowledge of the negotiations said.

While the woes facing Silicon Valley Bank are unique to it, a financial contagion appeared to spread through parts of the banking sector, prompting Treasury Secretary Janet Yellen to publicly reassure investors that the banking system was resilient.

Investors dumped stocks of peers of Silicon Valley Bank, including First Republic, Signature Bank and Western Alliance, many of which cater to start-up clients and have similar investment portfolios.

Trading in shares of at least five banks was halted repeatedly throughout the day as their steep declines triggered stock exchange volatility limits.

By comparison, some of the nation’s largest banks appeared more insulated from the fallout. After a slump on Thursday, shares of JPMorgan, Wells Fargo and Citigroup all were generally flat on Friday.

That’s because the biggest banks operate in a vastly different world. Their capital requirements are more stringent and they also have far broader deposit bases than banks like Silicon Valley, which do not attract masses of retail customers. Regulators have also tried to keep the big banks from focusing too heavily in a single area of business, and they have largely stayed away from riskier assets like cryptocurrencies.

Greg Becker, the president and chief executive of Silicon Valley Bank, last year. The bank’s downward spiral accelerated this week.

“I don’t think that this is an issue for the big banks — that’s the good news, they’re diversified,” said Sheila Bair, former chair of the F.D.I.C. Ms. Bair added that since the largest banks were required to hold cash equivalents even against the safest forms of government debt, they should be expected to have plenty of liquidity.

On Friday, Ms. Yellen discussed the issues surrounding Silicon Valley Bank with banking regulators, according to a statement from the Treasury Department.

Representatives from the Federal Reserve and the F.D.I.C. also held a bipartisan briefing for members of Congress organized by Maxine Waters, a Democrat from California and the ranking member of the House Financial Services Committee, according to a person familiar with the matter.

Silicon Valley Bank’s downward spiral accelerated with incredible speed this week, but its troubles have been brewing for more than a year. Founded in 1983, the bank had long been a go-to lender for start-ups and their executives.

Though the bank advertised itself as a “partner for the innovation economy,” some decidedly old-fashioned decisions led to this moment.

Flush with cash from high-flying start-ups that had raised a lot of money from venture capitalists, Silicon Valley Bank did what all banks do: It kept a fraction of the deposits on hand and invested the rest with the hope of earning a return. In particular, the bank put a large share of customer deposits into long-dated Treasury bonds and mortgage bonds which promised modest, steady returns when interest rates were low.

That had worked well for years. The bank’s deposits doubled to $102 billion at the end of 2020 from $49 billion in 2018. One year later, in 2021, it had $189.2 billion in its coffers as start-ups and technology companies enjoyed heady profits during the pandemic.

But it bought huge amounts of bonds just before the Federal Reserve began to raise interest rates a little more than a year ago, then failed to make provisions for the possibility that interest rates would rise very quickly. As rates rose, those holdings became less attractive because newer government bonds paid more in interest.

That might not have mattered so long as the bank’s clients didn’t ask for their money back. But because the gusher of start-up funding slowed at the same time as interest rates were rising, the bank’s clients began to withdraw more of their money.

To pay those redemption requests, Silicon Valley Bank sold off some of its investments. In its surprise disclosure on Wednesday, the bank admitted that it had lost nearly $2 billion when it was all but forced sell some of its holdings.

“It’s the classic Jimmy Stewart problem,” said Ms. Bair, referring to the actor who played a banker trying to stave off a bank run in the film “It’s a Wonderful Life.” “If everybody starts withdrawing money all at once, the bank has to start selling some of its assets to give money back to depositors.”

Those fears set off investor worries about some of the regional banks. Like Silicon Valley Bank, Signature Bank is also a lender that caters to the start-up community. It’s perhaps best known for its connections to former President Donald J. Trump and his family.

First Republic Bank, a San Francisco-based lender focused on wealth management and private banking services for high net worth clients in the tech industry, warned recently that its ability to earn profits is being hampered by rising interest rates. Its Phoenix-based peer in the wealth management industry, Western Alliance Bank, is facing similar pressures.

Separately, another bank, Silvergate, said on Wednesday that it was shutting down its operations and liquidating after suffering heavy losses from its exposure to the cryptocurrency industry.

A First Republic spokesman responded to a request for comment by sharing a filing the bank made to the Securities and Exchange Commission on Friday stating that its deposit base was “strong and very-well diversified” and that its “liquidity position remains very strong.”

