Good Bank-Bad Bank: A Clean Break And A Fresh Start.

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Good Bank-Bad Bank: A Clean Break And A Fresh Start.

With global financial markets in varying states of disarray, financial institutions and government officials are seeking to stabilize the banking industry and restore the flow of credit. Financial institutions have been plagued by continuing losses from troubled assets on their balance sheets. The application of mark-to-market accounting results in the announcement of new write-downs each quarter. These write-down announcements sap investor confidence in financial institutions and lead to stock price declines and increased volatility. This chain of events continues to overshadow efforts to refocus attention on business prospects. Over the course of 2008, the scope of troubled assets broadened—from subprime mortgage-related assets, to auction rate securities, to derivatives, to commercial real estate related assets. Uncertainty regarding future losses and a market and asset value "bottom" inhibit private investment in financial institutions.

Initially, the U.S. government plan, proposed by former Treasury Secretary Paulson, contemplated purchasing troubled assets from financial institutions. However, for a variety of reasons, including concerns regarding the appropriate valuation of those assets to be purchased, this plan was abandoned. Instead, the government proceeded with direct capital injections into financial institutions, through the Capital Purchase Program. In recent months, market participants and regulators both in the U.S. and in Europe have debated alternative measures to restore financial stability and investor confidence. There are two principal alternatives (and many permutations of these) that have been put forth: an asset guarantee model and a good bank-bad bank model. Both of t...

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