Howrnthe loans would actually be transferred to the RTC2.0 would depend on theirrnownership. For those held in banks or by the GSEs the transfer would be arnsimple sale; the only obstacle being whether the financial institutions werernwilling to recognize the loss.  Secondrnliens, few of which are securitized, present some complications, matching and valuationrnproblems which can be overcome, and the fact that many second liens are held byrnsmaller institutions more immune to litigation or regulatory leverage.  Whether these could be included in a quasirnvoluntary program is questionable.</p

The big problem with portfolio loans is thatrnlarge-scale principal write-downs will significantly decapitalize many major institutionsrnand the throw the bill for the GSE portfolios on the taxpayers.  However, the largest financial institutionsrnhave a book equity that greatly exceeds their market capitalization indicating thernmarket believes that banks are carrying assets at inflated values or failing tornrecognize liabilities.  If principal isrnreduced to resemble market values then it will also help narrow the book-marketrngap by both reducing inflated book values and increasing market value.  Indeed wide-scale principal reductions wouldrnbe a rising tide that could lift all housing prices and increase the value ofrnthe written down mortgages.</p

Securitized loans present differentrnchallenges.  The GSE loans can only bernremoved from pools under specified circumstances, all of which require the GSErnto buy the loan at outstanding face value. rnPartial prepayment of the loans by the GSEs would get around many of thernlegal restrictions without saddling them with the liquidity burden ofrnrepurchasing underwater mortgages at face value from securitization pools.  Such prepayment would address negative equityrnbut the GSEs still could not restructure the loan nor reunite first and secondrnlies.  These could, however, bernundertaken through other means.</p

Private-label MBS (PLS) also cannotrngenerally be removed from their securitization trusts.   Settlements provide an exception so underwaterrnmortgages could be extracted from PLS as part of a litigation settlement withrnPLS trustees.</p

The central negotiation point will berntransfer pricing.  At what price will thernbad bank acquire the bad loans?  Levitin notesrnissues that would likely arise in determining price.  First, the transfers would have to bernnegotiated in bulk, raising some valuation issues but ultimately the questionrnwill be how much loss recognition the institutions can afford.</p

Second, a negotiated solution shouldrncover entities that were part of the origination and securitization processrneven if they no longer own or service loans. rnThose that do not contribute mortgages to RTC2 can still contributerncash.</p

Third, price may depend onrnownership.  For whole loans it is simplyrna matter of a “haircut” for the bank, albeit complicated by loss recognition especiallyrnin regard to second liens.  Forrnsecuritized loans investor rights must also be considered.  One can imagine a basic transfer pricingrnschedule like that used for modifications in the federal-state servicingrnsettlement.</p

There is also the related issue ofrnfinancing RTC2 which would acquire mortgages for a combination of (1)rnlitigation releases/permission to do future business, (2) cash, and (3) itsrndebt and equity.  RTC2 would require tremendousrnliquidity to acquire the underwater mortgages and the duration of its liquidityrnneeds would depend on the time needed to restructure and resecuritize thernmortgages.  Doing this on a rolling basisrnwould reduce liquidity needs, but they would still be enormous.</p

There are two realistic sources ofrnliquidity – financial institutions or the government and it is likely that RTC2’srnneeds would outstrip anything that financial institutions could provide.  Ideally, however, a two-tiered liquidityrnstructure could be employed with the Federal Reserve providing a seniorrnliquidity tranche and financial institutions providing a junior one.  </p

The equity ownership of the RTC2 is thernfirst loss position on the mortgage restructuring.  If that restructuring is convincing and valuernenhancing then it could be a call option on the U.S. housing market and couldrnbe given to financial institutions as part of the transfer pricing.</p

Once loans are restructured the RTC2rncould retain them and collect the mortgage payments but it might be preferablernto sell the loans to provide liquidity to the financial institutions.  This could be done by securitizing the portfoliornas the original RTC did but this presents some challenges.  The RMBS market is “moribund” and investorsrnmight be especially caution of RTC2 loans, as a new product and one that looksrnquite different from a pool of conventional mortgages.  The product might have to be issued at arndiscounted price or with some type of government or third-party guarantee. </p

Levitin concludes by admitting thatrntechnical questions could bedevil the design of a bad bank for housing, but thernfeasibility of his proposal is ultimately not a matter of technical design butrnrather a question of will.

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