Thanks for your thoughtful comments. I see a couple of typos in my post. You are kind for not pointing them out.

Throwing more money at the investment banks or attempting to salvage bad mortgages is bad business.

This paragraph in the above article shows the problem and points to the solution:

“Usually, banks recover 75 to 80 percent of the value of a mortgage by foreclosing and reselling the home. Because of the foreclosure crisis, that percentage is down to 40 percent, Wyss said. And in places like Detroit, it’s negative-10 percent, meaning it actually costs a bank to foreclose – giving it little incentive to do so. In Detroit, Buffalo and Cleveland, banks have been accused of walking away from homes, filing foreclosure notices but never following though. Cleveland housing professor Kermit Lind calls the result “toxic titles,” because a house is left empty, no one claims responsibility, and the city has to pay to clean it up. Housing courts in Cleveland and Buffalo have been trying to crack down on the practice.”

Local units of government are left with the problem anyway. If the federal government bought all of these assets at 30 cents on the dollar and gifted them to the local unit of government where the property is located, 100% of the sale price of the home would be available to the local government to sort out and finance the cleanup. You could worry about dumping low cost homes on the market but values are going down anyway. In this case, the benefit is accrued locally and the cost of cleanup is assessed where it should be, with the Wall Street banks. If they go under, smaller and healthier banks can buy them at a good bargain. If local economies are revitalized, it is a moot point if Wall Street loses. We should not be held hostage to the notion that any bank is too big to fail. If they are too big to fail, then they should.

One Trillion dollars, roughly the total already earmarked for the investment banks, would buy 5 million $200,000 dollar mortgages. The banks are only recovering 40% of the mortgage anyway. That means that a $200,000 mortgage could be bought for $80,000 or less if the government bargained with the banks. One Trillion would then buy twelve and one half million %80,000 mortgages. If these mortgages were purchased by the federal government and gifted to the local government, there would be plenty of value in them to recoup the local losses.

Someone with a more math aptitude than me should correct me if my numbers are wrong.

In any case, this is a market based solution that deals with the problem locally. local communities have a vested interest in protecting these properties and maintaining their value. Investment banks have an interest in maintaining their bonuses and their bottom lines. They know little and care even less about the impact of forclosures on communities. Their loss could be our gain if this is handled properly.

Instead of gifting banks large sums of public money while allowing these foreclosed homes to sit unoccupied and unprotected, the federal government should be buying these assets at rock bottom prices and giving them to the local units of government where the homes are located.

This plan accomplishes 3 things.

1. It deeply penalizes the banks and their shareholders for their bad business practices while at the same time removing the cloud of uncertainty that hangs over them.

2. It allows the homes to go on to foreclosure which is the natural consequence of the bad behavior of both lenders and borrowers.

3. It stimulates the local economy by providing jobs to those who manage, rehab or complete the construction on the foreclosed homes to prepare them for sale.

4. Since the homes would be given to the local units of government in lieu of stimulus money, the proceeds of the sale of the homes would be government revenue to be used to finance the program with the rest targeted at deficit reduction.

5. Those who have lost their homes through no fault of their own as a result of this damaged economy would be able to find a very good deal on a replacement home.

6. Local banks could then make new mortgages on these properties with improved mortgage to value ratios. Local governments could also use this affordable housing to draw homeowners and businesses back into the communities.

Solutions like this will seem more reasonable when we get tired of throwing bad money after bad. A plan like this makes the real culprits pay for their mistakes and allows the real victims to benefit from the solution.