This statement:

In reality all that is needed is more trust.

is precisely and 100 percent incorrect. It is not trust that is needed, but trustworthiness. That is what is missing from the current situation, and it is laid out as plain as day by Mr. Hempton:

… nobody (at least nobody normal) can understand their accounts. I can not understand them and I am a pretty sophisticated bank analyst. I know people I think are better than me – and they can’t understand Citigroup either.

I spent enough years in the newspaper business to know that when someone can’t provide a reasonable explanation of how something works, they don’t know. You can’t buy a meal from a chef who can’t tell you what’s in your dinner and you can’t buy securities from a guy who can’t tell you where the money is coming from.

What the government should do is allow the banks and homeowners to write down the amount of the mortgages that makes the borrowers solvent again and able to pay the loans. There are a few incentives in this so bear with me.

How this would work is the government would guarantee the difference between the current cost of the loan and the amount the bank and the borrower agrees to write the loan down. The amount of the writedown will be decided between the bank and the homeowner. They will basically do a redo of the application to make sure the person can actually pay their mortgage this time.

Incentives:

1. In order to make sure the bank does not try to write down a larger chunk of money than normal, they can only write down the difference as a loss on their books that they can carry forward on future taxes. This will give them the incentive to write down as little as possible in order to get as much of a monthly payment as possible from the borrower.

2. The borrower will not be able to sell the house and collect more than the new loan is worth with one exception. This is the difficult part so I hope this comes through clearly. In order to get the borrower to hold on to the house and rebuild equity every dollar that the house is sold for above the new loan value goes back to paying off the difference that the government has guaranteed. Only if the value goes above the original loan cost can the borrower earn those dollars. This will make sure the person holds onto the house in order to build equity in it. Now here is an example:

-Lets say the original loan value is 100K

-The borrower and the bank come to an agreement to write the value of the loan down to 80K based on the borrowers ability to pay

-The Feds guarantee the 20K difference and the bank writes down the 20K difference as a loss against their taxes never to be recovered

-In a short time, the value of the house rises to 90K and the borrower having built 5K of equity payments into it decides to sell

-The borrower is allowed to pocket the 80K which is the original cost of the new loan. They make the 5K equity difference that they built in between 75K and 80K. The Feds pocket the difference between 90K and 80K or 10K and they end up with a 10K loss on the original difference they guaranteed.

-This gives the borrower the incentive not to sell the house because the government pockets the difference and they are no further ahead

- Let’s assume that the house instead goes to 110K in value and the borrower decides to sell. What happens? The borrower gets their 80K. The government gets paid back the 20K that they guaranteed and the borrower gets the extra 10K that the house gained in value on top of the original value of the 100K loan. This provides an incentive for the homeowner to sell when the market recovers and ensures that the feds get the full value of their guarantee back minus inflation. It keeps the borrower in the house and making payments and it minimizes the amount the Feds need to guarantee. It saves the bank a ton of money in foreclosure and gets their cash flowing again