The current approach to the banking bailout is distinctly WOBW – worst of both worlds.  Somehow nationalization has been deemed not an option.  So we keep running bankrupt banks as private enterprises governed by existing equity holders with all the wrong incentives (worst of private).  That in turn necessitates having to regulate operational details such as compensation and lending practices with crude across the board measures such as $500K salary cap (worst of public).

The only way to get incentives properly aligned here is to wipe out the existing equity holders, set up an interim governance and create new proper incentives from scratch.  This would allow us to accomplish the crucial bits:

1. We don’t need to artificially determine a price right now for bad assets.  We simply get to keep the bad assets in a pile that we can slowly work off over time.  In any of the currently contemplated regimes (including the sidecar one proposed by Soros), we have to come up with valuations right now for the bad assets.  There is no way to get those numbers right (there are no right numbers!) and getting them wrong will either keep the firms bankrupt or will transfer wealth from taxpayers to equity holders.

2. 
   

3. We can immediately free up the good assets by spinning out parts of banks (and insurers) that are in ok or even good shape.  The management of these new entities can have significant equity (vesting over 4+ years) in lieu of exorbitant cash comp.  This would not have to be regulated – the S1s for these entities would detail the compensation of the management teams.

4. 
   

5. We can reshape the industry structure by creating many smaller stand alone entities which will make the industry more resilient and will make it much harder to hide risks inside of some arcane part of a huge firm.

If we are so hung up about “nationalization” let’s call it “supervised restructuring” but let’s get on with it instead of continuing to combine the worst of both worlds.

The current approach to the banking bailout is distinctly WOBW – worst of both worlds.  Somehow nationalization has been deemed not an option.  So we keep running bankrupt banks as private enterprises governed by existing equity holders with all the wrong incentives (worst of private).  That in turn necessitates having to regulate operational details such as compensation and lending practices with crude across the board measures such as $500K salary cap (worst of public).

The only way to get incentives properly aligned here is to wipe out the existing equity holders, set up an interim governance and create new proper incentives from scratch.  This would allow us to accomplish the crucial bits:

1. We don’t need to artificially determine a price right now for bad assets.  We simply get to keep the bad assets in a pile that we can slowly work off over time.  In any of the currently contemplated regimes (including the sidecar one proposed by Soros), we have to come up with valuations right now for the bad assets.  There is no way to get those numbers right (there are no right numbers!) and getting them wrong will either keep the firms bankrupt or will transfer wealth from taxpayers to equity holders.

2. 
   

3. We can immediately free up the good assets by spinning out parts of banks (and insurers) that are in ok or even good shape.  The management of these new entities can have significant equity (vesting over 4+ years) in lieu of exorbitant cash comp.  This would not have to be regulated – the S1s for these entities would detail the compensation of the management teams.

4. 
   

5. We can reshape the industry structure by creating many smaller stand alone entities which will make the industry more resilient and will make it much harder to hide risks inside of some arcane part of a huge firm.

If we are so hung up about “nationalization” let’s call it “supervised restructuring” but let’s get on with it instead of continuing to combine the worst of both worlds.