In countering the current financial crisis, the U.S. Government has rolled out several bailout plans and stimulus packages. Existing programs (including TARP, PIPP, and TALF) are all pinned to the hope that by pouring enough money into financial institutions to buy up non-performing mortgages and toxic assets, the financial institutions and the economy will eventually recover. However, existing programs encounter major difficulties in valuing mortgage-backed securities, while the housing prices continue to drop, and foreclosure rates (and now unemployment rates) continue to rise. With this huge cloud of uncertainty, bank lending keeps dropping — analysis of treasury data paints starker picture than official government snapshots (Wall Street Journal 04/20/2009 cover page). Extraordinary circumstances call for extraordinary responses.  Existing government programs are extra-ordinary responses; unfortunately, they seem to be stimulating the wrong places, with limited success so far but huge confusions. 

Under this backdrop, we propose a bold new strategy, as indicated by its name — “Good Asset Purchase Plan” (GAPP). The U.S. Government, serving as the ultimate liquidity provider, should buy good assets, as opposed to toxic assets. Backed by good assets, the long-term integrity of the U.S. dollar will be strengthened, rather than weakened; in the meanwhile, large amounts of liquidity will be released from good assets and flow into the real economy for more productive use.

Action: The U.S. Government offers to buy up to 20% shares of homes.

We expected the GAPP will have the following effects:

·         Immediately stablize the U.S. housing market

·         Effectively stem the foreclosure tide

·         Reduced household debt

·         Increase available fund for investment

The implementation of GAPP will be through refinancing (and new purchase) transactions. For homes with more than 20% home equity remaining, the GAPP refinancing can be depicted the following diagram: 

Due to falling house prices, the homeowner equity may be insufficient for a 20% down payment in the new loan. In this case, we propose that the old lender agrees to take a haircut through a debt-for-equity swap. With such an arrangement, the homeowner equity will be restored and loan balance reduced, as depicted in the following diagram.

We estimate that up to $1.25 trillion is required to fund GAPP. The U.S. Government can finance GAPP through debt issuance backed by shares in acquired real assets. The funding will not increase the budget deficit or the net national debt, thus will keep the long-term integrity of the U.S. dollar intact.

Under GAPP, vast amounts of liquidity will be released from good assets and flow into the real economy. With $1.25 trillion total government investment, there would be an estimated $5 trillion stimulus impact on the U.S. economy. Further, GAPP can serve as a macro-economy tool — the Government can adjust the size of its minority shares as a lever to counter economic cycles.  

Aggregate U.S. Residential House Prices, Homeowner Equity and Mortgage Debt

(Before and After GAPP;  in billions of dollars)  

It is expected that GAPP will also help restore the health of the ailing banking sector by strengthening the surviving banks. When a large number of home mortgages are refinanced through GAPP, it will expedite the cleaning up of banking balance sheets by sorting out non-performing mortgage loans and hard-to-value mortgage securities. The surviving banks after this process will be strengthened, and will play an important role in GAPP implementation, by underwriting new loans and administering the Government’s minority shares of real assets.

In summary, the GAPP represents a new thinking, shifting our eyes away from complex mortgages and to focus on the underlying real assets. The author hopes that this paper is thought-provoking and will help the U.S. Government to form a new strategy to combat the financial crisis and bring the U.S. economy to prosperity.

Many detailed aspects of the GAPP still need further consultation with various professionals and government agencies. You are invited to contribute additional inputs and discussions on this discussion forum.

To see the entire paper, please go to: http://papers.ssrn.com/abstract=1381002