Our pundits joined a growing chorus of market watchers sounding off on the government s latest idea to get the nation s ailing financial system back on solid footing. A so-called bad bank would serve as a repository for the toxic mortgage-backed assets that have been a major contributor to the economic downturn. The bank would hold these securities and then eventually sell them off once the dust settles. In concept, the plan would serve as a powerful complement to the $819 billion stimulus package that was passed by the House last week and is now working its way through the Senate.

The idea of a bad bank has its roots in former Treasury Secretary Henry Paulson s original idea for the Troubled Assets Relief Program, or TARP, and even harkens back to how the government handled the collapse of the savings and loan sector in the 1980s. While details of the plan remain scant, it would probably be run out of the Federal Deposit Insurance Corporation. Sheila Bair, head of the FDIC, has argued her agency has the expertise to handle the job and it could finance it by issuing bonds.

The idea has its fair share of defenders and detractors. Liz Ann Sonders, chief strategist at Charles Schwab, recently wrote the bad bank structure could allow the government to rewrite some of the mortgages that sit under banks' toxic assets. Bank of America Merrill Lynch economist David Rosenberg agreed. The entity would buy the toxic assets from the banks at a price that won't require massive write-downs, he said. It would make a market for them and then sell them off, which, from our end, makes perfect sense.

But some pundits noted that a fix may not be so easy this time around, especially since the recent calamities were fueled, in part, by firms far outside traditional banking circles. Bill Gross, Pimco s longtime bond guru, said in his February Investment Outlook, the recapitalization of banks has been the major thrust, in the hopes that banks would extend credit which would reinvigorate asset pricing. He added: Those who argue strongly for a recapitalization of the banking system, however, may be missing the distinction between the banking system as we once knew it, and the shadow banking system that superseded it.

Other experts think the crux of the problem lies elsewhere. Ed Yardeni, founder of Yardeni Research, believes the huge decline in home values which were supposed to keep rising and hedge against the national debt frenzy we ve worked ourselves into must be addressed. If that doesn t happen, he argued Jan. 26, no bank plan, good, bad or ugly, will work.

It is amazing and depressing to me that the new clowns in the Washington circus seem to be as clueless as the previous clowns about the imperative need to revive home prices, he wrote. All the money they are spending is completely missing this vital objective. A large amount of it is simply throwing good money after bad into the TARP trap. It s like shoveling sand into a sink hole and wondering why the hole isn't filling up.

Regardless of which camp our pundits fall into, though, there was one fact that couldn t be denied: Both bulls and bears were clamoring for any news of the plan, as evidenced by mini rallies and declines all last week. That trend will continue. If this plan is announced shortly the stock market may experience another relief rally, LPL Financial strategist Jeffrey Kleintop wrote Jan. 26. If not, there is a risk that the market may break the lows and our bear case may begin to unfold.