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An old idea is new again: Put toxic loans in one giant bank

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It’s looking like the government is going back to Plan A for dealing with the ravaged financial system: Get the garbage loans off banks’ books, put them on the government’s books, and let the banks start over.

From Bloomberg News:

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The heads of the U.S. Treasury and Federal Deposit Insurance Corp. gave further momentum to the idea of a new government-backed bank to remove toxic assets from lenders’ balance sheets. ‘A lot of work has been done on an aggregator bank’ and other ways of using the $700-billion financial-rescue fund ‘to let it go further when it comes to dealing with illiquid assets,’ Treasury Secretary Henry M. Paulson told reporters today in Washington. FDIC Chairman Sheila Bair praised the idea in an interview on CNBC, saying it might have ‘some merit.’ Today’s remarks come days before President-elect Barack Obama takes office, and signal a readiness among regulators to undertake what’s likely to be the most radical effort yet to unfreeze lending. Federal Reserve Chairman Ben S. Bernanke earlier this week urged a ‘comprehensive plan’ to address illiquid assets, floating the idea of a ‘bad bank.’

The original $700-billion bailout plan, as approved by Congress in October, called for a Treasury program to buy toxic assets from banks, to clear the decks and get the institutions to start lending again.

Instead, Paulson shifted gears and decided to begin injecting government capital into the banks, while still leaving them saddled with garbage loans.

Obviously, it hasn’t worked -- as theCitigroup and Bank of America sagas have demonstrated. As bad loans get worse, the banks just come back for more government money. The crisis just stretches on and on.

With financial stocks tumbling again today (the average bank stock is down about 4%, while the broader market is rebounding), investors are demonstrating that they have no faith in Washington’s piecemeal efforts to buttress individual institutions.

It’s time to clear the decks. Actually, it’s past time. Paulson is on his way out, but Bernanke seems intent on pushing the bad-bank concept on the Obama administration. And as the Associated Press notes here, Former Fed Chairman and current Obama advisor Paul Volcker has been supportive of the idea.

-- Tom Petruno

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