The US proposal to create an RTC has helped stabilise markets today- or so it seems for now. The RTC would buy bad assets from banks at an appropriate price.It would auction those assets later once markets have stabilised. What does this achieve? It helps stabilise the value of assets of financial firms and prevents the collapse of highly leveraged institutions. Hopefully, the RTC will make a profit later; if not, the government incurs a cost equivalent to the losses on sale of assets the RTC has bought.
Writing in the FT, Raghuram Rajan argues that this is not the right proposal because it ends up rewarding institutions that have taken wrong decisions at a cost to the tax payer. He says it won't address the basic problem which is lack of capital at financial institutions. He suggests intead that these institutions be asked to withhold dividend payments; and stronger firms be asked to make rights issues.
It's doubtful this will work. Shareholders of existing firms lack the incentive to subscribe to rights issues until then are sure that asset prices have stabilised. Secondly, capital will be ready to flow into today's distressed institutions once investors are reasonably sure that the firms' asset values will not decline further.
So, the RTC is indeed the way out. Yes, there is moral hazard. But the world is falling apart, that's not the time to think of moral hazard.