During the years leading up to the financial meltdown, banks primarily took mortgages and other loans and bundled them together. Rating agencies were called in to bless them -- we now know those ratings were bogus. No one bothered to ask what was in the packages and no one cared as long as the value kept rising. Then when the crash came, it was too late. Not knowing what was in the packages, investors could not sell because no one on the other side of the trade wanted to buy. The markets froze and the meltdown was on.

Now U.S. Treasury Geithner wants to change the rules and force lenders to retain at least 5% of the loans they generate. In a way, this is akin to a margin requirement for these securities. Obviously the banks oppose such a measure because it would tie up a portion of their capital.

It seems that the Federal Reserve is doing some back peddling these days. The evidence is there to show that interest rates are rising both for U.S. treasuries and mortgage rates. The Fed was going to buy loads of U.S. treasuries -- a move that would have sparked a rally in the bond market. This did not happen.

Now we have yet another program that is put on hold -- the Fed's program to prop up the market for distressed securities backed by mortgages. The Financial Times reports that William Dudley, who oversees the implementation of the $1 trillion term asset backed securities loan facility (TALF) program, said: "We have not made a final decision on whether it is doable and, if is doable, whether it is worth the cost."

This post is part of a 12-article feature that can be read here: Today's best income ideas.

"We're riding the coattails of the federal government as Uncle Sam continues to purchase mortgage-agency debt while driving longer-term mortgage rates lower," says Eric Roseman.

In yield-oriented advisory -- Accelerated Income -- he looks at Blackrock Income Trust (NYSE: BKT) which seeks to provide "high monthly income while preserving capital by investing in a portfolio of mortgage-backed securities."

Citigroup (NYSE: C) and American International Group (NYSE: AIG) have already taken about $496 billion in U.S. cash and guarantees to keep them from failing. This makes me wonder: Is there no way to allow them to simply fail without causing the entire global financial system to collapse? And if not, is there a limit to how much more taxpayer money we pour into them before we say "no more"? The answers: Maybe and Yes.

Citi looks to be a basket case after $345 billion in taxpayer bailouts. It has already gotten $45 billion in cash -- $25 billion of which was recently converted from preferred to common -- and $301 billion in guarantees of its toxic assets. The U.S. now owns 36% of the common stock of Citi -- which lost $27.7 billion in 2008 and has a market capitalization -- Citi common shares times price per share -- of $8.2 billion.

Since last October, I have been repeatedly suggesting that the U.S. would be better off creating new banks rather than putting capital into zombie banks -- whose financial toxic waste prevents them from lending. This is the fifth time I have made the suggestion -- I previously posted on it here, here, here, and here. Until today, I had no idea whether anyone was listening. Now I have a hunch that at least one person might have gotten wind of the idea -- maybe he listened to this radio interview last month on KCRW.

That one person is none other than Paul Romer, an economist at Stanford's Institute for Economic Policy Research. Yesterday Romer wrote in the Wall Street Journal that the U.S. needs banks that can lend and that it would be easier for that to happen if we put TARP money into new banks rather than trying to use the money to revive the zombie ones.

Now that the Fed effectively has interest rates to zero, what does it do as the economy worsens.?One Fed official says that policies need to be set up so that rates are effectively below zero.

According to Reuters, Charles Evans, president of the Chicago Fed said, Quantitative easing, a way to flood the banking system with large amounts of money, "is a way to mimic below-zero rates and provide support to the economy." Usually that would involve the agency buying up huge amounts of assets from banks.

There is another potential alternative, although it has never been tried. If the Fed plans to spend tens of billions of dollars buying assets, why not put the money into the system by offering the capital to banks at a negative .5%? The reasoning against this is the the Fed would be paying the banks interest on the money they borrow instead of the tradition model of the banks paying the Fed.

The odd program might have two effects. The first would be to increase bank lending to business and consumers. With the Fed paying interest for bank borrowing, the risks of bank lending would drop. The other by-product is that banks could rebuild their balance sheets damaged by losses from investments like mortgage-backed securities, with capital being underwritten by the Fed.

It's crazy, but it might work.

Douglas A. McIntyre is an editor at 247wallst.com.

The Federal Reserve will buy up to $500 billion in mortgage-backed securities early next year. This marks the first move by the agency that may actually help turn the credit markets around quickly.

The Fed has tried cutting interest rates to 0%. This does not seem to have improved lending by banks. It has also allowed banks to use its emergency lending window to trade securities with questionable value for cash to build their reserves. This has not done much to improve bank balance sheets, earnings, or lending.

Finally, the Fed is headed back to the major cause of the current market's troubles, the housing market. The Fed cannot go into the marketplace and refinance every single mortgage that is in default or underwater -- in terms of its relationship to the actual equity in houses. But by buying the securities, it can improve that value that is attached to that part of the economy -- the MBS.

Most of the hundreds of millions of dollars in bank losses over the last few years were due to the falling value of MBSs. With housing prices still falling, the value of underlying derivatives is still in trouble.

