The ever-provocative Willem Buiter has a real debate-starter of a suggestion in his column today. Create good banks, and torpedo the remaining bad banks.
New lending business, indeed all new business activity would be undertaken only by the new good banks. To address the credit crunch, government guarantees or insurance could be provided for new loans and investments made by the good banks. No further guarantees should be extended to existing assets, either in the good banks or in the legacy bad banks. The good banks would receive their capital from the state. Other funding would be provided by the transfer of the deposits from the bad legacy banks, through loans from the state or through the sale of bonds by the new good banks to the state. The state could also guarantee new loans to the new good banks from the private sector or bonds issued by the new good banks and purchased by the private sector.
As regards the the legacy bad banks, the easiest and cleanest way to proceed is to stop them from doing any new business on the asset side of their balance sheets: no new lending and no new investment. They would also not be permitted to take new deposits. A simple way to ensure this is to take away their banking licenses. They would exist only to manage and ultimately to run down the portfolio of bad and toxic assets they hold on their balance sheets. Maturing liabilities could be refinanced if that made more sense than accelerating the sale of the assets.
Taking away the banking licenses of most of the existing large universal banks in Europe and the USA would be appropriate because recent developments have demonstrated that the existing institutions, managements and boards are not fit for purpose. They have failed as banks, even if they have not (yet) failed in the technical, legal sense of becoming insolvent. For most of them the past, present and anticipated future financial support of the state is the only thing that stands between them and bankruptcy.