A Western Alliance spokeswoman pointed to a news release by the bank on Friday describing the condition of its balance sheet. “Deposits remain strong,” the statement said. “Asset quality remains excellent.”

Representatives of Signature and Silicon Valley Bank had no comment. Representatives for the Federal Reserve and F.D.I.C. declined to comment.

Some banking experts on Friday pointed out that a bank as large as Silicon Valley Bank might have managed its interest rate risks better had parts of the Dodd-Frank financial-regulatory package, put in place after the 2008 crisis, not been rolled back under President Trump.

In 2018, Mr. Trump signed a bill that lessened regulatory scrutiny for many regional banks. Silicon Valley Bank’s chief executive, Greg Becker, was a strong supporter of the change, which reduced how frequently banks with assets between $100 billion and $250 billion had to submit to stress tests by the Fed.

At the end of 2016, Silicon Valley Bank’s asset size was $45 billion. It had jumped to more than $115 billion by the end of 2020.

Friday’s upheaval raised uncomfortable parallels to the 2008 financial crisis. Although it’s not uncommon for small banks to fail, the last time a bank of this magnitude unraveled was in 2008, when the F.D.I.C. took over Washington Mutual.

The F.D.I.C. rarely takes over banks when the markets are open, preferring to put a failing institution into receivership on a Friday after business has closed for the weekend. But the banking regulator put out a news release in the first few hours of trading on Friday, saying that it created a new bank, the National Bank of Santa Clara, to hold the deposits and other assets of the failed one.

The regulator said that the new entity would be operating by Monday and that checks issued by the old bank would continue to clear. While customers with deposits of up to $250,000 — the maximum covered by F.D.I.C. insurance — will be made whole, there’s no guarantee that depositors with larger amounts in their accounts will get all of their money back.

Those customers will be given certificates for their uninsured funds, meaning they would be among the first in line to be paid back with funds recovered while the F.D.I.C. holds Silicon Valley Bank in receivership — although they might not get all of their money back.

When the California bank IndyMac failed in July 2008, it, like Silicon Valley Bank, did not have an immediate buyer. The F.D.I.C. held IndyMac in receivership until March 2009, and large depositors eventually only received 50 percent of their uninsured funds back. When Washington Mutual was bought by JPMorgan Chase, account holders were made whole.

Emily Flitter covers finance. She is the author of “The White Wall: How Big Finance Bankrupts Black America.” @FlitterOnFraud

Rob Copeland covers Wall Street and banking. @realrobcopeland

https://www.nytimes.com/2023/03/10/business/silicon-valley-bank-stock.html

How I Analyze a Bank Stock

How I Analyze a Bank Stock
A four-part framework to clarify banking.

Anand Chokkavelu (TMFBomb) Apr 29, 2014

Here's the beauty of the banking industry: Banks are similar enough that once you learn how to analyze one, you're pretty much set to analyze 500 of them.

That's about how many banks trade on major U.S. exchanges.

Now, the details get messy when you factor in complicated financial instruments, heavy regulations, byzantine operating structures, arcane accounting rules, the macro factors driving the local economies these banks operate in, and intentionally vague jargon.

But at their core, each bank borrows money at one interest rate and then lends it out at a higher interest rate, pocketing the spread between the two.

And as investors we can get far by focusing on four things:

1. What the bank actually does
2. Its price
3. Its earnings power
4. The amount of risk it's taking to achieve that earnings power

To give a concrete example, let's walk through one of the banks I've bought in the banking-centric real-money portfolio I manage for the Motley Fool: Fifth Third Bancorp (NASDAQ:FITB).

As quick background, Fifth Third is a regional bank based out of Cincinnati whose 1,300+ branches fan out across 12 states. It's large enough to be in the "too big to fail" group that gets stress tested by the Fed each year but still less than a tenth the size of a Bank of America or a Citigroup -- and much simpler.

Alright, let's start with...


1.  What the bank actually does

When you read through a bank's earnings releases, it's easy to get sidetracked by management's platitudes and high-minded promises -- guess what, EVERY bank says it's customer-focused and a conservative lender!

Words are nice, but in banking, you are your assets -- the loans you make, the securities you hold, etc. They're the things that will drive future profitability when they're chosen carefully, and they're the things that will force you to fail (or get bailed out) when you get in trouble.

