Rather than buy "toxic assets," I suggest the government adopt the following plan for banks and mortgage trusts that voluntarily agree to participate.
All banks and mortgage trusts (the things that issued the CDO's) that want some relief from troubled loans would be offered the opportunity to convert existing loans into federally guaranteed loans. This program would be limited to mortgages issued during the problem years (2004-2007).
If they say yes, the lenders would:
- Agree to write down the principal balance by X% (probably 20%) for every loan they have issued. Subprime, prime, alt A, the whole kit and caboodle.
- Agree to offer EVERY SINGLE borrower the option to convert their loan into a fixed, 30 year loan. The interest rate would be based upon credit scores and would be competitive with current rates.
- The Federal Government would agree to insure the remaining loan balance (thus capping the lender's losses).
- Lender balance sheets would stabilize.
- At a 20% discount to current value, the "new" loans would more accurately reflect the value of the collateral. As a result, borrowers would have an incentive to fight for their properties. With a reasonable fixed rate interest rate in place, people would eliminate the risk of having their mortgage payments spike on them.