BNY Mellon explores role at 'bad bank'

Gathering steam in the Obama administration is creation of a specialized bank to purchase troubled mortgages and securities, or "toxic assets," from financial institutions to improve their balance sheets and spur lending. Such a bank could be operated by the Federal Deposit Insurance Corp., whose Chairman Sheila Bair said the concept "has merit," said FDIC spokesman David Barr.

"I've been a big believer for a long time that the way to end this (banking crisis) is to get the toxic assets off the balance sheet," Kelly told analysts at a banking conference in New York yesterday.

"I've been a proponent of creating some kind of 'bad' bank," said Kelly. "We would look very seriously at participating in that."

The "good bank/bad bank" strategy was pioneered by Mellon Bank in 1988, when the Pittsburgh bank was in deep financial trouble. The innovative strategy turned around Mellon, which merged with Bank of New York in 2007, the year after Kelly arrived.

The strategy: Remove the toxic assets from the "good banks" and transfer them to a newly capitalized "bad bank"; hold the troubled securities and work out the bad loans there, and pay back investors over time.

The bad bank created by Mellon was called Grant Street National Bank, which was liquidated in 1995 when its mission was complete.

"This is something that has to be proposed, or the government is going to keep fumbling around," said economist Peter Morici, a business professor at the University of Maryland, College Park. "This is superior to (government) buying stock in the banks because that nationalizes the banks."

But the concept of creating a special bank to sweep up banks' toxic assets has its detractors.

"I am skeptical about the feasibility of the concept, in large part because of the extreme difficulty of pricing the assets the bad bank will buy," said Bert Ely, a bank consultant in Alexandria, Va.

BNY Mellon already is a major player in the government's Troubled Asset Relief Program, popularly known as TARP.

In October, BNY Mellon won a Treasury Department contract to serve as custodian of up to $700 billion worth of troubled assets the department buys from banks as well as the banks' own stock the agency buys.

BNY Mellon will keep the records and provide accounting work for the Treasury Department, which is purchasing some $250 billion in bank stocks. So far, the agency has purchased about $194 billion in bank stock from 317 financial institutions. That includes $3 billion in BNY Mellon shares the New York bank sold to the Treasury in October.

In addition, the TARP contract calls for BNY Mellon to oversee about $450 billion in troubled securities, which banks would sell to Treasury to bolster their balance sheets. The government would sell the securities later, presumably at a profit, once the stock market improves.

So far, Treasury has not bought up any of these toxic assets. While Mellon is doing the accounting and administrative work, Treasury has not selected a financial institution to manage the troubled assets.

Yesterday, newly confirmed Treasury Secretary Timothy Geithner said the department is "looking at a range of options" to resolve the bank crisis, but did not say if the government would create a "bad bank."

Federal Reserve Board Chairman Ben Bernanke floated the idea of setting up "bad banks" in a Jan. 13 speech in London.

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