Bad Bank

  

An answer to a question on Jeopardy perhaps? Dewey, Cheatum and Howe Federal? What is "bad bank," Alex?

That is not far from the correct answer. Bad bank is a bank that is established to buy the bad loans of another bank that has significant nonperforming assets. The nonperforming assets are purchased at market price.

Why do banks do this?

Think of a friend in college who never had money, and ended up writing a bad check or two. The bank played along for a while. They had their lowest level employee call your friend incessantly, in hopes that she would eventually pay up. Now, if a bank has 100 of people like your friend, more time is devoted to getting their money than seems necessary. They have more red numbers on their balance sheet than they want. So the bank sells that pool of loans to a collection agency (think bad bank). The collection agency (again, bad bank) bought the pool of loans cheaply, and only has to have a portion of the bad loans turned into payers to make their money back, and the purchase worthwhile.

Related or Semi-related Video

Finance: What is a Savings & Loan v. a B...187 Views

00:00

finance a la shmoop what is a savings and loan versus a bank all right

00:09

savings and loan some savings and loans yeah it's a cleverly named you know like [Case of cash appears]

00:15

home loans car loans stuff like that banks issuer of credit cards and big

00:20

lines of credit for small to large business savings and loans the little

00:25

local retail gal banks the big fat cat corporate dude with big appetites and [Woman sitting behind savings and loans desk]

00:31

small fast red convertible cars with a stick-shift

00:34

savings and loans owned either by the lenders and borrowers of the savings and

00:39

loan itself you know kinda like a co-op or it can be set up like you know normal

00:43

ish corporation banks usually owned just by shareholders some are big like this

00:49

guy and that guy yeah and there's a whole bunch of other small fries too

00:52

savings and loans can loan up to 20% of their assets half of that for big [Savings and loans assets pie chart appears]

00:57

business half of that for small business loans at least these days and why did

01:01

delineation well because small business is default a whole lot more than big

01:06

businesses savings and loans are allowed to tap into the very liquid Federal Home

01:11

Loan Bank system Fannie Mae in the gang those guys and in order to do that ie [Man with savings and loans briefcase for head appears]

01:16

get cheaper money in return SNL's have to have at least 65% of their assets

01:22

invested in residential mortgages meaning most of their loans are you know

01:27

small home mortgages a lot of first-time buyers there all right well why is this

01:30

a thing well because the American Dream from a political perspective revolves in [A couple moving into house]

01:35

large part around owning your own home right not a bad idea the government has [Uncle Sam appears and boy walks away with pile of cash]

01:40

gone to a whole lot of effort to make it easy for the little guy to borrow money

01:44

and have his or her own little castle a little to start anyway banks those cold [Boy dancing outside castle]

01:49

cruel concrete walled things don't live under this same structure they don't get

01:54

to tap into the same cash fool reserves that SNL's do is not all the time but

01:59

they get to loan money a more or less wherever they want to loan money there's

02:02

way fewer strictures on banks than SNL's banks exist to make money for the

02:07

shareholders of the bank duh and they're financially Darwinian beasts [Charles Darwin beast appears in misty forest]

02:12

good at lending money that costs them low rates to rent and then they rent it

02:16

out at much higher rates to customers right and they live on that spread so

02:21

banks also get hot and heavy with other kinds of borrowings things like credit [Man and woman sitting in car looking at sunset]

02:25

card issuance like I think about how much money your credit cards charges and

02:29

so on they get a big piece of that and servicing a debt you know and wealth

02:32

and/or financial management services like they take a percent of year or so

02:37

for managing all your dough and to some extent merchants and investment banking

02:41

services as well you know for the big guys who are global so banks think big

02:45

loans big money big spreads wholesale savings and loans think small loans

02:50

small money small spreads retail banks mr. Potter savings and loans [Mr Potter appears]

02:55

George Bailey and the rest of the Bedford Falls gang did you hear that a

02:59

video editor just got his wings [Man grows wings]

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