Amongst all the mortgage mess/credit crunch/bank bailout/global recession palaver the condition of the distressed homeowner continues to get short shrift.

This is perhaps because to pay too close attention to this problem is to be reminded of how we got ourselves into this mess. Not just that the meltdown in home values precipitated the current crises, but that the artificially prolonged housing bubble was a main structural prop in our economic house of cards.

We took a real truism - that property values in the United States always end up going up, and made ourselves believe that they continuously go up. We had to engage in this collective delusion because the tens of thousands of dollars the average American family extracted from their semi-annual refinance was--except for national borrowing--the only thing keeping our society's financial boat afloat.

To accomplish this feat our financial wizards invented complex new financial instruments better suited to creating the illusion of wealth than actually creating it. "Masters of the universe", preying upon the almost primal yearning for one's own home, cynically exploited those desires in order to keep the charade going for yet one more round.

And we all joined in.

My main purpose here is to point out that the stretching of a basic truth beyond recognition does not alter that basic truth; in this instance, that home values in America always end up going up. I emphasize this idea because it is central to my modest proposal: the federal government should, yes, exploit, that belief/fact to help us out of our present difficulties.    

The Fed would create a program wherein every resident homeowner who owes more on their home than it is presently worth is given the option to refinance their mortgage at the home's present value, and at a 30 year fixed rate. In return--with an eye toward that eventual price rebound--the homeowner will sacrifice some equity opportunity for a fixed period of time.

The Federal program would require participating banks, mortgage companies, investment banks or packaged securities holders (the bank) to offer the restructure deal to all eligible homeowners who opt to participate. No cherry picking.

The average value of a home in the U.S. has fallen approximately 20% from its high in 2006. For our purposes then, we'll use as our example a home where the original mortgage was $500,000, and the home is presently worth $400,000. The bank would refinance the home at $400,000, at a fixed rate.

The Fed provides banks 2/3 of the difference between the original mortgage and present value; in our example: $66,000. This punishes banks ($34,000 or about 6.5% of their original investment) in a modest but meaningful manner for their irresponsible lending, but enables them to replace a toxic asset with a relatively strong one, as well as providing a jolt of desperately needed liquidity, which when multiplied by most of their eligible mortgages, would significantly add to the banks' health.

The homeowner is relieved of $100,000 in debt, and has the remaining $400,000 put on significantly more affordable terms. In exchange the homeowner signs a 7 year (could be 5 or 10?) "equity note" where he gives up any equity accrued (above $466,000) during that period.

To recoup its money, the Fed packages the notes, and issues 7 year bonds (or some other instrument?) backed by the notes. Investors worldwide who have confidence that the U.S. housing market will bounce back in that timeframe will purchase these bonds. At the end of the bond's term the Fed will pay the bond holder the difference between $400,000 and the home's value at that time. The actual payouts would, of course, be based on an average of notes from all over the country.

The homeowner would not be required to actually refinance the home at the end of the 7 years. The Fed gets repaid when the homeowner eventually sells the home, or when she refinances at some point to free up equity accrued above the amount at the end of the 7 years. Her mortgage remains based on the $400,000 principle until that time. What the Fed will likely do to pay the bonds is just issue some simple interest debt backed by the liens on the participating homes, then pay off that debt as it is paid when the homes sell or refinance.

The 7 year term is a best guess. It is based on the average U.S. home value having fallen approximately 20% from its high in the summer of 2006. Certainly, lesser "underwater" figures will mean shorter notes. But the general question remains the same: what length of term(s) would give the housing market the chance to make enough of a comeback to make the notes attractive to investors and fair to homeowners? Finally, there would almost certainly need to be some limited form of guarantees on these notes and mortgages from the federal government.      

My thinking is that there would be a self-fulfilling aspect to this plan; the massive injection of liquidity would spur more housing purchasing, which would in turn raise home values. I would hope that this effect would go a long way toward assuaging the frustrations of those homeowners who do not directly benefit from the plan.    

This proposal is meant as a starting place in an attempt to help out distressed homeowners, put a floor under the housing market, and infuse a huge amount of liquidity into the credit markets without that infusion coming in the form of more national debt. I've obviously left out tons of detail, but the general idea is all here. If there are fundamental flaws in the idea, or any ideas for improvement, please let me know.