Although the details have not yet been decided, this approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposalsuffers from the same shortcomings: the toxic securities are, by definition, hard to value. The introduction of a significant buyer will result, not in price discovery, but in price distortion.
Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection. Even with artificially inflated prices, most banks could not afford to mark their remaining portfolios to market so they would have to be given some additional relief. The most likely solution is to “ring- fence” their portfolios, with the Federal Reserve absorbing losses that extend beyond certain limits.
These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity.