Bad Bank Idea Delayed, But Not Dead – Buy The Underlying Mortgage Loans, Not The Highly Levered Toxic Assets

President Obama indicated today that he is delaying until next week the announcements on the "bad bank" that being proposed to buy complex, hard to value securities from banks.   The idea is a bad one that should not see the light of day.  The idea that our government should buy toxic assets from banks who created these opaque instruments to hide their lax lending practices based on the same fraudulent model pricing that inflated the assets on the insolvent banks’ books to begin with is absurd.  It neither solves the problem nor forces banks to lend.  Indeed, the problem is not that the banks do not have capital to lend, it is that the balance sheets of the potential borrower – the American consumer who accounts for 70% of our GDP (and probably 30% of the global product) – is not in sufficient shape to make a sound loan and has no bankable collateral left.

 Given that most of the original toxic assets are related to mortgage backed securities where the underlying mortgage loans were made with to people who had insufficient equity in their real estate to withstand a cyclical downturn ( a foreseeable event) or did not have the income to sustain the mortgage payments by traditional guidelines, one solution could be to have the government refinance every taxpayer’s mortgages at favorable interest rates.  Refinancing the underlying mortgages will result in the early payoff of the mortgage loans found in the CDO and RBMS.  Subprime, Alt-A, all of that will not be an issue.  Reducing interest rates assists the American consumer in adjusting their balance sheet.  Having the government hold the mortgages means that our government can decide how to modify mortgages for borrowers who by circumstance cannot maintain payments.  It is like another webbing on the safety net our society has built.  It also avoids the unseemly problem of having bankruptcy courts modify third party mortgages.  It gives the government power to determine when it should ease its foreclosure activities, and when to forgive, and when to allow short sales.

 Of course, because becoming the nation’s mortgage banker will utilize taxpayer dollars, the program should be made available to every taxpayer, and should only be for a short time period.  In the end, the government will hold the worst of the mortgage loans, but not the highly levered CDOs and RBMS.  If there are losses attributable to the early payment of the underlying mortgages, those losses should be suffered by the foolish parties that created and purchased those complex instruments in the first place.