Here's the asset portion of Fifth Third's balance sheet. Take a look, let your eyes glaze over, and then I'll let you know the numbers I focus on (until we get to the "Its price" section, I'm using the financials from Fifth Third's last 10-K because they're more detailed for illustrative purposes).

Loans are the heart of a traditional bank.

In my mind, the greater a bank's loans as a percentage of assets, the closer it is to a prototypical bank.

In this case, two-thirds of Fifth Third's assets are loans (87,032/130,443). This number can range far and wide, but Fifth Third's ratio is pretty typical. For context, note that Fifth Third's loan percentage is double the much more complex balance sheet of JPMorgan Chase.

If a bank isn't holding loans, it's most likely holding securities. You'll notice Fifth Third's various buckets of securities in the balance sheet lines between its cash and its loans. There are many reasons a bank could hold a high percentage of securities.

• For example, its business model may not be loan-driven, 
• it may be losing loan business to other banks, or 
• it may just be being conservative when it can't find favorable loan terms. 

In any case, looking at loans as a percentage of assets gives you questions to explore deeper.

The next step of digging into the loans is looking at what types of loans a bank makes. You can see in the balance sheet that Fifth Third neatly categorizes its $88.6 billion in loans. Clearly, Fifth Third is a business lender first and foremost: When you add up "Commercial and industrial loans," "Commercial mortgage loans," "Commercial construction loans," and "Commercial leases," almost 60% of Fifth Third's loans are business-related. Also, given the almost $40 billion in "Commercial and industrial loans" (as opposed to mortgage loans), a lot of Fifth Third's loans aren't backed up by real estate (though other forms of collateral may be in play).

For simplicity, I'll stop here. The one-line summary: On the assets side, look at the loans.

Let's move on to the rest of the balance sheet:

Just as the loans tell the story on the assets side, the deposits tell the story on the liabilities side. The prototypical bank takes in deposits and makes loans, so two ratios help get a feel for how prototypical your bank is:

• 1) Deposits/Liabilities 
• 2) Loans/Deposits.

Deposits are great for banks for the same reason you complain about getting low interest rates on your checking and savings accounts. Via these deposit accounts, you're essentially lending the bank money cheaply. If a bank can't attract a lot of deposits, it has to take on debt (or issue stock on the equity side), which is generally much more expensive. That can lead to risky lending behavior -- i.e. chasing yields to justify the costs.

Fifth Third's deposit/liabilities ratio is 86%, which is quite reasonable and leads to an equally reasonable 89% loan/deposit ratio. All of this confirms what we suspected after looking at the loans on the asset side. Fifth Third is a bank that, at its core, takes in deposits and gives out loans with those deposits. If that wasn't the case, we'd want to get comfortable with exactly what it's doing instead.

We're now ready to take a quick peek at the income statement:

The big thing to focus on here is the two different types of bank income: 

1. net interest income and 
2. (you guessed it) noninterest income.

Still lost in that mess above? See the lines

1. "Net Interest Income After Provision for Loan and Lease Losses" (3,332, or $3.332 billion) and 
2. "Total noninterest income" (3,227, or $3.227 billion).

I told you earlier that at its core, a bank makes money by borrowing at one rate (via deposits and debt) and lending at another higher rate (via loans and securities). Well, net interest income measures that profit.

Meanwhile, noninterest income is the money the bank makes from everything else, such as

• fees on mortgages, 
• fees and penalties on credit cards, 
• charges on checking and savings accounts, and 
• fees on services like investment advice for individuals and corporate banking for businesses.

For Fifth Third, it gets almost as much income via noninterest means ($3.2 billion) as it does from interest ($3.3 billion).

Like most of what we've covered so far, that's not necessarily good or bad. It furthers our understanding of Fifth Third's business model. For instance, the noninterest income can smooth interest rate volatility but it can also be a risk if regulators change the rules (e.g. banks can no longer automatically opt you in to overdraft protection...meaning they get less of those annoying but lucrative overdraft fees).

There are many, many line items I'm glossing over on both the balance sheet and the income statement, but these are the main things I focus on when I'm looking over the financial statements. As you'll see, many of the things I've ignored are covered a bit by the ratios we'll look at in the other sections.

Next up is...



2.  Its price

The oversimplified saying in banking is "buy at half of book value, sell at two times book value."

