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.