A New Goal For TARP Money: Create Mutual Banks

Call this a wild idea, but if the government wants to leverage its efforts in encouraging credit in the US economy, it should consider seeding mutual banks.  The US government would contribute money to 435 new banks (say $250 million to each), one for each congressional district, with the provision the government’s stake could be bought out at 1.5x what it put in.  The government would have a preferred dividend of 3 month LIBOR plus 5% or so.

The mutual banks would attract deposits, because the institutions would be healthy.  WIth the leverage from deposits, these new mutual banks would make loans that many current lenders would shun because their balance sheets are compromised.  They would be smaller institutions, not large like Fannie, Freddie and the FHLBs.  Depositors would own 2/3rds of the banks, with the government’s preferred stake getting 1/3rd of the votes.  These banks would pay dividends to depositors above any interest paid, in proportion to the profit earned on balances deposited.  (CDs being a higher cost source of funds would not get much of a dividend.)  The dividends would be paid out of profits in excess of what is needed to maintain the bank’s capital levels.

The mutual banks must remain mutual for 10 years, after which, they can be demutualized, with shares going to existing depositors in proportion to the cumulative profit earned off of each account for existing depositors.

That allocation system, similar to what is done with mutual insurers (“the contribution principle”) solves a lot of problems: people rushing to deposit when they hear about a demutualization, or, small depositors that think they will get a biggish slug of stock.  Sorry.  This is yet another area where the insurance industry is a lot brighter than the banking industry, and why?  We have actuaries, and you don’t. 😉  Actuaries are the best kept secret in business, at least, that is what the Society of Actuaries tells me. 😉  This insures fairness in who gets equity, and how much.

Now, this provides a much sweeter deal to depositors than what they currently have at their banks.  It is almost as good as a credit union, except these are subject to taxation.  (As the credit unions should be.)

This raises the objection: what of our current banks?  Will you let them go bust?  Why not prop them up?

This is one of the stupidities of how the current TARP was set up.  We reward incompetence.  Better we should allow the institutions to fail, wipe out the common, preferred, sub debt, etc.  After that, transfer the deposits and clean assets to the new mutual banks in the vicinity, and let the FDIC reconcile the crud through a new RTC.

This would set the incentives right.  Failure gets punished.  Depositors get rewarded for depositing in healthy institutions.  The government makes no big promises, but the interests of depositors are protected.

This puts the stick in front of existing banks.  No handouts, and more competition.  Show that you can delever and deliver, and you will survive.  Aside from that, we consolidate the failures into new healthy institutions.  With big failures the FDIC kicks additional funds into the affected mutual banks absorbing problems, but with an increased ownership interest to be bought out.

This is my idea of how the government and private industry could cooperate, with low ultimate costs to the taxpayer, while not subsidizing incompetence.  Such a deal.  Should I send it on to the Obama Administration?