Just as if I told you to "buy a stock if its P/E ratio is below 10, sell if it's over 25" there are many nuanced pitfalls here, but it at least points you in the right direction.

If you're unfamiliar with book value, it's just another way of saying equity. If a bank is selling at book value, that means you're buying it at a price equal to its equity (i.e. its assets minus its liabilities).

To get a little more conservative and advanced than price/book ratio, we can look at the price/tangible book ratio. As its name implies, this ratio goes a step further and strips out a bank's intangible assets, such as goodwill. Think about it. A bank that wildly overpays to buy another bank would add a bunch of goodwill to its assets -- and boost its equity. By refusing to give credit to that goodwill, we're being more conservative in what we consider a real asset (you can't sell goodwill in a fire sale). Hence, the price-to-tangible book value will always be at least as high as the price-to-book ratio.

In Fifth Third's case, it currently has a price-to-book value of 1.3 and a price-to-tangible book value of 1.5. In today's market that's a slight premium to the median bank.

Like any company, the reason you'd be willing to pay more for one bank than another is if you think its earning power is greater, more growth-y, and less risky.

Our first clue on Fifth Third's earnings power is also our last valuation metric: P/E ratio. Fifth Third's clocks in at just 10.7 times earnings. That's lower than its peers. In other words, although we're paying an above average amount for its book value, we're seeing that it's able to turn its equity into quite a bit of earnings.

Let's look further into that...


3.  Its earnings power

I talked a bit about how Fifth Third has a lower than average P/E ratio (high Earnings Yield) despite having a higher-than-average P/B ratio. The metric that bridges that gap is called return on equity (ROE). Put another way, return on equity shows you how well a bank turns its equity into earnings. Equity's ultimately not very useful if it can't be used to make earnings.

Over the long term, an ROE of 10% is solid. Currently, Fifth Third is at 12.3%, which is quite good on both a relative and absolute basis.

Breaking earnings power down further, you can look at

1. net interest margin and 
2. efficiency.

Net interest margin measures how profitably a bank is making investments. It takes the interest a bank makes on its loans and securities, subtracts out the interest it pays on deposits and debt, and divides it all over the value of those loans and securities. In general, it's notable if a bank's net interest margin is

• below 3% (not good) or 
• above 4% (quite good). 

Fifth Third is at 3.3%, which is currently higher than some good banks, lower than others.

While net interest margin gives you a feel for how well a bank is doing on the interest-generating side, a bank's efficiency ratio, as its name suggests, gives you a feel for how efficiently it's running its operations.

The efficiency ratio takes the non-interest expenses (salaries, building costs, technology, etc.) and divides them into revenue. So, the lower the better.

• A reading below 50% is the gold standard. 
• A reading above 70% could be cause for concern. 

Fifth Third is at a good 58%.

There are nuances in all this, of course. For instance, a bank may have an unfavorable efficiency ratio because it is investing to create a better customer service atmosphere as part of its strategy to boost revenues and expand net interest margins over the long term.

Meanwhile, ROE and net interest margins can be juiced by taking more risk.

So that brings us to...


4.  The amount of risk it's taking to achieve that earnings power

There are a lot (and I mean a LOT) of ratios that try to measure how risky a bank's balance sheet is. For example, when the Fed does its annual stress test of the largest banks, it looks at these five:

1. Tier 1 common ratio
2. Common equity tier 1 ratio
3. Tier 1 risk-based capital ratio
4. Total risk-based capital ratio
5. Tier 1 leverage ratio.

If you think that's confusing, you should see their definitions -- they're chockfull of terms like "qualifying non-cumulative perpetual preferred stock instruments."

Personally, I rely on a much simpler ratio: assets/equity.

When you buy a house using a 20% down payment (that's your equity), your assets/equity ratio is at five (your house's value divided by your down payment).

For a bank, I get comfort from a ratio that's at 10 or lower. My worry increases the farther above 10 we go. Fifth Third's is at a reasonable 8.7 after its most recent quarter (8.9 if you're doing the math on the year-end balance sheet above).

We can get more complicated by using tangible equity, but this is a good basic leverage ratio to check out. If you're looking at a bigger bank like Fifth Third, it's also a good idea to check out the results of those Fed stress tests I talked about.

