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  Solution to the Financial Crisis  

The Third Bank of the US and AEMs


Watching current events have been extremely painful because, unlike the politicians, I know exactly what needs to be done, having worked in the mortgage industry in the not too distant past.

The problem is that:

1. The mortgages and mortgage-based investments, CMOs et al, are administered by profit-driven private entities;

2. Said entities find one excuse or another, the latest being Return on Equity (ROE), to invest in their own high-risk instruments, this "no-no" is usually referred to as "buying your own junk", the tendency to do so being a corollary of "Gresham's law"; and

3. When the high-risk mortgages start to unravel during a real estate downturn, the Standard Operating Procedure of foreclosing at a drop of the hat becomes suicidal for a lender because the collateral is no longer worth enough to cover the remaining principal. Not even close.

My solution for this is to:

1. Replace the Federal Reserve with a new federal bank system, the Third Bank of the United States, consisting of a central bank and state-based banks whose scope is limited to financing businesses based in the state and residents of the state, but wholly run by the federal government and staffed with civil servants paid on the standardized federal government pay scale (GS).  Because the scope of this bank is financial contract law, being a court system for such contracts, these would be judicial banks run by the judicial branch of the federal government.

2. Take over the administration of all mortgages, including those recently foreclosed, reversing those foreclosures and distributing to the state bank where the property is located. Also take over all CMOs, most if not all being distributed to the central bank due the multiple states involved.

3. Convert those mortgages to Adjustable Equity Mortgages (AEMs) by reducing the remaining principal proportionate to the reduction of equity, i.e. by current appraised value divided by the sum of the down payment and initial principal. Some adjustment in the term (period of time over which the mortgage is repaid) can be allowed, based on the borrowers current capacity to pay, during this conversion process.  The goal is to have mortgages which are either made "good" or, if irretrievably "bad", are truly backed by collateral.  Even more simply, we should be avoiding a real estate "fire sale".

(1) removes the profit motive and focuses banking on the local economy.

(2) moves the administration of mortgages and mortgage investments into the public, civil service sphere.

(3) converts non-performing and failed mortgages into performing mortgages and those from which current mortgage equity can be extracted from a foreclosure sale. In the future, the risk and reward of equity moves is borne both by lender and borrower proportionate to equity stake. This makes for a much stabler instrument, albeit not fixed income.  The prospect of a resurgence of real estate values encourages current investors to "hold" and other investors to buy under-priced AEMs.

The money spent in this effort would be for administrative costs, which can be recouped through a modest fee. Also the apparatus of the Third Bank allows for state and federal deposits, i.e. endowments, to be used as a funding source for low risk investments, with the interest used to replace taxes and possibly to forgo the administrative fee.

This is my fair, low-cost solution to the financial crisis.

Carl Peter Klapper
Popular Capitalist