Zombie Banks

A good opinion piece on FT.com by former Treasury Secretary James Baker on recommended steps the feds can take to prevent “zombie” banks, which hampered Japan’s efforts to recover from its real estate bubble in the 1990s.

The problem dogging the financial industry isn’t one of liquidity, it is insolvency. Baker’s solution, simplified – categorize banks into one of three categories: the healthy, the hopeless, and the needy. Leave the healthy alone, close the hopeless and reorganize and recapitalize the needy based on needs testing. Baker’s idea is akin to ripping the band-aid off at once, rather than slowly and potentially more painfully.

This idea is gaining more attention as ad hoc bailout solutions appear to be doing little good. The administration has shown interest in the healthy and the needy banks, but closing the hopeless appears to be off the table. For now.