As I suggested more than two months ago, “Freddie Mac to let residents rent homes after foreclosure” (USA Today). I’d like to see the proposed Bad Bank do the same: Buy up the defaulting bundled mortgages (now scattered as collateralized debt obligations or CDOs), rent the homes to the current occupants at market prices, outsource management and maintenance to private contractors, hold the assets until this crisis is resolved — to keep the homes off the already overflowing real estate market — then auction them over a multi-year period to again avoid flooding the market. Someone could figure out a flat purchase rate. For example, we could offer to buy the mortgage assets for 35% of the CDO book (original) value. The homes have probably decreased 20% in value already and that should be low enough to make the investors feel that moral-hazard pain for their bad-investment decisions. After all, everyone else’s investments are down 20%-40% because, in part, of their indiscretions.
TARP #1 failed because it’s impossible to answer the question. “Who holds the mortgage on this home?” The mortgages have been bundled and re-split, so we can’t make this optional for the owners of CDOs. We’ve got to round up and buy all these splintered assets in order to actually get full title to the houses. This is what the proposed Bad Bank should do. Nationalize the CDOs, rent and manage the underlying assets for 2-5 years, then sell them over the following five years. The Band Bank goes out of business by the end of 2018.
If we take this action quickly, we can stop giving cash to the banks. Get these troubled assets off their books while sharing the pain with them, then let them sink or swim on their own. If they want to pay billions in bonuses, let their shareholders foot the bill.