A great plan to dispose of financial toxic waste

Such guarantees would unfreeze the market for the toxic waste which might then be valued at 90% of its face value. And once an active market for trading the toxic waste emerged, we would no longer need to rely on mark-to-market accounting to estimate its worth. Suddenly, the toxic waste would become worth something that private investors would be willing to buy.

Granted, this plan would cost the government. Assume we are dealing with the 3 million mortgages expected to fail over the next 3 years. Further assume that the average loss on a failed mortgage is $100,000. This would be a 50% loss on an original mortgage of $200,000. In this case the total cost of the program would be $300 billion. If the average loss is higher, say $150,000, then the program would cost $450 billion. (These are initial estimates for discussion purposes).

Considering the $8 trillion that the U.S. has thrown at the financial crisis so far, this program would be relatively small -- about $100 billion a year for three years. And it would create real benefits. As my colleague pointed out, "Banks would have their capital bases restored. The toxic character of assets on their books would be eliminated. They could function normally, sort of, and make money available to any and all who can qualify for a loan. And the government would be out of their business and their lives, except that they would be more regulated to prevent this from ever happening again."

My colleague continued: "When the government redeems a failed mortgage at face value, say an average of $200,000, it takes over the property used for the mortgage. This would make the banks happy because they now do not have to deal with a foreclosure process. Instead, the property would be given to the FDIC -- which has great expertise at disposing of assets from failed banks.Thus, there would be an asset with a $200,000 mortgage, which was paid off to the [toxic waste] owner and the government would sell the asset for, say, $100,000, so the net cost to the government would be $100,000."

The FDIC is really good at the process of disposing of assets from failed banks. And once it takes over these mortgages, the banks that previously held them can stop spending time trying to work out the problems and go back to their core business which is lending. Meanwhile, the FDIC -- which specializes in workouts -- can get to work solving this knotty problem.

One other thing. There are about 8,000 small and medium-sized banks -- out of a total of about 8,500 -- in this country which are in the traditional banking business of originating and holding mortgages instead of selling and packaging them into securities. This plan would replace their bad mortgages with cash -- and would free them to seek out profitable lending opportunities. Rather quickly, this plan would get credit flowing back into the economy.

I think my colleague's idea is worth a try.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.