New banks: No better than old banks

By Felix Salmon
June 22, 2009

When the TARP was being unrolled last fall, a simple question was often asked: rather than pouring good money after bad into banks which clearly had inadequate risk controls, why not just use that cash to start up fresh new banks unencumbered by toxic assets?

Well, for one thing, the banks needed to be saved, to protect the economy from the systemic consequences of them failing. But more to the point, no one had any particular reason to believe that fresh new banks would be any better at banking than the old ones were. And Daniel Massey has a great example: Herald National Bank, which opened up last fall with an impressive $62 million of initial capital.

In its first full quarter of operation, its return on average assets was negative. Which might be predictable, for a startup. But it wasn’t just negative, it was -27%. Which is insane. Oh, and despite the fact that the bank has only been operating for a few months, it has already started laying people off, including nine managing directors.

And that’s not all:

The loss of Executive Chairman Daniel Healy, an industry veteran who is believed to have attracted many of the bank’s initial investors, may loom even larger than the one on the balance sheet. Mr. Healy had been the chief financial officer at North Fork Bancorp. for 14 years before it was sold to Capital One Financial Corp. He resigned his post at Herald on May 19, leaving for “personal reasons,” according to a regulatory filing.

Mr. Healy did not return several calls seeking comment.

In general, scrapping failed old firms and replacing them with something new is something which is often very attractive in theory, but which can be highly problematic in practice. During the airline rescue after 9/11, for instance, there was a strong case made that the lumbering old legacy airlines should be allowed to fail: small nimble upstarts would surely take their place and be much more successful. But the history of, say, JetBlue since then has hardly been particularly glorious.

The fact is that most startups fail. As a result, placing one’s hope in startups to replace large and established institutions is generally foolish. They can help drive change at the margins, but it’s rare indeed for the mammals to overthrow the dinosaurs entirely, and it’s a bad idea to enshrine such an overthrow as part of public policy.


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right analogy, but an imperfect conclusion. Launching a de novo bank brings it’s own risks, of course, but I’d think in two years this institution could still survive. Were I to start my own, i would NEVER be fully staffed at the outset…just insanity. Get the basics staffed, open 1-2 branches and move up from there. Hire enough loan officers to start…easier to add as needed I’d hae to think.

Paying bankers NY wages, to boot; no wonder they’ve let folks go. But as Ive thought before, any doofus with capital and the charter docs can open one.

Posted by Griff | Report as abusive

You’re comparing two dumb ideas. Who cares which one is dumber?

The principle that needs to be enshrined in public policy is: if you invest in a bank, you might lose money. Duh.

Posted by Max | Report as abusive

Felix, my understanding of an “ultra-clean new bank” [1] would have been to put the *entire* loan portfolio (performing & non-performing) of a troubled bank into a Chapter 7 bankruptcy estate for orderly liquidation (e.g., sort of like runoff mode for insurance companies) by its creditors and shareholders (after all, that was the bet that they took!). Note that here the FDIC does not have to go through the messy and labor-intensive determination of distinguishing between a performing & troubled loan. In addition, the government would buy the operating assets of the troubled bank.

So an ultra-clean new bank, say Citibank, would be recapitalized with a fresh injection of equity capital: it is essentially the old Citibank except that it has a tabula rasa loan portfolio. As was touted in Q1, banks with zero loan losses were *enormously profitable* due to the steep yield curve.

[1] Khan, Salman and David Leinweber, “New American Bank Initiative: Removing Structural Flaws in the Economic Rescue,” November 11th, nabi-Nov11.pdf (see especially Figure 4, p. 8); eM (seek 10:20 to 12:15 for elevator pitch).

Posted by Mike A. | Report as abusive

I disagree 100% . If the too big to fails actually failed the market would purge itself of them and new growth would spawn. I am sure there would be some new companies that would not survive right off the bat but that would be quite minimal if there is indeed a market for those businesses and the field is fair. That’s like saying if you cut down big trees the little ones under them who gain the new sunshine would just die. Horse hockey! I don’t believe it for a second. And we are damaging the ground underneath in our frantic efforts to save these big trees from rotting.

Posted by jason | Report as abusive


Posted by maria errico | Report as abusive

I’m inclined to agree with the sentiments in the last two paragraphs, but I’m wondering if you’ve thought about the implications of this point for your ongoing “burn down the SEC and start over” crusade? Does the distinction between a governmental agency and a for-profit corporation entirely alter the administrative and operational challenges of replacing large institutions with new organizations, or is there more to say on the subject?

Posted by JC | Report as abusive

I was one of the first proposers of new “good banks” and would like to make few points. First we have not even tried to get something closer to setting up a “good bank” so I do not see how we can say now that it would not work. As a matter of facts the banking problems are still there but we are buying time. Instead of solving the problems and fixing the system we are waiting the recovery to fix the bank balance sheets. If one thinks that good credit and sound banking can generate or help the recovery one should not wait the recovery to help banks to fix their balance sheets. The causation should not be inverted and cash to trash or toxic is not really a good allocation of resources. In the new good bank proposal it was not actually a matter of having start ups with implicit risk of failure but a system of parallel new, smaller, good banks replacing the old bad ones and too big to fail. It’s a pity that we continue to discuss the too big to fail or to save banks. Have got a cost benefit analysis of setting up good banks instead of trying to fix the zombies?

To quote Terry Pratchett: “Ave! Bossa nova; similis bossa seneca” or (in Mr. Slant’s tortured Latin), “Hail! The new boss; same as the old boss.”

Of COURSE we get what we got; that’s what we paid for.

Posted by Cortland Richmond | Report as abusive

Really? You are going to pick one of the 97 banks that started business in 2008 as THE PROOF that a clean bank plan wouldn’t have worked? And one that didn’t even open its doors until the end of November 2008? Even though it is admitted in your cited article that profitability usually isn’t achieved until after a year and a half of operation?

I’ll admit the grocery list of errors since opening would suggest poor management, but Herald isn’t exactly representative of new banks.

Posted by Nate | Report as abusive