That leverage ratio gives us a good high-level footing. Getting deeper into assessing assets, we need to look at the strength of the loans. Let's focus on two metrics for this:

1. Bad loan percentage (Non-performing Loans/Total Loans)
2. Coverage of bad loans (Allowance for non-performing loans/Non-performing loans)

Non-performing loans are loans that are behind on payment for a certain period of time (90 days is usually the threshold). That's a bad thing for obvious reasons.

Like most of these metrics, it really depends on the economic environment for what a reasonable bad loan percentage is. 

• During the housing crash, bad loan percentages above five percent weren't uncommon. 
• In general, though, I take notice when a bank's bad loans exceed two percent of loans. 
• I get excited when the bad loan percentage gets below one percent (so Fifth Third's 0.8% is looking good).

Banks know that not every loan will get paid back, so they take an earnings hit early and establish an allowance for bad loans. As you've probably guessed, banks can play a lot of games with this allowance.

• Specifically, they can boost their current earnings by not provisioning enough for loans that will eventually default. 
• That's why I like to see the coverage of bad loans to be at least 100%. Fifth Third's is at a conservative-looking 202%.

Finally, I use dividends as an additional comfort point. In an industry that has periods that incent loose lending, I like management consistently taking some capital out of its own hands. I like to see banks paying at least a two percent dividend. A bigger dividend isn't a foolproof way to gauge riskiness, but I get warm fuzzies from a bank that can commit to a decent-sized dividend. As for Fifth Third, it pays out about a quarter of its earnings for a dividend yield of 2.3%.


Putting it all together

I've tried to simplify analyzing a bank as much as I can. I've left out many metrics and concepts, but you've still been bombarded with a lot of potentially boring information.

What's important to remember is that a bank (through its management) is telling you a story about itself. It's our job to figure out whether we believe the tale enough to buy it at current prices.

Because most banks share similar business models, the numbers will go a long way to help you determine if those stories hold water.

If a bank says it's a conservative lender, but half of its loans are construction loans, it has a 10% bad debt ratio, and it's leveraged 20:1, I'm trusting the numbers not the words.

Look at the numbers over the last decade or two and you'll see many clues. When a bank has been able to deliver large returns across a few economic cycles while keeping the same general business model, that's a very good thing. Even better if the same management team has been there the whole time or if the bank clearly has a conservative culture in place that stays in place between management teams.

It's easy to get lost in the minutiae of analyzing a bank, but going in with a framework helps you keep your eyes on the big picture. What I've shared today are the four tenets of my basic framework...I hope it helps clarify yours.




Anand Chokkavelu, CFA owns shares of Bank of America, Citigroup, and Fifth Third Bancorp as well as warrants in Citigroup. He swears his other articles are more interesting. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and Fifth Third Bancorp. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

http://www.fool.com/investing/general/2014/04/29/how-i-analyze-a-bank-stock.aspx

Spain's banks hold billions of euros in properties that will be tough to sell

The Real Threat Facing Spanish Lenders

Spain's banks hold billions of euros in properties that will be tough to sell

One analyst estimates it could take 40 years for banks to unload their holdings Denis Doyle/Bloomberg

While Europe’s sovereign debt crisis grabs all the headlines, distressed real estate may pose a bigger threat to the Spanish banking system. The country’s lenders hold about £30 billion ($41 billion) of unfinished homes and land that’s “unsellable,” according to Pablo Cantos, managing partner of MaC Group in Madrid. MaC Group is a risk adviser to several leading Spanish banks. “I’m really worried about the small and medium-size banks whose business is 100 percent in Spain and based on real estate growth,” says Cantos. He adds that only bigger, more diversified lenders such asBanco Santander (STD), Banco Bilbao Vizcaya Argentaria (BBVA), La Caixa, and Bankia are strong enough to survive their real estate losses: “I foresee Spain will be left with just four large banks.”

Spain’s central bank tightened rules last year to force lenders to set aside more reserves against property seized in exchange for unpaid debts and is pressing them to sell assets rather than wait for the market to recover from its four-year decline. Yet unloading the real estate may be difficult or impossible. Bank-owned land “in the middle of nowhere” and unfinished residential units will take as long as 40 years to sell, Cantos predicts. Fernando Rodríguez de Acuña Martínez, a consultant at Madrid-based adviser RR de Acuña & Asociados, has a more dire view. About 43 percent of unsold new homes are in exurbs far from city centers, he says, and “if you take into account population growth for these areas, there’s no demand for them. Not now or in 10 years.”

