As the discussions around toxic loans held on banks' balance sheets and their appropriate buyers escalates this week, another hot button issue — the regulation of the banks themselves — prompted at least one industry group to speak up on behalf of banks.

The official proposal of a single banking system regulator — sort of a bank czar — might be as near as weeks away, unnamed sources told the Wall Street Journal. The regulating agency is expected as part of a proposal by Treasury Department secretary Timothy Geithner and White House officials to come in a matter of weeks. In response, a major banking group issued a statement supporting a systemic regulator–within certain limits.

In a letter Thursday to Geithner, the American Bankers Association (ABA) CEO Edward Yingling urged the creation of a council of regulators chaired by the Federal Reserve chairman to act as the systemic regulator. The extent of the council's authority should be limited, he said, to identifying systemic issues and recommending solutions, without going so far as to actually regulate institutions.

The letter supported regulation of institutions and financial products that pose significant harm to the economy, consumers and businesses but that are not currently subject to effective regulation. The ABA, Yingling wrote, also supports the creation of a mechanism to address the failures of systemically important institutions, but opposes suggestions to grant the Federal Deposit Insurance Corp. (FDIC) any systemic resolution authority.

"The FDIC is seen by the public as the insurer of bank deposits," he wrote. "Consumer confidence in this insurance system for bank deposits has prevented bank runs for many decades. This consumer confidence in the FDIC should not be undermined by having the FDIC directly involved in the failures of all types of institutions, an involvement that would clearly confuse consumers."

The Administration may consider a separate consumer financial products protection agency, which Yingling said would need to be large enough to deal with all financial products, including those regulated at the federal, state and foreign levels and those that aren't regulated at all, to ensure all financial products compete fairly. Such a scenario, according to his comments, might establish an agency that ends up too large in the end.

In the mortgage lending space, for example, a consumer financial product protection agency would have to focus on all mortgage originators and investors, Yingling wrote. The same breadth of jurisdiction would therefore be required for all savings, investment, lending, transaction and other financial products, he noted.

"Legislation including the creation of an agency with such wide authority would engender broad opposition," he wrote.

The Administration is also reported to be considering a single prudential regulatory agency for banks, effectively merging the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the bank regulatory functions of the FDIC and Federal Reserve Board.

"The ABA is adamantly opposed to this concept because we believe it would, as a practical matter, be the end of a true dual banking system," Yingling wrote. "Such a federal regulatory agency would undoubtedly have a strong bias toward federally regulated institutions. Therefore, state regulated banks would be at a disadvantage."

Write to Diana Golobay.

The Federal Deposit Insurance Corp. (FDIC), which is designing the Legacy Loans Program, is receiving concerns from both potential buyers and potential sellers of the loans that the rules of the program might change as public and political views of Wall Street deteriorate further.

The Legacy Loans Program, a big part of the Public-Private Investment Program (PPIP) designed to attract private capital to buy up toxic — or so-called "legacy" — loans may even be closed, reports say, as regulators shuffle programs to find the right balance.

Much like the banks that found themselves the targets of public criticism and tight regulatory oversight for taking Treasury Department funds through the Troubled Asset Relief Program, prospective participants in the Legacy Loans Program fear they might be subject to changing regulations and heightened criticism.

In response, the FDIC may scale back on the program or put it on the back burner altogether, unnamed sources told the Wall Street Journal.

The issue of toxic loans is far from averted by the news, however, and some banks are getting creative with alternatives. Bank lobbying groups asked the FDIC to allow banks to bid on the same toxic loans they put up for sale, sources told the WSJ. Such a move, the trade groups argue, would give banks an incentive to sell assets at low prices or even at losses, to keep capital flowing between banks, remove toxic assets off their balance sheets and encourage lending.

But the request raises the question of just how much more taxpayer money banks would receive through the government-subsidized legacy loan purchases under the PPIP. It remains unclear just how much banks would lose by selling loans at or below market prices, although one analysis of SEC filings by Bloomberg today suggests the figure tops $168bn.

Despite the creative solutions, the only plausible cure-all to the toxic asset situation is for a so-called "bad bank" to buy these legacy loans, according to statements published this week by Pricewaterhouse Coopers.

"The crisis is about to enter a new phase where efforts to remove troubled assets from bank balance sheets must be accelerated," the firm said, according to a Market Watch bulletin. "US government interventions to date have stabilized individual institutions, but have not created a functioning market and pricing mechanism and therefore have had little impact on reviving the broader markets."

A real pricing mechanism, according to Pricewaterhouse Coopers, would be for the government to set the price for the assets by purchasing them through the bad bank. Real price discovery, however, cannot be achieved through the PPIP, in which banks would be forced to accept losses on the loans and which would create a disincentive situation, the firm said.

"It is likely that this approach will prove inadequate to the task of relieving banks of all of their troubled assets in a timely manner," the firm added, "making some form of bad bank solution inevitable — meanwhile prolonging the crisis and increasing the cost of its resolution."

HousingWire takes a critical look into the PPIP, its mechanisms and the way it works — or doesn't — in the June magazine issue, out today.

Write to Diana Golobay.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.

After government-sponsored enterprise Freddie Mac (FRE: 0.00 N/A) saw its mortgage portfolio decrease at an annualized rate of 8.1% in April, the central bank's efforts to lift mortgage-related securities off its balance sheet continued well into May.

The Federal Reserve’s weekly agency mortgage-backed securities (MBS) purchases picked up in the week ending May 27 as its balance sheet, although still heavy with efforts to relieve mortgage-related assets from banks’ balance sheets and stimulate continued lending, contracted to $2.07trn.

The Fed bought a gross $33.4bn MBS from mortgage giants Freddie Mac and Fannie Mae (FNM: 0.00 N/A), as well as from Ginnie Mae, up from $25.52bn last week but still down from the $35.6bn purchased in the week before. The Fed bought $11bn from Freddie, $19.5bn from Fannie and $2.9bn from Ginnie. It sold a total $7.86bn in MBS this week up more than 800% from last week's $845m in MBS sales.

The weekly purchases continued to favor MBS with 30-year maturations at 4.5% coupons,with $3.35bn to settle in June, $10.3bn to settle in July and $3.5bn to settle in August. Despite the Fed's $17.15bn in purchases of these MBS, no sales of similar MBS was slated this week. This disparity is not a new phenomenon. In last week's round of sales and purchases, for example, the Fed bought $15.05bn of the same MBS and sold only $95m of similar MBS.

Elsewhere in the weekly purchase report, the figures seem a bit more level. In the week ending May 27, the Fed also bought $7.25bn of 30-year MBS at 5% coupons, with $6.25bn to settle in June and $500m to settle in both July and August. It purchased $3.15bn of 30-year MBS at 5.5% coupons, with $2.65bn to settle in June and the rest to settle in July. During the same time, the Fed sold $5.5bn of 30-year MBS at 5% coupons and $2.36bn of 30-year MBS at 5.5% coupons, both of which settle in July.

See a detailed chart of the Fed’s weekly purchases and sales.

Despite a bit of week-to-week normalcy in the low end of the purchases, months of discrepancy in purchases and sales has made an impact on the Fed’s balance sheet. The balance sheet contracted $90.67bn the same week ending May 27 to a total $2.07trn, down from $2.17trn the week before, according to a weekly summary released Thursday. The balance sheet shows the Fed added $417m in MBS to its balance sheet this week, for a total of $430.9bn in MBS added to its balance sheet since the same time last year. It also added $79.75bn in agency debt securities since last year, in an attempt to free up capital at the agencies and encourage more mortgage activity at lenders that package and sell loans to the agencies.

Write to Diana Golobay.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.