"Bad Bank" For Toxic Mortgages Gaining Support from Obama Administration

Lawmakers and Wall Street are buzzing about the prospect of a "bad bank." This plan would create an aggregator bank to acquire, rewrite, and liquidate these troubled mortgages. Sources indicate that the Obama administration is behind the proposal and the FDIC is lobbying to manage the operation.

The aggregator bank initiative, recalling historical references to the Resolution Trust Corporation, would allow the government to rewrite and gradually liquidating troubled mortgages. Thesetroubled mortgage assets underlie banks' bad debt and continue to stall lending.

However, the final solution will be a challenging balancing act. A viable aggregator program would need to distinguish between viable banks needing help and those that should be closed, minimizing public ownership of financial institutions, protecting taxpayer investment, and assisting homeowners directly with foreclosure prevention.

FDIC arguably has a primary role to play in running any aggregator bank. Reportedly FDIC Chairman Sheila Bair is pushing their bank management expertise. This does seem to align with their charter to take troubled banks and assets into conservatorship, restructure, and return them healthier to private markets. The FDIC is citing is recent success with failed IndyMac Bank.

Newly confirmed US Treasury Secretary Timothy Geithner, explained one of the major challenges to an initiative such as this--valuing the impaired assets. Geithner illustrated three distinct methods: market pricing, computer-modeled pricing, or bank supervisory pricing. Each have weaknesses to a successful result, which ledGeithner to propose a potential hybrid approach combining the three methodologies.

Wall Street already appears to be reacting positively to strengthening rumors and support--with higher global equities signaling higher US equities market open today. Further positive momentum is being stimulated by expectations that the Federal Reserve may lend support to the idea and announce further quantitative easing in today'sFOMC meeting statement. With Fed rates at an effective level of 0 percent, they will need to reveal other monetary tools.

Federal Reserve Chairman Ben Bernanke has already endorsed the idea of a bad bank. The Fed has participated in the Treasury-led initiatives to insure toxic assets still on the balance sheets of Bank of America and Citigroup.

Ultimately, the aggregator bank could give government control and expediency to workout contagion mortgage assets with loan modifications and prevent foreclosures--a crisis that has already reached 1.3 million homeowners.