According to Reuters, "When they are buying along the lines of $80 billion to $100 billion a month, if they're going to do it in six months, they have to buy everything they can get their hands on," said Kevin Cavin, a mortgage strategist at FTN Financial in Chicago.

It is the first government program that will help both home owners and banks at the same time.

Douglas A. McIntyre is an editor at 247wallst.com.

As the U.S. market wraps up a wild day in which central banks cut rates in unison, one sector has no doubt at all about where it wants to go -- down. Three leading insurance companies have lost as much as a 28% of their stock market value in today's trading alone. How so? As I posted, insurers are the next part of the financial foundation to crumble due to mortgage-backed securities (MBS) gone sour.

Here's the latest insurance industry carnage:

• XL Capital (NYSE: XL) -28%. The property-casualty insurer holds $29 billion in asset-backed securities such as MBSs and collateralized debt obligations (CDOs), 330% of its shareholders' equity.
• Met Life (NYSE: MET) -27%. This life insurer announced plans to sell 75 million shares and to fire an unspecified number of employees. It also expects to earn between 83 cents and 93 cents per share -- way below analysts' $1.44 forecast.
• The Allstate Corp. (NYSE: ALL) -21%. This property-casualty insurer holds $83 billion in fixed income securities such as MBSs, 421% of its shareholders' equity -- and the $22 billion in Level 3 -- difficult to value -- fixed income securities exceed its $19.7 billion in capital.

I expect this problem to affect every insurance company to some extent. Will the $810 billion rescue plan relieve these institutions of their bad investment decisions? We might know in a year. Until then, look out below.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Now that the SEC has had some time to sift though all the evidence of why credit rating agencies were so wrong in their view of mortgage-backed securities, the most disturbing finding is that S&P analysts thought their own conclusions about risk were often wrong.

According to The Wall Street Journal (subscription required), an S&P analytical staffer emailed another that a mortgage or structured-finance deal was "ridiculous" and that "we should not be rating it."

What should the government do now that it has the goods? It could fine S&P, and probably will. The fine could never be large enough to match the hundreds of billions of dollars lost by financial firms that put money into the securities. The SEC could bring charges against some of the analysts. As it is, some of them will probably lose their jobs.

The most sensible solution would be to bar S&P from rating derivatives at all. Would that leave a hole in the market? Probably. Other credit agencies might have been involved in similar misdeeds. That would mean they would have to exit the business as well.

The net effect of moving credit ratings out of the business of covering derivatives would almost certainly mean a huge drop-off in the market for the instruments. That might not be such a bad thing.

Douglas A. McIntyre is an editor at 247wallst.com.

The slow rolling collapse of the housing industry in this country -- which the Center for Economic and Policy Research estimates could wipe out $6 trillion in housing wealth in 2008 -- has gotten me to thinking about the future. Why do we even have mortgages? What would the housing industry look like without them? Is there a better way? My conclusion is that we should eliminate mortgages altogether. This will cause housing prices to drop, which will make it possible for more people to buy homes instead of living in houses that are really owned by the mortgage holders.

The reason we have mortgages is that the $10 trillion industry supporting them is powerful and self-sustaining. It fuels an enormous housing construction and furniture industry. And there are those in government who think home "ownership" is a worthy social goal. Unfortunately, when people take on a mortgage and then move into a house, the people who live there don't have its title -- the mortgage holder does. Simply put, home ownership is an illusion for most people -- the mortgage holder owns the house until the mortgage is paid off. Instead of renting from a landlord, the "homeowner" is living in a house that's owned by a mortgage holder.

With the rise of securitization, that mortgage holder is no longer the company that originated the loan. It's an investor who holds a mortgage-backed security (MBS) that contains your mortgage and thousands of others. It's an oft-repeated illusion that this is "home ownership." But that illusion is critical for keeping the mortgage industry alive. Unfortunately, if Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) fail, it will be us citizens who will be on the hook for the $1 trillion needed to bail them out.

Research firm Punk, Ziegel & Co is putting a "buy" rating on Citigroup (NYSE: C). The research firm feels that the bank is the best proxy for investing in the global investment industry and that its write-downs are secondary. Quoted by MarketWatch, the firm said "The stock allows one to invest in the world's financial growth better than any other company. Others perform in one part of the financial sector or operate in one portion of the world."

That comment may be akin to saying that if you are going to drown in quicksand, you might as well find the best quicksand available. Citigroup is hardly a strong investment and the fact that its business operations are global and that it operates in many sectors has nothing to do with whether the bank can do well over the next year.

Citigroup is being scuttled by huge write-offs in its mortgage-related investment portfolio. Earnings from other divisions in the company are not likely to offset this and the bank may have to raise more capital. The resulting dilution could certainly drive the price of the company's stock down. There have also been comments from Wall Street that the big bank may have to cut its dividend. That is likely to make it much less attractive to a certain category of "yield-minded" investor.

