Send naughty loans to a "bad bank" and other ways to stimulate the economy

Jan. 13, 2009 -- Locking up toxic assets in a "bad bank" may sound childish, but banking expert Stuart Greenbaum says, "by isolating impaired assets and preventing them from contaminating other bank assets, banks can concentrate on the business of making new loans."

Fed chairman Ben Bernanke suggested the creation of a so-called bad bank in a speech at the London School of Economics Jan. 13. Bernanke also predicted the Obama $800 billion stimulus package won't guarantee a lasting recovery.

Stuart Greenbaum, finance professor at the Olin Business School, Washington University in St. Louis, agrees. Fiscal stimulus alone won't fix the economy; the Fed needs to use monetary policy to help stabilize the credit markets. One of the Fed's remaining powerful tools is "the option to buy assets that the Fed would not normally purchase," says Greenbaum. "For example, by purchasing consumer paper the Fed may expressly encourage that type of lending."

On the subject of injecting more funds or loan guarantees to faltering banks like Citigroup, Greenbaum says, "Citi is at once too big to fail and too big to succeed, sad to say. Dismantlement is probably the best public option."

Editor's Note:Stuart Greenbaum is available for interview. Washington University provides free ISDN and VYVX lines for live or taped broadcast use. Please contact Melody Walker, 314-935-5202, melody_walker@wustl.edu to arrange an interview.