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Is Paulson right about bank bailout?

Bank analyst Dick Bove says the government "is coming to its senses" by making "high return" bank investments instead of buying loans. Duke and IMF Prof. Fullenkamp says it won't work; only a costly loan buyout will get banks lending again.

"Mr. Paulson is right" to buy bank stock instead of bad debt, says Richard X. Bove, bank analyst at Ladenburg Thallman & Co. Since the government has to borrow money to help the banks, buying bad debt means a net loss on every investment. "The new policy puts money where it can get a higher return and stimulate economic activity at the same time."

  Bove expects recapitalized banks will start financing businesses again. But he doubts they'll boost consumer loans.  He says the solution -- as in the Great Depression -- is for the government "to create a non-bank system to make loans guaranteed by the government." Those loans will "reawaken" the asset-backed bond market, to be funded by new commercial paper issues.

  By contrast, "Paulson has abandoned the one strategy - buying troubled assets from banks - that coudl actually help restore confidence in the markets," says Duke University economist and IMF consultant Connel Fullenkamp. "Paulson still seems to be thinking like an investment banker, not a policymaker. He keeps searching for a bailout plan that turns a profit" instead of helping banks get bad debt off their balance sheets so they can make new loans.

  Why don't banks spin off their bad assets into work-em-out subsidiaries, like Mellon Bank did in the early 1990s? "Mellon could only do that when the rest of the market was healthy," Fullenkamp told me. "We need to hit this sweet spot, where we're paying banks more than tehir assets are worth, but less than they'll be worth when assets recover."