The Future of Securitization

Furthermore, it is not clear that cutting rates is going to solve the basic problem. As rates continues to drop, foreigners may begin withdrawing their money from dollar-denominated investments, driving rates up. "What the Fed is doing is unprecedented," says Allen. "It is laudable that it is trying to stop a recession, but how many risks should you take to do that? We're now moving into an area where the Fed is probably taking too many risks. If inflation picks up and long-term rates go up, we'll be in a situation where we have to raise short-term rates as we go into recession, which is not a happy thing to."

Vulture Capital

The private sector has begun to show signs of willingness to get back into the fray. A number of vulture funds have begun to form to take advantage of distressed real estate prices. BlackRock (BLK Quote - Cramer on BLK - Stock Picks) and Highfields Capital Management have announced they will raise $2 billion to buy delinquent residential mortgages. The companies have hired Sanford Kurland, the former president of Countrywide Financial (CFC Quote - Cramer on CFC - Stock Picks), to run the new venture called Private National Mortgage Acceptance, or PennyMac. "Many distressed funds will come in to discover prices," says Gyourko.

Wharton real estate professor Peter Linneman offers an intriguing prescription to bring prices down to the point where the industry can start to rebuild. He suggests that the government tell banks that if they want to maintain their federal insurance, they should fire their CEO by the end of the day, and the government will pay the CEO $10 million in severance. Ousting the former CEOs gives the new bank CEOs an incentive to write down all the bad assets immediately, so that any improvement will make them look good going forward. That would speed the painful process of gradual price declines.

"There's plenty of money out there waiting for these assets to be written down to bargain prices," says Linneman. In another quarter or two, the lenders would have new cash and be ready to lend again. Meanwhile, he says, the government should tell bankers it will keep interest rates down but raise them after the end of the year. "That says, 'Get your house in order in the next nine months because the subsidy ends at the end of the year.'" Linneman figures that 1,000 CEOs are accountable for about 80% of the current lending mess. If the government were to spend $10 billion to restore liquidity to the market in nine months with only 1,000 people losing their jobs, it would be the best investment it could make to restore the economy. "I'm only half-kidding," he quips.

Linneman also argues that concerns about moral hazard -- or the tendency to take greater risks because of the presence of a safety net -- because of a bailout are not valid. Those concerns, he says, already exist and have been in place since the U.S. government agreed to insure bank deposits. "The minute you say to somebody, 'No matter what you do I'll give your people their money back,' you've created moral hazard," he says. "Now it's only a matter of how often and how much they will have to spend to settle up. If you go through our history, every eight years to 15 years we have had an episode."

Indeed, Wachter cautions that while the plan she outlined for the Congressional committee might halt the current meltdown, it would not prevent a replication of the crisis in the future. "The ultimate question before us is do we want a system that produces risks such as those that we have seen in the current market. It is clear that Wall Street will underwrite any risk," she testified. Wachter told the committee that adding financial risk to the home-loan market not only poses potential problems for borrowers and investors, but it also exposes all homeowners and the overall economy to increased house price volatility and risk. "We, as a society, will have to decide whether we wish to encourage such financially vulnerable funding as backing to the asset we also call home."

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