An intriguing proposal from Mario Draghi

We are now inundated with proposals to fix the financial problem, including Willem Buiter’s proposal for a good bank, Jeffrey Sachs’ proposal to for a bad bank that buys toxic assets in exchange for contingent warrants, lots of other private and nationalised bad bank setups, Tim Geithner’s public private partnership, or proposals to turn preferred stock into ordinary stock.

An interesting new proposal – that is shooting in a very different direction - came from Mario Draghi, governor of the Bank of Italy, and head of the Financial Stability Forum. It came in a not widely reported speech over the weekend. We attach the original Italian version.

He starts with the observation that government assistance has so far focused on the liability side of banks’ balance sheets, such as guarantees for new debt, but not on the asset side. He welcomes concepts such as  bad banks, but notes that many of these concepts still do not guarantee that the banks will start lending again.

He proposes public guarantees on the senior tranches in new emissions. The idea is forward looking in the sense that banks would find it easier to revive an important channel of finance – namely securitised finance - which is currently clogged.

So this is not another bad bank proposal, nor is it an alternative to a bad bank proposal, but something that is in addition to a bad bank proposal. The idea is essentially to revive the market for securitisation, so that banks can get out to lend again. We don’t know, and have not thought through, whether government guarantees of the senior tranche alone are going to do trick, what effect this would have on the pricing of, and demand for, the other tranches. There are many questions that have yet to be worked out. But the point that a comprehensive bank rescue package also has to incorporate provision for the future, and not only past, securitisation appears plausible to us. Simply accepting the death of securitisation, and going back to old fashioned bank lending may not provide sufficient credit for the real economy – even in risk-averse post-crisis world.

There is a big market for competing proposals right now, some more plausible, some less so. This is probably that should, and will, deserve some discussion.

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