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The Old Banks Are Busted, Why Not Create New Ones?

Stanford economist Paul Romer unveils an innovative credit-crisis fix in today's Journal:

The government has $350 billion in Troubled Asset Relief Program (TARP) funds that it can use to encourage new bank lending. If this money is directed to newly created good banks with pristine balance sheets, it could support $3.5 trillion in new lending with a modest 9-to-1 leverage. Right out of the gate, the newly created banks could do what the Fed has already been doing -- buying pools of loans originated by existing banks that meet high underwriting standards. ...

If the government lets new banks provide the new lending that the economy needs, it could return to clearly stated and familiar policies for bank regulation. The government could announce that it will not invest any new capital in a troubled bank that it hasn't yet taken over. Nor will it offer troubled banks any transfers or implicit subsidies. It can stick to a policy of assigning accurate values to assets as new information comes in. It can follow the usual FDIC procedures for protecting depositors and taxpayers and for deciding when to take over a distressed bank, and managing careful workouts that avoid the turmoil that a Lehman-style bankruptcy proceeding can cause.

I'm not sure how easy it is to simply set up a handful of new banks--seems like the practical complications are potentially endless. At the very least it would probably take longer than would be ideal. But, analytically, this doesn't seem that different from taking over a handful of banks, capitalizing them well, and letting them get on with the business of lending, while treating the remaining banks as Romer suggests.

--Noam Scheiber