Kneale: Toxic Assets ... Here's the Cure!

Well, two outta three ain't bad--or is it?

President Obama confronted three huge problems upon moving into the White House 30 days ago: the housing meltdown, the Great Recession and the toxic-assets banking mess.

This week he went all in on two fronts. On Tuesday the President signed the $787 billion stim-pack to stoke the poky economy. Yesterday he unwrapped his $275 billion fix for housing foreclosures. J.P. Morgan Chase chief Jamie Dimon, in an interview on CNBC, branded it "very elegant and well-designed."(Let's ignore, for now, the downsides of the housing rescue: rewarding deadbeats and speculators, sparking a rise in new defaults as people game the system, and keeping home prices artificially higher than they should be -- my colleague Rick Santelli is overseeing a revolt in the pits about that.)

But we have heard only scant details on the third challenge: the Bam Plan for rescuing big banks imperiled by all those scary mortgage-backed securities. It’s the most important piece of the puzzle.

Yet Wall Street and the private sector already have begun dealing with this morass on their own, if only the President and Treasury Secretary Timothy Geithner would take heed.

Some risk-takers have started shopping for the distressed derivatives now glowing radioactively on banks' balance sheets. On Tuesday on Power Lunch we heard from three buyers (their basic take: the banks, in denial, haven't cut prices enough).

Now imagine if thousands of investors could get into the bidding through ETFs—Exchange Traded Funds. On Friday this column talked about the Rob Plan, proposed by a pal of mine.

A quasi-government entity would take the banks' worst MBS assets and hand them new ETFs, paying a 4% tax-free dividend on the new shares and wrapping the underlying assets in a government guarantee. Eventually the banks could sell the ETFs, dividend intact, into the open market.

Turns out the glimmerings of an ETF fix already are in vitro. Invesco PowerShares, an ETF maker, hopes to offer two new ETFs based on distressed mortgage securities. The Securities and Exchange Commission could okay the plan in 45 to 60 days.

Invesco would seed a tiny sum, $20 million or so, to buy fallow securities now held by banks or institutional investors, says H. Bruce Bond, president and chief executive. The firm then would sell two ETFs based on this small asset pool, one for “non-agency” prime MBS outside the realm of Fannie and Freddie, the other for Alt-A loans.

Once extant, this PowerShares fund could attract other players. What if, say, Fannie and Freddie pumped a few billion dollars of their mortgage derivatives into the new fund and extracted ETFs in return? They could sell those shares later at a profit, if the outlook for the underlying loans improved with time.

The ETF-ication of the mortgage mess would let thousands, or even millions, of investors bid in a newly transparent market and place a new, broad-based valuation on these obtuse assets, the aptly named Bond says. Institutional investors that loaded up on the bad stuff would have a new way out.

We heard from quite a few fans of the ETF approach in response to the column last Friday.

“Love the EFT idea,” writes one wealth manager for ultra-high net worth clients. An asset manager forwarded the plan to his clients, and an ETF newsletter did the same. The CEO of a multibillion-dollar manufacturer praises the “straight-forward approach.”

The underlying value of the toxic assets may be helped, meanwhile, by other actions underway. As millions of homeowners take advantage of lower interest rates to refinance, their original loans get paid off and can't default.

Government and private efforts to forestall foreclosures also may help. J.P. Morgan’s Dimon says Chase this year will end up helping a million homeowners get easier terms on their loans. Bank of America is likely to do much the same.

Obama's new program aims at helping up to nine million homeowners sidestep foreclosures. All of which is good for the tranches of securities based on those loans.

On Wall Street, the markets still haven't recovered from the flop that greeted Secretary Geithner’s sketchy scheme for toxic assets on Tuesday of last week. The Dow fell just over 380 points that day, and since then it’s down another 340; that’s a combined decline of almost 9% in just six days of trading.

“If you don’t tell us what the new rules are, we can’t start buying,” says one trader at a Wall Street titan. The President and his new Treasury secretary must get on this immediately. The ETF solution could speed up the whole process.

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