Henry Paulson’s connections with the Chinese elite, nortured by more than 70 visits to the mainland as a private banker, have been widely acknowledge by the media. Perhaps that explains why Paulson latest plan to dump financial system’s toxic assets into a single ‘aggregator bank’ looks eerily similar to the Chinese effort in the late 90s to dump nonperforming loans into state-financed ‘asset management companies’ (AMCs). In a paper titled “The Chinese Conundrum: External Financial Strength, Domestic Financial Weakness”, Brad Setser, now a fellow at Council on Foreign Relations, elaborates on the Chinese model:
In 1999, RMB 1400 billion ($169 billion at 1999 exchange rates) in bad loans—roughly 20 percent of total loans at the time—were taken off the banking system’s books and given to four asset management companies.
In addition to taking the banks’ bad assets, AMCs also assumed some of the banks’ liabilities to the People’s Bank of China. As a result, both the central bank and the SCBs ended up with large claims on the AMCs. Early recovery rates on the bad loans transferred to the AMCs were around 30 percent of book value, but recovery rates subsequently fell to 15 to 20 percent of the book value. Formally, the finance ministry has not guaranteed AMC bonds (Ma, 2006)—but there is little doubt that taxpayers ultimately will need to bailout the AMCs.
The gov’t will probably take the ‘carve-out’ approach, which means that they will purchase toxic assets at book value (or higher, possibly at par) and thus avoid write-downs on equity (or to recapitalize by cash inject if they are to buy at par).
Presumably, the government does not have to mark its assets to market if the public does not demand strict supervision. But if the recovery rate is low and if the Dem. congress uses this as a tool to further impair the assets in order to bail out the segment of the constituents facing default, the ultimate cost will be levied on all taxpayers.
Setser, Brad. (2006), The Chinese Conundrum: External Financial Strength, Domestic Financial Weakness (May), CESifo Economic Studies. <http://cesifo.oxfordjournals.org/cgi/rapidpdf/ifl005v1.pdf>