Forget the bailout, start over: the New American Bank Initiative

The bailout of the US financial system isn’t working. The government’s rescue plan has fundamental flaws, including incentives that favor the failed firms, not the country as a whole. New ideas are needed. In “New American Bank Initiative: Removing structural flaws in the economic rescue,” Sal Khan and I propose a radically different plan–don’t prop up existing banks, take part of the $700 billion earmarked for the bailout, and capitalize a new financial system. Sounds crazy at first. But we’re in the midst of a crisis that requires bold, even drastic, action. Using the systems thinking that drives technology innovation, we lay out a simple, direct approach to re-creating our financial system in a way that benefits the taxpayers, and the country, and that doesn’t reward failure and irresponsible decisions.

David Leinweber will be speaking at the O’Reilly Money:Tech Conference, February 4-6, 2009 in New York City.

  • “The easiest way to create a new program is to modify an existing program.” — Richard M. Stallman (personal communication).

    There are two ways to create a new system of finance. One is to fail out existing infrastructure, the other to fix it by coordinated increments. The difference in transaction costs distributed across the economy is likely to be stellar, isn’t it?


  • Sean Hogan

    Isn’t that how the current administration tried to fix the problem of Iraq?

  • My main concern over the bailout is that I doubt many involved can even *spell* Power Law. I’d prefer folks at least conversant with Complex Systems manage the recovery.

    — Owen

  • Brilliant. Especially in light of huge bonuses still about to be paid out, limos and high cost parties still being enjoyed. Putting 100s of billions of dollars into bailouts only creates ‘contained depression’, but at the end of the ‘contained depression’, we’ll be bankrupt and behind all our allies. Instead, do not throw good money after bad. Start over! I believe strongly that our old paradigms are dying, some swifter than others. This is now a global world. We can’t have such egregious profit raping continue, but the proverbial hungry foxes are in charge of the henhouse and the bailout STINKS.

  • Well, let’s hope they fix their own mess whatever is what they’re going to do.


  • I think the diagnosis is correct. Where the plan will fail is in how the banks deal with the new situation.

    Firstly, it looks to me that there is a huge incentive for insolvent banks to declare that they are solvent in the hope that this is true as the credit markets unfreeze. As you suggest, they may be “zombies”, but they ensure that existing management is able to continue in business. There will need to be some mechanism to force the banks to declare themselves insolvent so that the operational assets and deposits can be liberated.

    Secondly, is it really so simple to let the various creditors fight over the assets? How will mortgagees be protected from forced termination of their loans? And this is just one class of borrower. I could see a lot of chaos resulting as vultures swoop in to force asset sales at below market values. Any major problems in these area and you would damage bank credibility completely, wrecking the credit markets for a very long time.

  • KnotRP

    > “The easiest way to create a new program is to modify an existing program.” — Richard M. Stallman (personal communication).

    This statement is not true by itself.
    It presumes the existing program is well built,
    functional, and not riddled with impossible to
    find bugs. Translation: are the banks levered
    properly, appraising risk properly, and not
    riddled with fraudulent behaviors and bad
    assets marked AAA and valued at level 3.

    It’s can be easier to build fresh, than it
    is to rework something that’s in very poor

  • Here’s drastic action for the Auto Industry:

    BAILOUTS ARE COMPLEX BEASTS, but one should be implemented to save the U.S. Auto Industry.

    Here is a workable plan with common sense for the U.S. Auto Industry –

    There is much creative talent hidden inside the U.S. Big 3 that has been smothered by mismanagement and the UAW.

    Do not leave it to Paulson or Congress to come up with a creative plan or consider taxpayers’ interests.

  • hjmler

    what it so hard about html that you have to stuff your screeds into an abominable pdf – you afraid someone might read you stuff so you hide it?

  • Hi David, we missed you on our first BarCampBankSF, hope we will have you among us for BarCampBankSF2 end of April 2009

    We will be talking innovation and creation of new business models in banking and finance. With P2PVenture, I will be most interested exchanging ideas on how we could redesign the investment food chain. Seems to me like you and Salman should belong to our unconference.

  • Excellent read. European banks hoarding injected capital preceded the rollout of our own bailout, but proceded anyway. I wish Washington was open-minded enough to try this.

  • Excellent read. European banks hoarding injected capital preceded the rollout of our own bailout, but proceeded anyway. I wish Washington was open-minded enough to try this.

  • Barco

    This is a good starting point, and I am interested to see you expand upon the implementation of these New Banks.

    I like the idea of separating the operating assets of failng banks from the bad assets, and letting the FDIC become the collections agency for the failed bank’s unsecured creditors.

    However, maintaining the bank’s operating assets, along with the new “clean” cash to lend, does not in and of itself keep the bank from making bad loans.

    How will you find a management team for the New Bank that will not replicate the mistakes of the old team? Keep in mind that evaluating loans in hindsight is easy, but at the time the loan is made no lender thinks they will lose money.

    Under the current system, when the FDIC steps in to close a failed bank, other banks in the area bid on the assets (bad loans, operating assets, etc…), and the lowest bidder wins. Thus, a solvent bank with good lending sense and a successful business model bids for the opportunity to acquire a new branch at a discount.

    Why not structure your plan so that (instead of creating a New Bank) after the FDIC bidding process, the existing, solvent bank acquires the operating assets of the failed bank plus the “bailout” cash, and leave the collections of the bad loans and payment of creditors to the old bank and the FDIC (rather than the solvent bank as is currently the case).

    To me, the creation of a New Bank with an untested management team (or worse, a team that lost their jobs from other failed banks) is less a guarantee of success than helping a successful bank take over the existing operating assets so they can expand their successful business.

  • gizmo

    Where are we going to find people to run these new banks?

    It’s still the problem we have now. The people that got us in the mess are now trying to lead us out.

  • Simon Hibbs

    The big problem with this plan is that it would take a year or so to get such institiutions up and running, while we need liwuidity back in the financial system right now. In fact in the medium term it would make the situation worse.

    If the market knew that the existing banks were going to be up against with freshly capitalised competitors in 6 months to a years’s time, confidence in the current system would collapse totally and immediately, leading to economic armageddon long before the new institutions could be in a possition to do anything about it.

    Simon Hibbs

  • The true core of the lending crisis seems to be borrower credit. The days of easy credit are over. the CRA (Community Redevelopment Act) mandated easier credit, which some will say, precipitated the current Global financial condition.

    Credit terms – credit worthiness of the end borrower – seems to be the actual issue. The banks want to be assured their loan will be re-payed. How does the bank know you will not lose your job in these trying times? And with housing prices in freefall, there is no security ‘rat hole’ when/if the loan goes south. This retail credit crunch parallels the interbank credit crunch.

    Should Mr. Khan et al have a solution for this deflation conundrum, the World is waiting with baited breath to hear it.

  • joe kaufman

    What are pitfalls of having the federal reserve becoming a nat’l bank (with proper oversight). The process time would be shorter and the USA would be responsible. Their incentive is:if the federal bank fails the whole country loses. This includes the profiters as well as the (gonifs)

    Under your plan what happens to individuals who make their monthly payments?