The “Bad Bank” plan has two main problems: (1) determining asset values is difficult and (2) it creates a whole new government entity to buy up and eventually sell these toxic assets.

A more effective and simpler solution would be for the government to assist the banks in selling these assets directly. The program would work as follows:

1) Banks would be responsible for finding buyers and disposing of their own toxic assets at market determined prices
2) Buyers would make a downpayment of say 20% of the agreed on purchase price, with the bank to finance the balance of the purchase price at market rates. Since the bank is already familiar with the assets there is no new underwriting or due diligence required ti issue the loan.
3) The government would in turn invest directly into the bank - in the form of preferred stock - a portion (say 50%) of the difference between the assets book value and the price it was sold to the buyer.

This would accomplish many objectives:1) Toxic assets would move off banks balance sheets as they sell them. 2) Banks would receive new capital to the extent that they were successful in disposing of these toxic assets. 3) New buyers would emerge since the banks would have an incentive to sell these assets at “bargain” prices.This would generate demand for real estate and stimulate new lending. 4) The bureauracracy of a government owned REIT would be avoided.

For example:A bank has a loan with a balance outstanding of $1,000,000 secured by real estate. The current value of the property is $500,000 and the loan is in foreclosure and/or the bank already owns the real estate. The bank sellsthe property to Buyer A for $450,000 who makes a downpayment of $90,000 with the balance of $360,000 to be financed by the bank. The government then invests say 50% of the banks loss ($550,000) which in this case would be $275,000 in the form of preferred stock in the bank.

This solution addresses many of the shorcomings of the current proposed “Bad Bank” and it ALSO addresses the biggest shortcoming we had with the first $350bn TARP money which was that banks did not use the money for new loans. This solution would force them to make loans in order to receive new capital from the government.