It might be time for retail investors to start buying toxic mortgage securities. That's not as radical a notion as it sounds. People will profit and it will help restart the credit markets in a way that the current institutional investor approach simply can't. Retail participation will build political support for TARP and other government programs that might be required to strengthen the financial system.  Before the presidential election, I worked with Nouriel Roubini advising officials at the Federal Reserve on the financial crisis. Nouriel convinced Larry Summers to back equity infusions to provide capital to the banks, which was critically important at a time when Bear Stearns and Lehman Brothers ( LEHMQ - news - people ) had failed and Morgan Stanley ( MS - news - people ) shares were selling at under $10 per share. Professor Summers played an important behind the scenes role in speaking to political leaders in the Congress.  At that time, I discussed the idea of Public Private Investment Partnerships to purchase the mortgage-backed securities with the Federal Reserve. My suggestion was to include private equity and hedge funds that had been successful making money shorting mortgage-backed securities. If the markets saw these firms going long on mortgages and mortgage-backed securities, it would instill market confidence and place a floor on this asset class.  In 2007, John Paulson had two funds that shorted mortgage-backed securities. One of the Paulson funds was up 590% for the year. The other Paulson fund was up 353%. If John Paulson would go long and buy mortgage-backed securities it would give the markets confidence in the prices that were being set by new purchases of MBS and would help unfreeze the market for this asset class.  Follow Intelligent Investing on Twitter.  Sign Up For The Weekly Intelligent Investing Newsletter.  However, the current requirements for the PPIP government program for legacy securities precludes firms like Paulson & Co. from applying. The requirement to be able to raise $500 million of equity capital that would be matched by the Treasury is not an obstacle for private equity and hedge funds.  However the current rules for the government PPIP legacy securities program require a firm to have $10 billion of eligible assets under management. This requirement can be met only by the largest asset managers. There is perceived political risk of applying for this program. The program guidelines are ambiguous on whether firms would be subject to the TARP salary caps from participating.  The intent of the program is to provide low-cost funding to purchase MBS, yet the interest rate has not been specified and there is a clause in the guidelines that would require warrants, which some of the PE and hedge funds I have spoken with are concerned could be used as a way of clawing back money if they have strong returns.  This ambiguity has scared off some of the best performing hedge funds and private equity funds that have told me they would not apply or participate in a joint application. The head of one of the largest U.S. asset management firms told me that his firm would not apply for the PPIP program.  So, turn to the people. Retail investors participate and profit alongside the big institutions who are already on board with the program. The government should allow the public to put up the debt and equity capital and guaranty that there will be a repayment of 93% of the principal with substantial upside rewards when there is a recovery in the housing market. Ninety-three percent is the same level of protection that is being provided to institutional asset managers currently in the proposed whole loan program. In this program, investors put up $1 and have it matched with $1 from the Treasury. They can then borrow $12 from the Federal Reserve with FDIC guarantees. Thus, 7 cents in equity creates a $1 investment.  With this highly leveraged structure, there is risk to the small amount of equity capital. If the asset managers overpay for whole loans, all of the equity can be wiped out. However one can make the case that if these are long-term investments and if retail investors holds on until real estate recovers there will be profits from these investments.  Under the approach I am proposing, let the retail investor put up the full dollar and let the government guarantee the repayment of 93 cents in principal. Otherwise it is too risky for retail investors to put up the equity portion that is leveraged 12:1 with government money. This is the current leverage in the PPIF whole loan program. And this leverage could be obtained from borrowing from the Federal Reserve with qualifying mortgage-backed securities purchased under PPIP.  With real estate prices still falling and projected to continue to fall, purchasing mortgages and mortgage-backed securities at this stage can still be risky. The investment strategy must be to buy and hold, otherwise short term there could be losses in this program. The government regulations are asking asset managers that participate in the PPIP to re-price their portfolios of MBS every month. There will be fluctuations and in the short term prices could decline.  Housing prices declined an average of 19% this January from prices a year ago, based on data from 20 metropolitan areas. The data for NYC the first quarter of 2009 also shows a 19% decline from a year ago, according to the Real Estate Board of NY. For NYC, which has been hit by layoffs in the financial industry, we can expect that prices on apartments and homes in outlying suburbs will continue to decline.  Foreclosure rates on subprime mortgages soared to 13.7% in the fourth quarter of 2008, up from 8.65% the same quarter a year earlier, according to the Mortgage Bankers Association. Mortgage delinquencies increased to 7.9% of all loans in the final three months of last year, the highest level in records going back to 1972. Foreclosures continue to drag down real estate prices.  With increasing unemployment driving foreclosures, we have not reached a bottom for real estate. Some economic analysts, like my colleague Nouriel Roubini, are projecting that unemployment could rise to 11% in 2010. Unfortunately unemployed persons are largely left out of the administration's foreclosure relief program.  A program for a new lending facility for distressed homeowners that I have presented to Larry Summers and other administration officials could help to stem foreclosures. This work out loan program combined with other foreclosure relief measures enacted by the Obama administration could begin to put a floor on real estate prices.  The Obama administration is interested in this program to help unemployed homeowners who are currently left out of the foreclosure relief programs. Effective government measures to prevent foreclosures and stabilize real estate prices are necessary to make retail investing in Public Private Partnerships of mortgage backed securities more attractive.  Michael Jaliman is a senior adviser at Vantage Partners.  See More Intelligent Investing Features.
The Public Private Investment Partnerships are a mess. What we need is more public participation at the retail level.