Debt is savaging the American economy. Exposure to subprime mortgages buried Bear Stearns and Lehman Brothers, and worries over commercial debt are helping drive record Dow losses. CMBS markets have become increasingly troubled, on fears that massive commercial loan defaults will soon materialize. If those defaults do arise, they’ll poison banks’ balance sheets. Those banks are now hording cash, afraid to lend.

Kingsley Greenland sees a way out. And it’s on the Internet.

Greenland, a former president of Boston Capital Mortgage Co. and COO of Fleet Real Estate Capital, founded the Boston-based firm DebtX eight years ago. He and his co-founders, all former commercial bankers, wanted to push liquidity into the debt markets by eliminating “friction points.” They created and online secondary market for residential, commercial and finance debt at DebtX.com. The site created a robust marketplace for both liquid and illiquid assets by lowering barriers to entry, standardizing closing documents and ensuring price transparency.

In better days, DebtX helped banks sell unwanted assets from other banks they’d acquired. Or, if a bank was exiting a particular line of business, DebtX would help them liquidate their holdings. Banks uninterested in maintaining loan workout staffs would turn to DebtX to help them sell troubled loans to banks that did.

Recently, however, DebtX has given Greenland a front-row seat to the economy’s steady unraveling.

Liquidation Leader

“Volume has doubled in the past year,” he said. “A couple years ago, it was good loans, finance companies getting out of lines of business. Now, the concentration has shifted. Acquisition and development loans, residential – those became far more significant. There were a lot of projects built, and then the horizon radically changed, and the underlying credit changed. Two years ago, the residential market was so liquid they didn’t have to worry about finding buyers. We’ll see an increase next year in retail. We’re already seeing it. A year ago, it was anything automotive-related. Now, it’s retail.”

Greenland’s exchange holds multiyear contracts to sell distressed debt for the Federal Deposit Insurance Corp. and the U.S. Department of Housing and Urban Development. Last month, they announced the sale of more than $200 million in CRE loans from failed banks IndyMac and Integrity Bank. Those loans were part of a $1 billion offering that also included $518 million in non-performing CRE loans originated in Michigan, and $245 million in construction and development loans from a commercial bank that had become overextended in southern California. Both areas have been seriously damaged by the shards of a punctured housing bubble.

November also saw DebtX selling off the detritus from two other banks in FDIC receivership: First Priority Bank of Bradenton, Florida and Columbian Bank and Trust of Topeka, Kansas. The banks’ combined portfolios totaled nearly $400 million, and were heavy in commercial real estate; half of First Priority’s loans were performing, while nearly three-quarters of Columbian’s CRE and residential loans were good.

“Our business was a mix of 50-50 performing and stressed/nonperforming loans,” Greenland said. “Clearly, that’s changed. This year, the volume of stressed loans is up slightly, as banks try to get ahead of those loans, or put them behind them. Banks are looking at their portfolios, and finding liquidity in our marketplace. There’s a great deal of value for them.”

Making A Killing By Waiting It Out

That value exists, Greenland insisted, because there is a healthy market of buyers for so-called bad debt. “There are dedicated pools of capital raised to do this,” he said. Investors range from hedge funds, private entities and other forms of patient capital willing to wait out the economic downturn, to local players who see value in specific developments.

What’s more, DebtX has brought bidders to the table by lowering the barriers to marketplace entry.

“Before, smaller polls of liquidity were unable to play – you might have $10 million, but you couldn’t get in at $100 million,” Greenland said. He recalled the Savings & Loan crisis, when prospective buyers of failed institutions’ debt had to bring $500 million to the table.

“We’ve taken that to the other extreme,” he said. Players can get in the game with as little as $1 million. That dramatically increases the number of active marketplace participants – and, in turn, increases the volume of bids on assets, drives up prices and fuels liquidity. Greenland also drives bids by cutting pools of debt into smaller pieces, letting investors target specific tranches.

“Our marketplace is not impacted by liquidity crisis,” Greenland said.

Greenland believes DebtX can provide liquidity to illiquid assets because it has brought three changes to bear on an “inefficient” loan marketplace: reach, price certainty and standardization. Technology, in an online marketplace, has allowed Greenland to tap a global pool of buyers. A robust marketplace of bidders means that debt, performing or not, can be transparently priced by market forces. That reduces research and opportunity costs. Buyers can look at a loan, decide whether they want to buy at particular price, and move on, encouraging multiple simultaneous bids and bringing dead deal costs near zero. Standardized closing documents increase efficiency, and the velocity at which bidders are willing to act. And the more activity there is, the more sellers’ prices rise.

In Greenland’s mind, that’s the point. He has created a marketplace that encourages activity because he believes the health of banks lies in their ability to actively manage their debt portfolios. Rather than holding on to packages of shaky loans, he wants banks to move stressed debt off their balance sheets, sell it to buyers who want that type of debt and use the revenue to “focus on what they do: making good loans.”

“We’ve been preaching about the flow of liquidity forever,” he added. “The hope is, banks’ chief risk officer will look at their portfolios every month, or every quarter, and balance them out, like you and I do with our 401Ks. We’ve always thought the financial system would be healthier if managed like that. It goes against the grain of asset aggregation. But it’s a personal belief by us, that you should reduce the downside of risk so you don’t get yourself in a bind. Dispose of assets you don’t want; there still is capital that wants to buy those assets.”