One more time: Start new banks

Romer suggested that if the next $350 billion of TARP money was used to create new banks and was leveraged at a conservative 9:1 ratio, it would make $3.5 trillion in lending capacity available to the economy. This sounds to me like a good use of the TARP. However, while there may be $3.5 trillion of loan demand in the U.S., it is unclear what proportion of those borrowers would have a reasonable chance of repaying the loans. Moreover, the new bank plan still begs the question of what to do about the zombie banks.

For that little problem, I would suggest the plan my colleague proposed -- let the FDIC buy the 15% of mortgages that have defaulted in the Mortgage-Backed Securities (MBSs) that constitute so much of the zombie banks' financial toxic waste. This plan would allow the MBSs to trade – rising to 90% of face value – shifting them from Level 3 status -- no way to value them absent internal financial models -- to Level 1 status -- meaning that since they trade, there is a real market price to use in valuing them.

The banks would be able to resume lending and their stock prices would rise. They could issue stock and raise more capital. Meanwhile, the FDIC which excels at workouts could restructure the mortgages with homeowners – reducing the number of foreclosures.

Although Romer does not tackle the problem of what to do with the zombie banks, I am happy to see that a credible economist has gotten the idea of creating new banks some attention on the editorial page of the Wall Street Journal. I hope someone in Washington takes it and my colleague's plan seriously.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.