Kass: Two Solutions to What Ails the Market

The solution to the emerging failure of the monoline insurers that hold insurance on homes, mortgages, bonds and derivatives is straightforward but requires bold initiatives and imagination. It is a public/private permutation of a Resolution Trust Corporation-type facility that will somehow acquire the equity of the leading monoline insurers and will, with or without private sector partners, retain their portfolios of financial asbestos and sell them over time.

This solution will, importantly, serve to retain the AAA ratings of the individual bonds -- the U.S. government has the highest bond rating extant -- and the portfolios insured by MBIA, Ambac, MGIC Investment, Radian Group and PMI Group. In turn, this would prevent the domino effect of bond and mortgage downgrades and further forced selling and price markdowns at the world's leading financial institutions.

This program will, however, require a degree of financial creativity that has yet to be apparent from a thus far non-creative Executive Branch nor from an equally timid and tardy Federal Reserve, which seems to be behaving like Milton Friedman's "fool in the shower." It will, if enacted, immediately alleviate the concerns with regard to counterparty risks that have cast a pall over the world's equity markets and wreaked havoc with some of the world's largest financial institutions.

I would note that I have already drawn a clear parallel between the S&L crisis of the 1980s and the current credit crisis. So, not surprisingly, the solutions could be similar.

Again, the equities of the monoline insurers have declined by an average in excess of 85% from 2007's highs. The existing industry equity value of under $4 billion is de minimis against the size of the problem and low relative to the cost of a government acquisition of these companies.

Suppose the government acquires these companies en masse at a 50% premium to current prices: At a cost of only $6 billion, the U.S. government will own the majority of the companies that insure mortgages, plain vanilla municipal bonds and structured investment vehicles. More importantly, the total value of the toxic portion of the structured products insured that the government would inherit is manageable and modest relative to the cost of acquisition. For example, MBIA, the largest bond insurer has "only" about $30 billion of insured mortgage-backed bonds.

Solving the Housing Depression

The credit problems facing the world started with housing and moved up the credit ladder. As I have mentioned consistently over the last 24 months, for more than a decade, the normal/historical rigor of lending was abandoned in the residential and non-residential real estate markets. The problems were exacerbated by the ratings agencies, which abrogated their responsibility of providing accurate assessments of risk.

As such, the solution to our currently dysfunctional credit markets lies squarely on the shoulders of housing. Policy must be immediately enacted that provides the framework that will specifically allow homeowners who are now unable to service their mortgages to become current on that payment. We have to stop foreclosures and begin to whittle down the inventory of unsold homes. This will serve to begin to remedy what ails the RMBS, CMBS, CLO and CDO markets -- and aid the monoline insurance companies as, in the fullness of time, banking industry financial writedowns could turn into write-ups.

As Punk Ziegel's Dick Bove reminded me over the weekend, the mechanism and solution for turning around the housing markets is already on the books and requires no new legislation: It is Section 8 of the Housing and Community Development Act of 1974.

The solution could take several steps:

1. The homeowner who can't currently service his debt and uses his home as a primary residence would refinance his mortgage at a bank with a new fixed mortgage at a subsidized rate of 1% to 2% guaranteed by the Federal Housing Administration (FHA).

2. The bank providing the new mortgage loan pays off the homeowner's previous mortgage with the proceeds of the new loan.

3. The bank gets the new loan off its balance sheet, allowing it to continue to lend, and sells the FHA-guaranteed mortgage to the Government National Mortgage Association (GNMA) at a modest premium to par, which incorporates a bank profit for originating the mortgage.

4. GNMA takes a sizeable loss -- the aggregate cost would be only about $150 billion, which is not bad considering the magnitude of the problem and the solution it could bring -- and sells the mortgage at market rates (5.75% to 6.25% fixed mortgage) to Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote).

Voila!

I am absolutely positive that these two solutions would have a momentous, immediate and profound impact on equities. On Friday night's "Kudlow & Company" I suggested that stocks would literally rise by 10% overnight.