Bad Bank Could Mean Good Credit

Posted January 29, 2009

The US proposes to create a “bad bank” which led to significant increases in the stock markets and a very calm currency market. The British pound rose against the US dollar and the euro as investor fears were calmed over UK banking system instability.


The bailout packages that have been implemented the last few months around the world have still not loosened credit.  It is the puzzler of the day, because interest rates are at zero, even healthy banks have been handed massive funding amounts, and global businesses have been salvaged.  Yet credit remains tight.  So the economists have finally decided the problem is that banks cannot loan money as long as their balance sheets are carrying so many worthless mortgages. 

These mortgages are being called toxic assets and many are bundled and backed by bonds.  Though the mortgage meltdown began in the US, the packages were sold around the world so there are plenty of banks carrying these toxic assets.  

Enter the concept of the bad bank… 

A bad bank would be a US government bank that would assume the toxic assets on private bank balance sheets.  The government would then restructure the mortgages making them affordable for homeowners through tactics such as reducing the interest rate or eliminating adjustable mortgage features.  When the mortgage is considered to be a viable asset once again, it would be resold to a private bank. 

The US House of Representatives passed an economic stimulus package to the tune of $819 billion.  Its passage is not as certain in the Senate and the final bill that passes into law will probably include a number of amendments.  But the economic package and the bad bank proposal have made investors more risk hungry by restoring some confidence in the marketplace – at least for few days. 

UK investor confidence has returned somewhat in response to both the US activity on a stimulus package and because Citigroup, Inc. has indicated interest in buying Lloyds Banking Group Plc shares.  Also, Barclays Plc has said it has no need of government aid because revenues rose in 2008.  This means the UK government will not have to invest as heavily in a bailout package for the UK financial industry.  UK investors have not responded favourably to the idea of additional UK bank nationalization or additional stimulus funding for financial groups. 

This newfound UK confidence was reflected in the sterling.  The British pound rose against the US dollar to $1.4326.  It also strengthened against the euro to 92.43 pence per euro.  This restored some calm to the UK currency market because some analysts had predicted a continued weakening of the sterling against the US dollar and the euro. 

What is interesting about this increase in the sterling price is the fact Prime Minister Gordon Brown was quoted yesterday as saying the UK is beginning to enter a "deep recession". Yet the sterling increased.  To borrow US vernacular for a brief moment...Go Figure! 

Because investors are feeling a bit friskier when it comes to investing, and feeling less need to seek safe haven currencies such as the yen and US dollar, Canada's currency rose.  In fact it strengthened the most it has in a month.  Canada's economy is naturally closely tied to the health of the US economy and the news of the probable creation of the bad bank led to increased Canadian optimism.  The Canadian currency rose to C$1.2135 against the US dollar. 

The Japanese yen was sold by investors as the need for safe haven investing declined.  The yen weakened to 89.20 yen per US dollar. 

The US dollar closed to $1.3160 against the euro.  The euro right now is being heavily influenced by economic news from Germany.  Germany's Consumer Price Index for January has been reported to be -.5% and the forecast had been -.3%. 

The currency markets remain calm right now as investors wait to see what governments will due to jolt the economies out of the downward slides they are experiencing.  There seems to be general agreement that a bad bank in the US could be a good bank for the credit markets, but there are a lot of details to work out since the toxic assets are securities for bonds.