In September 2008, the Shadow predicted that a Resolution Trust Corp. (RTC)-type of entity would emerge to deal with the ill conceived, badly documented and unaffordable mortgages that are on the books of financial institutions. That day has arrived under Tim Geithner and the Obama Administration and has the potential, just as in the late 1980s and early 1990s, to generate enormous profits for entities that have the intestinal fortitude and work ethic to sift through the rubble to find properties that have value.

The plan is intended to work something like this: A bank will auction a pool of mortgage assets to the highest private sector bidder, for which the FDIC will provide leverage directly to the buyer on a six to one debt-to-equity basis. So if a bidder wins a $100 million asset pool for say $84 million, the FDIC will provide guarantees of $72 million. Of the remaining $12 million of equity, the investor will provide $6 million and the U.S. Treasury will provide the balance of $6 million. Let us assume that the actual value of the assets after disposition is $50 million and that the total profit on the transaction is $2 million, which goes evenly to the equity holders. The investor made $1 million on a $6 million investment, or 16.7% return on capital. The assets are now off the banks’ books (making them stronger institutions) who actually sold $50 million worth of assets for $84 million (they gained $34 million), and the investor and the Treasury has turned a profit of $2 million. Who loses $36 million? The FDIC of course, who blindly will extend loans on assets worth perhaps far less than the debt used to acquire them.

A friend of mine always recites a quote from Ronald Reagan during meetings when discussing mortgaged backed securities and it goes something like this: “What are the most feared words in America? ‘Hello, I’m from the Federal Government and I’m here to help.’” The point is well taken: if the government gets involved in any process that is normally handled by the private sector, you know that it will get screwed up somehow. No one seems to be accountable for any programs or behavior since it can be categorized as “the government.” How about using riot control tactics and singling out individuals. (“Mr. Geithner, you will be evaluated on this program” and perhaps have his pay tied to the success of the program.)

Will this program of $1.2 trillion take enough of the impaired assets out of the mortgage marketplace to get the economy back on track and restore confidence with investors and consumers? Time will tell but it seems the government does not end up following through on a program before it becomes distracted and turns to some other issue. Experience tells us that fixing the underlying cause of a problem will alleviate the symptoms and not the other way around. As painful or as inequitable or as much of a boondoggle that this new program may turn out to be, it is at least an attempt to correct the problem. I am hoping against hope that the phrase “Hello, I’m from the Federal Government and I’m here to help” will take on new, positive meaning.

The views expressed in this column do not necessarily reflect the views of Channel Capital Group. Inc.