Citi shares could be hit by more write-offs and the need to bring in a large sum of new capital.

That hardly makes it a "buy."

Douglas A. McIntyre is an editor at 247wallst.com.

The Dow lost 237 points today according to The Associated Press. The stated causes?

• The HSBC bailout of $45 billion worth of SIVs
• Citigroup Inc.'s (NYSE: C) announcement that it would fire as many as 45,000 people
• The Fed's announcement that it would inject $8 billion worth of liquidity -- in the form of short-term loans -- into the financial system

The daily explanations of market movements are not really that meaningful. But I am inferring three very disturbing messages from these market moves:

• There are serious unrealized losses in the banking system as a result of their holdings of Collateralized Debt Obligations (CDOs) and Mortgage-Backed Securities (MBSs) that nobody wants to buy.
• The banks may not have enough capital on their books to take the big bath write downs needed to account accurately for these bad assets.
• The banks and the government are hoping that if they can stall for time long enough, the problem will take care of itself.

The market will keep dropping until these messages are no longer true. This could take years to clear up.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares.

Merrill Lynch (NYSE: MER) may have used deals with hedge funds to delay reporting its exposure to risky mortgage-backed securities to investors, according to a report in the Wall Street Journal (subscription required)today. If this is sounding more and more like the Enron story to you, that's because it is.

Enron found ways to hide its derivatives (and that's what these mortgage-backed securities are) by setting up shell companies so the debt could be held off its books. Details about Merrill's moves are becoming clearer as part of an SEC investigation now in the works regarding how Merrill Lynch valued its mortgage securities and how it reported those holdings to investors.

Initial reports indicate Merrill Lynch sold commercial paper to hedge funds with promises of buying it back a year later and guaranteeing the hedge funds a minimum return. If this is true, the primary difference between Merrill's tactics and Enron's would be that Enron set up its own shell companies while Merrill used hedge funds. Merrill Lynch refused to comment on any specific transactions mentioned in the Journal's story.

It's a bit more than 20 years since the Dow fell 508 points, or 22.6%, in a single day. With Asian and European markets down a mere 1% to 4% today, it does not look like we'll have a repeat of that 23% decline today. What's happening in world markets? According to the New York Times, Hong Kong fell 3.3%, Japan tumbled 2.2%. South Korea was down 3.25%. In Europe the early news was not as bad -- London's FTSE 100 was down 1.4%, the German DAX dropped 1.3%, and Paris slid 1.8%.

Twenty years ago, the CEO of the company I worked for sent one of my colleagues to figure out good stocks to buy -- considering the market plunge an opportunity to buy good stocks at a discount. It turned out that he was right. The cause of the crash was found to be related to simultaneous computer driven-selling that somehow took the rationality out of stock valuations.

But will today's potential plunge also turn out to be a buying opportunity? The answer depends on your time frame and which stocks you buy. It's never clear to me why markets go up and down although "explanations" get printed every day. But it could be that the big reason for the selling in global markets is fear. In particular, investors fear that the U.S. has unleashed a subprime mortgage-backed securities (MBS) financial virus that is sucking an unknown -- but enormous -- quantity of credit out of the global financial system.

Hank Paulson's floundering effort to rescue the world from this MBS viral epidemic is not inspiring confidence. So I would not be eager to rush out and buy stocks in this market. Unlike the computer-driven selling of 1987, the economic costs of MBS's financial "innovation" are still too difficult to count.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

It is an extremely odd concept. Take a bank's mortgage-backed securities and pool them with those of others, then offer loans to keep the new pool solvent.

Yet, such a plan may be in the offing. According to The Wall Street Journal [subscription required]: "In a far-reaching response to the global credit crisis Citigroup (NYSE: C) and other big banks are discussing a plan to pool together and financially back as much as $100 billion in shaky mortgage securities and other investments." The paper adds that the Citigroup plan would create a "superconduit," a fund backed by some of the world's biggest banks that would issue short-term debt and serve as a buyer of securities tied to shaky U.S. subprime mortgages and other assets currently held by funds affiliated with the participating banks.

The U.S. Treasury Department is trying to help the idea along by hosting some of the meetings about the plan. It is obviously in the federal government's best interest to have the banking credit situation improve, especially if the banks can solve their own problems.

The program does seem a bit perverse; banks bailing themselves out by putting together weak assets and selling them at a discount, and at the same time, supporting them with more short-term bank money.

The sub-prime problem has already created strange bedfellows. Bank of America (NYSE: BAC) has made a large investment in Countrywide Credit (NYSE: CFC). At first, the deal looked like a steal for the big bank, but as Countrywide problems mounted and its stock fell, BAC may have come to regret the move.

That is the core of the issue. Will banks that pool weak assets and support them with short-term loans come to regret their own actions? They may if the mortgage disaster gets a lot worse a lot faster.

Douglas A. McIntyre is a partner at 24/7 Wall St.