A Private Sector Solution to Extinguish Toxic Mortgage Assets (CDOs) and Re-Liquify Homeowners on a Massive Scale

Current Situation

1) Toxic mortgage assets (CDOs) are destroying bank balance sheets. Vulture bids are far below price levels that will enable banks and other CDO investors to sell these assets at prices that will maintain balance sheet solvency.

2) Homeowners are walking away from their mortgage payments, because the outstanding principal balance is more than the home is worth and/or they cannot afford the monthly payments.

3) CDO structures decrease the value of the mortgage pools that act as collateral for the CDOs, and inject illiquidity and systemic risk into the financial system. CDOs must be permanently extinguished.

4) No one has an incentive to buy mortgages at realistic market prices in the current investment climate, other than the homeowner, whose purchase of his/her own mortgage will enable him to both stay in the home AND lower his monthly payments and mortgage principal owed.

The Solution

1) The Treasury Department buys entire mortgage pools, (especially those that serve as collateral for CDOs) at realistic discounted market prices. For this example, let's call it 60 cents on the dollar, which is far above sizeable vulture bids, which for this example we will say are 30 cents on the dollar (this pricing will vary greatly from pool to pool).

2) The proceeds are given to the trustee for the CDO, who distributes this money to the owners of the various CDO tranches, according to existing cash flow allocation rules. This extinguishes the toxic CDOs.

3) The Treasury now owns the individual mortgages, and offers to sell each homeowner his/her mortgage at this same 60 cents on the dollar. The homeowner now borrows (or uses savings) to buy his/her mortgage, at a substantial discount to par, from Treasury. This extinguishes the homeowner's original mortgage. If the homeowner can not, or choose not to by his/her own mortgage, it will be auctioned off to investors.

4) Because the home to loan ratio has been drastically reduced (the homeowner now needs to only borrow 60% of the previous mortgage loan balance), it will be relatively easy for him/her to obtain a private sector mortgage. Also, mortgage rates are the lowest that they have been in years, which further reliquifies the homeowner.

5) Therefore, the proceeds from the homeowner savings and refinancings have paid for the acquisition of the mortgage pools serving as collateral for CDOs, without significant amounts of taxpayer funds or a large increase in the Federal budget deficit.

6) Treasury then moves on to purchase the next group of mortgage pools, rolling through the system until all toxic assets are extinguished and most problem mortgages are resolved.

Benefits of Our Solution

1) Banks and investors receive relatively high prices for toxic assets, far above vulture bids, reliquifying the entire financial system. Homeowners will provide bids for huge amounts of these toxic assets; vulture bids are for insignificant amounts.

2) Homeowners are reliquified in huge numbers via large decreases in monthly payments and mortgage principal owed.

3) Need to price exotic CDO tranches is eliminated. Entire mortgage pools are relatively easy to price.

4) No or minimal use of taxpayer funds.

5) No or minimal increase to budget deficit.

6) Private market solution- Treasury acts only as a facilitator to buy entire mortgage pools and sell homeowners their own mortgages (which are in these pools) at substantial discount.

7) Systemically dangerous CDO structures are permanently extinguished.

8) Straight forward process that can be implemented quickly, easily, and with minimal legal ambiguity. This is particularly relevant, as compared to proposed government homeowner assistance plans, which require renegotiation/cram downs/removal of individual mortgages in pools serving as CDO collateral (renegotiation/removal of individual mortgages within CDO structures is a legal and operational nightmare).

9) TARP will avoid huge losses, as banks will not have to sell TARP their most toxic mortgage assets, (which are, or will soon become, close to worthless).