Plan to Repair U.S. Banking System Unveiled by Former Hedge Fund Manager

Very well thought out proposal. It is aimed at quickly achieving asset value discovery, future transparency in markets and a new effective regulatory structure. I can imagine that some purists will object to interference with free markets and expanding government; I would argue that your proposals are aimed at reducing market manipulation and establishing needed government involvement.

Get this to Obama, Geithner, and the rest of the Cabinet, so we can get back to consumer confidence, and prosperity.

I agree 100% with the plan presented here today, but I would take it a step further and integrate this final piece into the framework. I’m all in favor of using Government’s power to intervene in times of great turmoil to bring about much needed economic stability, but Secretary Geithner’s plan as it stands today, is nothing but a desperate scheme to save certain bondholders from insolvency. He and the President are simply throwing good money after bad. The only real solution is to restructure crippling debt and until we come to that conclusion then we may as well do nothing.

So far all of the bank bailout plans we’ve seen rely far too heavily on taxpayer dollars, and an outright refusal for insolvent banks to shed toxic assets at market prices. Until we come up with a solution that would allow mortgagees to service their debts with current income levels, then we solve absolutely nothing. The spread between debt and income is just too immense and is getting more severe by the day.

If one solution is to simply inject more cash into the system and allow banks to continue to hold toxic assets, in time we will all be right back at the same table asking for trillions more of bailout dollars. We will ask ourselves how come these consumers aren’t paying their bills—well, they don’t have the income, and furthermore the forecast for the income levels needed to service this debt is nonexistent and would potentially only be available in a hugely inflated economy. A large increase in “bailout” inflation can only come from huge government debt and further devaluation of the dollar.

In conjunction with Shah Gilani’s improved regulatory oversight we need a massive and uniform nationwide plan to write down mortgage principal amounts to affordable levels based on today’s real income data. This would give us a realistic price discovery for real estate values virtually overnight and put a floor under housing and commercial properties. It would also realign consumer debt to incomes ratios that would allow normal discretionary spending to resume quickly.

In exchange for this service, any individual, married couple, business group, etc. that takes a principal write-down has to carry with them a “future real estate appreciation” lien on their Social Security numbers. The lien would be proportioned out to anyone whose name is signed on the bottom line. At any time in the future that they sell any real estate, and there is a realized gain, then those funds would be used to pay off the outstanding real estate lien. Heck let’s even make those “pay down gains” tax-free if you want. This could even provide incentive for someone with a lien to go out and find a property, now priced correctly for the current market, fix it up and sell for appreciation gains to pay off old debts. Since financial institutions are equally culpable, they should absorb half of any mortgage principal write-downs upfront.

At the same time that we are writing down the loans to a new principal level, we should extract additional equity principal from the owner to finance upfront a term-life insurance escrow pool (assuming they don’t have cash in hand). This life insurance pool would pay for those individuals who carry an “appreciation warrant” but who might choose to never buy real estate again, and thus not have future property gains, and/or protect against those that might die before they had a chance to pay back the lien. It could also eventually pay for any final debt outstanding for some person or business that had any remaining partial unpaid lien balance. There would be no need for medical underwriting, as we could reasonably assume that this population would be a good cross-section of society and any individual lien should not be “too large.” The insurance is strictly only for lien payoffs.

The final part of this idea solves two huge problems (as Gilani points out that securitization is necessary) that we are currently faced with under any current proposals on the table. I suggest we could take these “real estate appreciation liens,” package them up, securitize them and sell them off to private (perhaps some public money if needed) investors. Government is the only entity that could bring back all the scattered pieces of securitized mortgages now in the marketplace back together to allow this to happen.

Bond holders of these units are virtually assured that they will be paid back, as we have now reset real estate levels to a new, sustainable level. We can’t predict the future, but I’m pretty certain that if we reset our real estate values to sane levels today, then we should have normal appreciation going forward. In the event that real estate goes negative or sideways for a very long time, well, at least all lien designees have a life insurance policy against this debt that would ultimately pay off. A bit morbid and perhaps draconian, but true. In the meantime cash flows go to into a pooled fund that pays out a proportional amount relative to the original new bonds sold.

I believe that this repackaged debt to be sold by the current holders of mortgages (banks and others) would generate a far higher price than “fire selling current toxic debt.” While the greedy vultures sitting on the sidelines ready to pounce and become wealthy with the help of taxpayers might be very disappointed, I think these new bonds might easily sell for $0.80 on the dollar or even higher. The currently compromised (insolvent) banks would be freed up of a large percentage of bad debt, generate large new cash amounts from the sale of the bonds and keep cash flow coming from the newly established mortgage levels of existing mortgage holders. Little or no taxpayer cash involved!

Those whom might cry, “I played by the rules, but got screwed anyway” might be stroked by getting a one-time bonus for good behavior. Perhaps those whom hold a mortgage and never takes a write-down could get a tax write-off in any given year of their choice. Find something, even if it is a token gesture, to assuage their rightful anger.

The basic question that has to be answered is, “Who is going to pay for the losses and get our economy moving again?” We obviously have lots of villains we could point fingers toward, but at the end of the day folks who put their name on the dotted line and the risk crazy bankers should be responsible for the bulk of the payoff.

The level of trust that we have in our government and our institutions is at a major low point in our history. We need a workable plan to rise to the challenge we face—to bring the power of our systems back to the people. If Congress and the president don’t succeed, I’m afraid an entire generation, or more, of voters and taxpayers will be disenfranchised, and that will weaken our country further for years to come.

Would it be a solution if the U.S Gov. was to issue, say 10 year Zero Coupon Bonds in exchange for the toxic assets of the banks. The banks would have to hold Bonds until maturity and would of course not be tradable and thus would not have to be "marked to market". The toxic assets would be put into a " Bad Bank" and could be worked out during the 10 yr. period of the Zero Coupon Bonds. The gov. would not have to pay out any funds until the Zero Coupon Bonds matured and the banks would accrue the income on the Zero Coupon Bond over the 10 years. With their Balance Sheets cleaned up the banks would be able to attract funds and deposits and thus build up their balance Sheets again. Give that the "Bad Bank" toxic assets could be worked on over a 10 year period there is a chance that the economy could have recovered somewhat, and as a result some portion of the toxic assets will have come good and thus be available to pay down the 10 year Zero Coupon Bonds

Hi Shah,
Could the U.S Gov. issue say 10 year Zero Coupon Bonds for the Toxic assets in the banks which would be put into a "Bad Bank". The banks would not be able to trade the bonds, so the would not have to "mark to market" but would accrue the income in the normal way. The government would not actually have to part with any tax payers cash and would have a 10 year period to work out the toxic assets in the Bad Banks. Hopefully during the ensuing 10 years the economy will recover and lead to some of the toxic assets coming good. The funds in the "Bad Bank" when recovered could be used to part pay down the 10 year Zero Coupon Bonds at maturity.
Given that the banks would be rid of their "Toxic Assets" they would be in a better position to start building their balance sheets and be in a position to attract deposits and business once again.

Efficient regulation is to be applauded. However it does not address the primary problem of an industry of paper shufflers who, in the main, have a negative contribution to the world economy. What % of activity is directed at primary versus secondary investments? The investing of funds "in funds" sets up the market for a misallocation of capital and develops a casino mentality especially when short term returns are the mantra. Direct investment at real R&D, production and services and maybe the economy can revive. "Gamblers ruin" maybe a concept worth understanding.