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Sunday, March 22, 2009

My Plan for What To Do with the So Called "Toxic Assets"

Here is the the problem as I see it.

RMBS can be sold for about 30 cents on the dollar now. But banks are unwilling to sell for less than 60 cents -- either because they really think the loans will experience only a 40 percent loss rate, or because they fear that acknowledging market value will put them into insolvency. Which it might very well.

In other words, If you sold these toxic mortgage bonds right now, the banks would be insolvent if they were sold at current market prices.(30 cents on the Dollar)In order to be solvent, these assets would need to be worth more like 60 cents on the Dollar. These banks are only in a position where they need to sell because they haveYet, banks actually now have plenty of cash. Of course they do, we just gave them $780 billion. In fact, the banks wouldn't even need to get rid of these RMBS if they could assign a value of 60 cents on the dollar.

In fact, the only reason that this is happening now is because of mark to market.

that investors think of the mark-to-market mess by using the following metaphor: A person buys a house for $250,000 and then takes out a $250,000 fixed-rate mortgage for 30 years. The person's income is adequate to make the monthly payments.

But under mark-to-market rules, the bank could call up and say that if your house is not sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth $200 ,000 and to please fork over the $50,000 immediately or else lose the house

These banks are only a position where they need to sell because they have to give these illiquid asset a current market value. If you were to suspend that rule and implement the banks one where they are allowed to value these at 60 cents on the dollar however the banks can't move these assets for at least five years. Force the banks to hold onto these assets long term. You could even create an onerous penalty for early withdrawal.

This keeps them solvent. Meanwhile we force the toxic assets on those that deserve to hold onto them. This also keeps the banks solvent. It also requires absolutely no more cash outlays. It gives everyone a chance to take a deep breath because finally we could all assess the damage without the fear that things would only get worse and you'd have to write down even more. Furthermore, all of these bonds are backed by real estate. Because that real estate is currently falling, the current market value of the bonds has no bottom. No one is paying back the mortgage and the underlying value of the real estate is dropping. Giving these bonds five years allows the price of the real estate behind them to settle.

The banking system could thaw without the uncertainty that assets would tighten up again. It's really so simple that no one in the government would ever think of it.

1 comment:

Anonymous said...

There is an interesting discussion of such ideas here.