Via Calculated Risk, CNBC is reporting that the “bad bank” concept is emerging as the vehicle of choice to recapitalize the banks. It may get kicked off next week. Not a lot of new news there but they did have some information on the mechanism for setting the price of the assets to be purchased from the banks.

According to CNBC they plan to use a model to price the assets they plan to buy. The model would assume a long-term hold or hold to maturity and utilize the governments low funding cost to arrive at a purchase price. And, Presto, you now have a scheme to pay more than market value for the assets. CNBC did not give any information on the target IRR that the government might be looking for but it’s probably safe to assume that it will be whatever is needed to pull off the charade.

Aside from a sham purchase price, there might be a few other problems here.

First, the government is going to have, say anywhere from a half a trillion to a trillion dollars worth of assets that have to be managed. The government has no idea how to do this. What do you think a GS 15 is going to do when he has ten half completed condo projects in Florida land on his desk? Roll up his sleeves and start figuring the least loss alternative? Guess again. He’s going to go out to the private sector and hire someone to work it out. Maybe back to the bank that dumped it on him in the first place, since they know it best.  Are you starting to get the idea here? It isn’t that simple.

Second, this is going to put a slug of debt on the federal balance sheet that is going to have to stay there for some time if indeed they do intend to hold these assets to maturity. Anyway you look at it, money will have to be spent and we will have to borrow. I know, the accounting argument is going to be that a like amount of assets will be acquired so there is no net effect, and the income from the assets will more than offset the cost of credit and blah, blah, blah. We both know that all of that will be based on assumptions that have little likelihood of ever being realized.

Look, there are losses here that someone is going to have to belly up to the bar and assume. We can continue to play accounting games that defer the problem and let it fester or we can just fess up and pay up. One way or the other get the assets out of the banks and sell them post haste. Make the banks’ shareholders eat the losses first and if you have to recapitalize them with taxpayer money after that then do so. Continuing to think that we can financial engineer ourselves out of this is lunacy.