Dozens of Spanish banks have failed or been absorbed since the economic crisis ended a debt-fueled property boom in 2008. The cost to taxpayers of cleaning up the industry’s books has come to £17.7 billion so far. Banks may face increased pressure following Nov. 20 national elections that propelled the conservative People’s Party to power. Its leader, Mariano Rajoy, has said the “cleanup and restructuring” of the banking system is his top priority.

“Stricter provisioning rules for land need to be implemented,” says Luis de Guindos, director of PricewaterhouseCoopers and IE Business School Center for Finance. De Guindos has been named by newspapers as a contender for finance minister in a Rajoy government. “Many banks will be able to deal with it, but others won’t.”

Idealista, Spain’s largest real estate website, currently advertises 45,912 bank-owned homes there, up from 29,334 in November 2010. In 2008 it didn’t list any.

Spanish home prices have fallen 28 percent, on average, from their peak in April 2007, according to a Nov. 2 joint report by Fotocasa.es, a real estate website, and the IESE Business School. Land values fell 33 percent nationwide. Fernando Acuña Ruiz, managing partner of Taurus Iberica Asset Management, a Spanish mortgage servicer, expects the slide in home prices to continue. “Spain has 1 million new homes that won’t be completely absorbed by the market until the middle of 2017,” he says. “Prices will fall a further 15 percent to 20 percent in the next two to three years.”

Banks are reluctant to acknowledge the size of the declines. There is an “enormous” gap between prices offered by lenders and what investors are willing to pay, preventing sales of large property portfolios, MaC Group’s Cantos says. He estimates that prime assets can be sold at a 30 percent discount, while portfolios comprising land, residential, and commercial real estate may sell only after 70 percent discounts. “Therein lies the problem,” he says. “Banks have already provisioned for a 30 percent loss, but if you are selling at 70 percent discount, you have to take another 40 percent loss. Which small and medium-size banks can take such a hit?”

The bottom line: With home prices down 28 percent from the peak, real estate losses may swamp smaller lenders, leaving Spain with four big banks.

Smyth is a reporter for Bloomberg News.

Graphic of banks’ shrinking market caps

All Big US Banks Must Go to Fix Crisis: Economist

All Big US Banks Must Go to Fix Crisis: Economist
By: Kim Khan 30 Jan 2009 12:55 PM ET

The creation of a government bad bank to buy toxic assets is necessary, but then the government will need to take control of and restructure major banks to fix the system, one economist at the World Economic Forum in Davos told CNBC.com.
"They have to do a bad bank," Harvard Economics Professor Ken Rogoff said. But "if that's all they do then it's idiotic."
Institutions like Citi and Bank of America will have to go, boards will have to be fired and equity stakeholders will be wiped out, Rogoff said.
The plan could mirror the one Sweden implemented, where all troubled banks were nationalized, their balance sheets were cleaned up and the good parts of the businesses were sold to the private sector.
That solution was "much cleaner," he said.
Sweden’s banks were effectively bankrupt in the early 1990s, but the government pulled off a rapid recovery that actually helped taxpayers make money in the long run.

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The government placed banks with troubled assets into a so-called bad bank, where they could be held and then sold when market and economic conditions improved.
In the meantime, it used taxpayer money to provide enough capital to allow banks to resume normal lending, but wiped shareholders out in the process.
Officials from the Obama administration are holding around the clock meetings with senior Wall Street executives on how to create a new government bank to buy bad assets from major financial firms.
However, people with direct knowledge of the talks tell CNBC there is no consensus on how such an entity would work or whether a plan could materialize any time soon or possibly ever.

Jobs Won't Come Back this Year
Looking to the overall economy, it unlikely the job market will improve this year, Rogoff told CNBC.
"I'm afraid unemployment is going to keep rising until at least 2010," he said.
The US is in "a very deep financial recession" and in those situations unemployment rises for almost five years, he added.
US housing and jobless claims data on Thursday showed there was no end in sight for the gloomy economy, while Japan's industrial outlook plunged by a record pace in December, contributing to the bleak picture of the world slowdown.

Baccardax: Bad Banks Are Good ... Aren't They?
© 2009 CNBC.com

http://www.cnbc.com/id/28928650?__source=yahoorelatedstorytext&par=yahoo