In all the talk about bailouts, markets, toxic assets and government intervention heard in the media, none of the pundits or media moghuls have noticed that there isn’t a real cure, only band-aid solutions. Let’s look at a cure.

With the very best of intentions, government financial and political leaders have been working extra hours and dedicating every possible resource towards stabilizing the economy to prevent a complete collapse of the global economic machine. Their efforts have not been without trials and tribulations, but in fact, they’ve been quietly successful.

In September, it became evident that the sub-prime crisis was not merely an American problem and global markets began to show serious flaws leading then Secretary of the Treasury Henry Paulson and Federal Reserve Chairman Ben Bernanke to the conclusion that steps had to be taken to stabilize the banking industry in quick time.

If you recall from previous postings of that period, Secretary Paulson put forth a three page proposal to Congress calling for $700 Billion to purchase toxic assets from the banks. The House failed to pass the bill as many Democrats joined Republicans because they believed the bill was fundamentally flawed.

Essentially, Secretary Paulson missed the fact that purchasing toxic assets is not an easy thing to do and takes an extraordinary amount of time. This Institute revealed this in a posting on September 30th, 2008 entitled Invest in America in which we outlined a proposal submitted by the Institute to Congress, the US Treasury and British Exchequer on September 28th.

As fate would have it, our proposal was fundamentally adopted in its basic format by the British, Italian (whom we also contacted) and later American governments as it became evident that toxic asset purchasing was a tough and slow road ahead and solutions were needed in the very short term, not the long.

Now, the quintessential and underlying problems in the system need to be addressed in order to resolve the systemic causes that brought the world to the brink of economic collapse. Without applying a direct solution to the banking system, where this crisis began, the problems are going to perpetuate.

In a recent study conducted by The Institute among former Mortgage and Commercial Mortgage Backed Securities investors, it was evidently clear that they plan to remain out of the MBS and CMBS markets as long as banks can and do make improperly qualified loans. They fear the risk of buying such securities when banks have proven their inability to safely and securely conduct proper due diligence in those whom the banks include in the securities.

One such investor said “I could get a better return dropping my cash in a Vegas slot machine”, while another pointed out “putting my money into MBS now is no different than investing blindly in businesses I know nothing about and cannot check out. It simply makes no sense right now.”

Investors collectively feel that banks used the securitization market to offload debt they created without regard to the quality of the debt or the ramifications of their actions either on the borrowers, the investors, bank shareholders or the banks themselves. As a result, they say, of such a lack of due diligence and oversight, the money they invested was lost but that the entire system was placed in severe jeopardy. It is a risk they’re not willing to try again… except, if there was real-time oversight, transparency and independent validation.

Investors still believe MBS and CMBS are potentially good investments. They have not lost faith in the fundamentals of the type of offering. Rather, they only fear what’s in the offerings at present.

Once more, the Institute steps in and conducts an analysis and much to our surprise, the solution is there, simply waiting for a missing element.

Because banks use software to determine regulatory compliance with loan processing, it has been heretofore easy for underwriters to “fiddle” the system. They could offer no-documents loans by playing the compliance system and charging a higher interest rate. By doing so, they could offer higher yield investments, with higher risk. Some investors admit their own complicity in being greedy for that extra yield.

To their credit, the majority of the investors surveyed said they’ve learned their lesson and if the MBS and CMBS were to include loans where compliance with regulatory obligations were independently verified, they’d buy again. Many referred to such securities as potentially the safest bets around on the basis that they would include deleveraged property valuations and validation of the borrower’s ability to pay the debt.

The cure, it seems is for an independent third party to validate the loans against existing regulation, with government oversight of the validation.

The form the cure will take came as much of a surprise to Institute analysts. It seems that by validating the loan process, once investors begin buying MBS and CMBS again, things begin to happen quickly.

First, the banks begin to see an immediate flow of capital through the system and they can and will begin lending again… slowly and cautiously. No matter the speed, money will once more become available for housing and business loans, student and auto loans and lines of credit.

Second, the real estate market will pick up once again and with due reduction in speed, will turn around into positive numbers, allowing buyers to acquire substantial volumes of the distressed properties on the market at present. This will shorten the time it takes to sell a home, but won’t immediately improve property values. It will stabilize them and minimize any chances of further devaluation

Third, the loans made to businesses and business lines of credit can be restored and small to mid-sized enterprises can rehire employees. They in turn will spend once again, though at a slower, more rational pace. This will spur trade and commerce again, building the market for more private sector jobs and durable goods purchases.

Fourth, with employment reduced, some of the overwhelming problems faced by states, counties and municipalities will reverse, reducing the need for more Federal intervention in state and city budget shortfalls.

Fifth, with properties returning to a stable value base, municipal taxes will increase or stabilize allowing essential services to resume or grow. With more people occupying once vacant homes, the need for additional services increases again, but corresponding revenue increases from taxes and fees will make such services affordable once more.

Sixth, with cash flowing again, banks will repay TARP money quickly, and with a profit for the US Treasury. Banks and others using TARP funds will be happy to pay off government debt to get rid of government oversight of fundamental business decisions like marketing, advertising and conferences.

Seventh, poverty will decrease, in turn reducing crime. With less people forced out of work and more businesses able to obtain funds and trade, employment will slowly recover and certainly stabilize.

Eighth, bank failures will reduce considerably, stabilizing the system and reducing risks for FDIC.

Ninth, securities markets around the world will stabilize and may turn slightly “bullish” from present “bearish” sentiment as investors breathe a sigh of relief that a core solution was found and implemented.

Tenth, the valuation of toxic assets may be set through this process and private market forces without government backstops, guarantees or intervention. Investors will take remaining identified toxic assets from the banks in the securitization market when such offerings become potential tax savings to certain investors and sound business investments for others.

All of these things happening not as a result of government bailouts or capital injections, but through government sponsored transparency, checks and balances and private validation of the banking process. Of course, it’s going to require legislation, so the Institute has sent a proposal to Congress once again.

This is as good a free market solution as Larry Kudlow undoubtedly dreams about in bed at night.

Well, there you have it… a cure using government to create a private sector solution with  both cooperating in a way that restores confidence, builds liquidity and hold on Larry, costs less than $40 Million (with an M). Now what would Cramer have to say about it?

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