Excellent Commentary on the Bailout Plan in Layman's terms. Easy to Understand.

Commentary: Like trauma room doctors - Treasury Secretary Paulson, Fed Chairman Bernanke together with support from most members of Congress are scrambling to revive the critically ill global financial system.

It looks like one of the treatment regimes being considered will strongly resemble a critical care technique from a bygone era. Treasury Secretary Paulson is finding growing support for the development of a government entity similar to the Resolution Trust Corporation (RTC) which proved useful in helping resolve the savings and loans crisis of the 1980s. Rather than hold and sell the assets of failed banks as the RTC did, the new entity would purchase toxic loans at a steep discount from solvent financial institutions -- and then eventually sell back those repackaged loans into the market through an auction.

This is not an all bad idea - especially if the majority of these loans are collateralized by an asset such as a single-family residence. Here's a look at the general idea. Because the original loan from the bank to borrower was not paid back - the bank must write the loan off as a complete loss - at least until the underlying collateral is sold and the true dimension of the loss can be calculated. For instance, a $100,000 loan secured by the "sticks-and-bricks" of a single family home goes bad - and the bank is forced to take a gross $100,000 ding to its balance sheet. Just because the bank took the write-down it certainly doesn't mean the value of the home has fallen to zero. If someone would simply buy the foreclosed home from the bank at $100,000 - the bank would generally be out nothing more than legal and administrative fees. No big deal.

The proverbial "rub" here is that many lenders have suffered more losses in their loan portfolio than their cash position can support - rendering many lenders insolvent and leaving many more hanging on the edge of financial disaster. The quick sale of the collateral (the homes) is too slow to stave off possible collapse and the short-term credit markets have frozen-up - cutting off any opportunity these institutions might have to borrow themselves out of trouble.

Treasury Secretary Paulson is proposing the government create a new entity, funded with hundreds of billions of dollars of taxpayer money, which will buy these troubled loans from still solvent institutions at a discounted price, and then eventually sell them back into the market through an auction process. The lenders off-load bad loans from their balance sheets for cash, immediately improving their financial viability. If the bank sells a $100,000 loan to the government for, say -- $45,000 - the lender's actual loss on the original transaction is now only $55,000.

The new government entity will ultimately auction bundles of these troubled loans they bought from the banks and other institutions. In this example, the government stands a good chance of getting its money-back under this structure - especially if auction participants (investors) believe the value of the underlying collateral- the residential properties themselves - are undervalued in terms of their then current fair-market value.

The strong rally in the stock market is a solid indication that capital market participants around the world believe this plan has a good chance of sharply diminishing -- if not resolving -- the massive credit crunch that has held the global banking system hostage over the past 18 months.

This structure will take time to develop, and it will require a mammoth bi-partisan effort on the part of Congress to enact. In the interim, mortgage interest rates will likely continue to swing wildly as all of the resources of the government are focused on stopping the seizures in the global banking systems -

By, Larry Baer
Market Alert