An Alternative to a Taxpayer-Funded Aggregator Bank

Since we are once again on the brink of impending government purchases of "troubled" or "bad" assets off of bank balance sheets, let's think of potential market solutions as substitutes to using taxpayer money to take these assets off of balance sheets.

The basic premise of segregating troubled/bad assets which underlies ex-Treasury Secretary Paulson’s TARP, Fed Chairman Bernanke's "bad bank", FDIC Chairwoman Bair’s “aggregator bank” is sound and, one that I believe, does not encounter political or intellectual opposition from different spectrums. What encounters opposition is using taxpayer-funded dollars—i.e. the government—to pay for the monetization of these assets.

These troubled/bad assets do not necessarily have to be monetized by taxpayer money. Indeed the current form of monetization via the proposed TARP/aggregator bank could run the risk of imposing even more opacity on the valuation of these assets. The question is how will the government put a price on these assets? What valuation guidelines will the government employ in the purchase of the assets given that there is no "market" so to speak of for these assets? The government assumes that there will be a market in the future for the disposal of these assets. However, the current valuation methodology for a purchase of these assets by taxpayer money is opaque in any version of the various versions of the “aggregator bank” concept.

As an alternative, therefore, let's turn to the markets to determine valuation for these troubled assets. How would this work given that there is no market for these assets? Let's segregate these bad assets into funds. The funds could be structured as unit investment trusts (UITs). The government would be the [co-] sponsor of the UIT. The prospectus of the UIT would list the securities the trust would hold until its maturity and the UIT’s sponsor(s) would have price guidance for the initial offering of shares. The proceeds raised through the initial public offering of the UIT would then be handed over to the banks to purchase the troubled securities from the banks, thereby monetizing these bad assets.

Monetizing banks' troubled assets through UITs would achieve the goals of the aggregator bank of segregating the bad assets without using taxpayer money, with the added benefit of giving transparency to the valuation of these assets. Multiple UITs, each with a [diversified] pool of assets—MBS, CDOs, CMBS, ABS, etc.—can be structured. Structuring of the UITs and demand by UIT investors would determine the pricing of the initial public offering of the UIT and the proceeds received by banks for their troubled assets. This market solution achieves the goals of an aggregator bank in segregating the bad assets and taking them off of bank balance sheets and yet it hinges on private investors and the market to price and monetize these assets, rather than relying on taxpayer money to fund an opaque monetization.

My Letter to the Editor published in the Jan. 10-11, 2009 print edition of Wall Street Journal and on WSJ.com on Jan. 9, 2009

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