For people that don’t understand the concept of the good bank bad bank I am going to introduce you to my version.  Obviously stabilizing housing and allowing confidence to return to the securities markets is the key to our problem. 

 

The end game is all about basic supply and demand but there are several variables that must be addressed to succeed. From a basic standpoint, demand must be enabled and supply must be stabilized.  Specifically, I am referring to demand as perspective homeowners that would like to own a home but maybe cannot get a loan, even though they are qualified, or maybe they are too scared to buy right now.  Supply is the current inventory of homes available for sale in the overall market.  To borrower a lyric from the song “I Want to Be a Rock Star”…”How Ya Gonna Do It?” This is a good song when you are working out.  Barrack Obama is going to need to be a rock star if he going to lead and fix this crisis.

 

Let’s talk about the bad bank.  I am not referring to Citibank.  You know I love the former CEO Chuck Prince and would be very distraught if a very large bolder fell on his head.  I am referring to the concept of “Bad Bank” as keeper of all the bad assets. 

 

First let’s set some ground rules.  For arguments sake let’s assume the National Bad Bank will hold 2 trillion in bad assets.  Whether the assets are performing or not, they must be related to residential real estate only, and the lender must have made a decision to increase loss reserves against them internally for the assets to be bad bank eligible.  The Bad Bank is the accountant and the assets really remain where they are today but now everyone has transparency.  I mention that the bad bank is for residential real estate only because that is all the government has to address to save the free markets in my opinion.    The housing save will reignite the consumer confidence and get us back on a path to normalcy.  All the other lending categories will not be eligible for the Bad Bank and require the banks to sort out on their own or with other government agencies. 

 

Now, with this plan, there is no need for additional capital injections to the banks.  All the banks will move their qualified bad assets off their books to The National Bad Bank.  The “Big Bad Bank” will have a picture of a Bull Dog atop the Federal Reserve Building as its logo.  Now each bank will be a depositor of these qualified bad assets.  The will be a legislated accounting allowance for a designated period of time.  I would recommend that the bad bank program provide a duration of five years.  Again, the banks will still hold the assets and be required to work them out, but the pressure relief from market to market accounting and capital requirements will now be off them.

 

Each bank will be required to work out the bad assets.  The choices will be as follows:

 

• Loan modification without the forgiveness of principle but with affordable terms for homeowners for a minimum of five years if this option is elected. 
• A Real Estate Short Sale with the forgiveness of the residual mortgage debt.
• Property foreclosures with standard recovery protocol.

 

Any assets deposited in the “Bad Bank” will not require any capital reserves by the counterpart healthy bank.  Each counterpart bank will be focused on prudent lending and cherry picking who they would like to lend to as well as bad asset workouts. 

 

As bad assets are worked out by the servicing agents or the actual bank staff, the Bad Bank will receive proceeds as workouts progress and return the money to the good banks.  Losses will be tallied within the Bad Bank.  At the end of the program all banks will receive a tally.  This will not be a bill they have to pay.  The final bill will be the money they owe to Uncle Sam.  We all know Uncle Sam can make it happen when he gets the whole team working together.  This bill will now be monetized by the government much like the tobacco bonds of the late 1990’s.  The debt will be sold into the private market with attractive coupons.  Our government effectively gets all its money back, as the “Bad Bank” accountant, and the counterparty “Good Bank” that has been healed is responsible for the interest payments on the “Bull Dog Bonds”. 

 

It gets better…’How Ya Gonna Do It?”.  The rates on the bond sold to the market will be assessed just before the securitization point based on individual bank performance. As an example, performance metrics will be established based on the quality and efficiency that the bank used to clean up its bad assets.  Also to avoid punitive terms the metrics must judge the individual banks on how many homeowners were provided 5 year solutions that allowed them to Avoid Foreclosure and kept their homes.  Now I have your attention.

 

If you are a bank and you have 60 months with the government on your side, no mark to market on your “Bad Bank” deposits, and the capital to lend, you are going to focus on the workouts and prudent lending.  If you do a good job you may end up with a 5.5% coupon.  The assets could also be broken into segments and the performance metrics applied to each segment of bad assets.  If you do a bad job that is against the public interest you may end up with a 13.5% rate on your bonds.  Then your shareholders will give you the beat down.  The incentive will be to do a good job and balance solutions.

 

The basic premise behind this model would solve the banking crisis.  It would save our government from pumping billions more into the banks.  Uncle Sam would only be the accountant.  Free market incentives would force the banks to work hard to clean up their bad assets.  They will be pressured from their stock holders to get creative and achieve high marks so the end bond payments are very favorable. 

 

The Bull Dog Bonds would be backed by the full faith of the United States.  Any banks that can not stay in business will have to be absorbed by the FDIC and the government will have to eat the losses.  They do this today anyway so its no big deal.

 

Given that just about all the banks we have and hold dear to our financial system are cratering under the pressure of this crisis, we have to get creative and find a solution.  This will work and we can legislate just about anything as you have seen.

 

Has The Short Sale Negotiator just solved the banking crisis?  Probably not!  However, this model will enable demand for housing by freeing up the banking system capital to lend and the punitive bond rates will incentivize the banks to provide real workouts for the people. Lastly, a five year time frame removes all the panic and the banks, the homeowners, and the government will win.

 

I want to reemphasize that the five year loan modifications the banks will provide will NOT provide for any forgiveness of principle.  If homeowners want forgiveness of principle then they must provide and satisfy their lenders a free market solution in the form of a Real Estate Short Sale.  No homeowners should be given a free ride.  Everybody must share in the work toward a solution. 

 

We are not recreating the wheel here.  A five year program term with mandatory five year affordable solutions based on traditional qualifying metrics of modern day mortgages is not a great leap.  The leadership must create balance. I am hopeful that President Obama will fix this mess.  All he has to do is get a couple entrepreneurial mortgage guys in the room and this show will be on the road.  I am ready for a solution.  My Bank of America stock hit 5 today.  Now that is making me mad.

 

Blogging from the front line of the housing crisis.  Buy your “Bull Dog Bonds” with thenegotiatedsolution.com insignia on them.

 

GHunter

Submitted on Tuesday, January 20th, 2009 at 8:09 pm