Don't nationalize: Create new banks and reverse securitize

The debate on whether to nationalize our banks continues. It seems somehow un-American to me, not to mention it won't even fix the problem. As I posted here, here and here, a better idea would be to create new banks that don't have all that toxic waste on their books. That's what's causing the banks that got the first half of the TARP to cut back on lending. To deal with the toxic waste, I would untangle each of the Collateralized Debt Obligations (CDOs) and Mortgage-Backed Securities (MBS) to separate the paying mortgages from the ones that defaulted.

As far as nationalizing banks, we already own 6% of Bank of America (NYSE: BAC) and 7.8% of Citigroup (NYSE: C). But after getting $45 billion each for those government stakes, the two banks cut back on their lending -- Citi's outstanding loan balances are down 3.1% and Bank of Americas' fell 1.2% between the third and fourth quarters of 2008. If we put capital -- from TARP and private investors -- to create new banks, they would be unencumbered by toxic waste and would gladly take on good lending opportunities. This would enable an orderly unwinding of the zombie banks that can't lend.

While the new banks would get lending going again, we still need to deal with the problem of all the toxic waste. To do that, we need to reverse securitize -- that is, put the financial engineers who created it back to work so they can dismantle their creation. MBSs consist of thousands of mortgages. The financial engineers need to unwrap their creations and separate the, say, 10% of mortgages that have defaulted from the 90% on which people are still making their payments.