ANALYSIS:FACED WITH tumbling bank shares and a worsening financial crisis, new US president Barack Obama is thought to be moving towards a version of the "bad bank" strategy discarded by his predecessor just months before, writes Prionsias O'Mahony

Federal Reserve chairman Ben Bernanke last week said that a “comprehensive plan” is needed to deal with the illiquid assets burdening bank balance sheets, a suggestion echoed by Sheila Bair, chairman of the Federal Deposit Insurance Corp (FDIC). Bair said that talks regarding some kind of programme to deal with banks’ toxic assets had gone beyond the “hypothetical” stage and that authorities were “nearing the point to make a decision”.

The current consensus is that some kind of government-run “aggregator” will be set up, its intention being to buy up to $1 trillion of banks’ toxic assets. Wary of further write-downs, banks have been reluctant to lend to customers. The removal of these toxic assets would allow for the unfreezing of lending, advocates say. Such assets would likely be restructured and resold on to the markets at a later date.

The bad bank idea is also tempting international regulators. Italian economy minister Giulio Tremonti has promised to raise the idea of a bad bank with other finance ministers at next month’s G7 meeting in Rome. Switzerland made plans for such a programme last October, setting up a structure to house up to $60 billion in bad assets belonging to UBS.

In Ireland, the nationalisation of Anglo Irish Bank means that the government has a “ready-made vehicle” for a similar structure, Goodbody’s Eamonn Hughes said. NCB’s John Cantwell yesterday said such a move would improve the fundraising ability of AIB and Bank of Ireland, adding that it would allow for the resumption of “normal lending activity” by “removing the uncertainty associated with latent bad loans sitting on its balance sheet”.

Speculation was rife last weekend that the UK was planning some kind of bad bank structure. Instead, the government opted to insure banks against the majority of future losses on their toxic assets. “One can argue that this makes the Bank of England the UK’s bad bank,” said Marc Ostwald of Monument Securities.

In Germany, Josef Ackermann has been arguing the bad bank case. The Deutsche Bank chief executive and chairman of the Institute of International Finance, a group that includes most of the world’s biggest banks, said that ring-fencing toxic assets would be a “good thing” because “confidence comes back” when “you have no time bombs ticking”.

German finance minister Peter Steinbrueck warns that a bad bank could cost taxpayers €150-200 billion. That figure was given credence by weekend revelations in Der Spiegelmagazine. It reported that a survey of the leading German financials found German balance sheets were weighed down by toxic assets worth up to €300 billion.

Minister for Finance Brian Lenihan appears to share Steinbrueck’s reservations, saying that he would “look at” the idea but adding that it was a “free lunch for the other banks paid for by the taxpayer”.

Indeed, as the US bad bank plan gathers momentum, an increasing number of critics are questioning such a move such as American fund manager Whitney Tilson. Nobel economist Paul Krugman said “the belief that by performing elaborate financial rituals we can keep dead banks walking” was “a new kind of voodoo”.

Both supporters and opponents cite the case of Sweden, which established its own bad bank in the early 1990s. Approximately 4 per cent of Sweden’s GDP was spent buying up toxic assets. These assets were subsequently restructured and sold on again, with the government losing approximately half of its initial investment – a small price to pay in the circumstances, most agree.

That’s not the whole story, however. The Swedish bad bank insisted that banks write down their assets to market value. Banks took the pain up front, with recapitalisation following. In the US and elsewhere banks have preferred to “wait and see” rather than accept market valuations they insist are irrational.

Sheila Bair appears to agree, saying that “we don’t have really any rational pricing right now for some of these asset categories”.