If we must have a 'bad bank'... Dean Baker proposes a provision that will keep taxpayers from being completely soaked when they buy up toxic securities from our nations bankrupt banks:
We can just attach a clawback provision, under which the bank will be forced to make up any money that the bad bank loses on their junk, plus a penalty. For example, if Citibank sells $100 billion in junk, and the bad bank ends up selling it for $70 billion, then Citibank has to cover this $30 billion loss, plus a 20 percent penalty ($6 billion). This structure will both ensure that Citibank doesn't run off with our money and also discourage banks from trying to mislead the bad bank about the true value of their junk. (Senator Dodd proposed a similar measure in the debate over the TARP.)Under the Bush-Paulson plan, we gave away a ton of free cash, no strings attached, and we were rewarded with... Yeah. Enough of that.
Note, though, that an honest valuation won't make the banks solvent.