When someone proposes a strategy for dealing with the economic crisis, he undertakes a hard issue.? There are many conflicting priorities:

• Don’t harm the taxpayer much.
• Arrest the decline in asset values.
• Protect the solvent banks.
• Increase the flow of credit to the rest of the economy.
• Prevent the contagion in credit uncertainty from spreading.
• Facilitate price discovery on illiquid assets.
• And more, depending upon the most recent disaster.

The recent talk in Washington is over guarantees, Bad Banks, and more.? I’m a skeptic on all of these, because you can’t get something for nothing.? Now, it is not as if I haven’t made my own series of proposals:

• Aggbank
• Against Bank Nationalization
• What I Would Do
• A New Goal For TARP Money: Create Mutual Banks
• And more, if you are willing to dig further back into my archives.

But others have proposals as well:

• Bank Rescue Would Entail Triage for Troubled Assets
• An open letter to Tim Geithner
• Bad Bank/Worse Bank
• How to Value Toxic Bank Assets
• Bad Bank? Bad Idea
• Bank Rescue Would Entail Triage for Troubled Assets
• Beyond the age of leverage: new banks must arise

I’m going to modify my Aggbank piece, because it represents my best thoughts on what could be done to minimize the uncertainty to all parties involved, leading to a simpler, more transparent bailout.

Aggbank should solicit offers of assets, with prices.? It should then publish that it will buy so much of assets that have been offered, so if anyone is willing to sell it cheaper, submit their offers.

The winning offers hand over the assets and receive cash in return.? They also issue equity to Aggbank the difference between par and the price paid, in exchange for an equivalent equity stake in Aggbank. The Aggbank equity stake is reducible/increasible if the eventual value of the asset sold proves less or more than the price it was sold for. [Changes in Bold]

The main idea here is that the auctions should produce reasonably fair results, leading to price discovery.? (Banks learn what their assets are worth.)? The secondary idea is that any subsidy to banks should be limited.? If an asset purchase price is high, they lend more money to the government, and give less stock, in exchange shares in Aggbank.? Vice-versa if the purchase price is low.

Now, Aggbank shares are a high quality asset, given that it is a “full faith and credit” institution of the US Government.? Capital charges on it would be low, as they are for FHLB common stock.? The difference here is that the amount of Aggbank stock eventually received depends on the value of the assets purchased, when they are sold.? Positive variances add to the number of shares, and negative variance decrease the number of shares, pro-rata.

The beauty of this idea is that the government does not have to be worried about whether the auctions are working perfectly right or not.? The second step after the auctions trues things up, as Aggbank stakes are increased or reduced.? Third, this allows banks taking losses to issue equity to the government, which will help them recover.

A proposal like this would give the banks time to heal, and would limit losses to the taxpayers.? The eventual payout form the liquidation of Aggbank would approximately give each bank back its pro-rata portion of value contributed.? It would give banks time, while facilitating price discovery in obscure structured lending markets.