(from time-to-time, we will print what seems to be a clever unique idea from one of our readers. This one comes from a long-time friend of ours and former chief-of-staffer type on Capitol Hill for many years, Mr. Roger France. As always, if it 'works' and helps 'save the Republic', we will be ecstatic. You can comment at the end of this posting and give us the benefit of your experience and expertise as to why this will or will not work. Roger is a big boy and can handle it)
Before we can get out of this economic slump, and return to a low unemployment, robust high growth economy, banks need to recapitalize to the extent that their capital can reflect reality. A price floor needs to be re-established under the housing market. The only way we can meet these goals is to establish a value of these assets in the absence of vigorous transactions on a daily basis. The value of houses and mortgages that the market will accept has to be determined so we can get out of this slump sooner than later.
With nearly 10% of all mortgages behind in payments and a third as many in some form of foreclosure, and maybe 23% of homeowners under water, the relationship between mortgages and home values has completely broken down.
To date, government efforts to stabilizing banking, through TARP and the mortgage market though pumping billions into Fannie and Freddie, combined with a new housing program every six months in the last 2 years have not succeeded in stabilizing the housing market or the credit markets.
This failure has to be recognized and it is time for some outside-of-the-box thinking about re-establishing credit and consumer confidence without totally separating the moral obligation to pay debt. The economy won’t grow until the housing and credit markets re-adjust. The time for band-aids has passed – even big ones.
What is required is major surgery.
So, here goes:
1) Devote all the resources currently devoted to hounding elected officials, such as the late Ted Stevens, and yes, former Governor Blagojevich among others and go after the tens of thousands of cases of mortgage origination fraud. While the vast majority of folks in foreclosure or are now' underwater' in their mortgage values simply made bad economic decisions, some were victims of fraud.
2) As an alternative to foreclosure, borrowers (note, not 'homeowners', as most of these folks are effectively 'renters' until they pay off the mortgage) are to be offered a new mortgage, with the same length as their current mortgage but with the following new terms:
a) the mortgage amount will be equal to the current market value of the home;
b) the difference between:
(i) the new mortgage amount and the eventual sale price of the home will be a ‘balloon payment’
(ii) the interest rate will be the current low rate and will adjust once annually according to a
simple understandable formula.
3) Mortgage holders (lenders) will be offered a one-time chance to exchange their currently 'worthless' (or unable to mark-to-market price) mortgages for a bond; the bond will be backed by the new mortgage.
4) Mortgage holders -- that is banks --will have to write down capital accordingly.
5) Federal tax law and the Fed will, in effect, allow banks to re-price their capital to reflect the new, market-based bonds in lieu of nonpaying mortgages. Unlike the mortgages, these bonds will have a price in the market. Effectively this creates a so-called ‘bad bank’, but one that is market-,not government-, priced.
6) Upon sale of a home in the future with this new mortgage when values hopefully have re-appreciated considerably, the existing mortgage will be paid off, and the balloon balance will be divided equally between the homeowner, the holders of the new mortgage bonds, and the federal treasury.
Let’s take an example:
Mr. X bought a shack in Fort Lauderdale in the ‘go-go’ days of 2004 and paid $425,000 with a down payment of $25,000 and a loan of $400,000 at 6%. Today, the home is worth only a mere $200,000 and Mr. X’s $2400 a month payments are unsustainable. Rather than go into foreclosure, Mr. X takes the one-time offer and exchanges his old mortgage for a new one of $200,000 at 4% with monthly payments of $800. Mr. X now can pay his real estate taxes, buy that new Government Motors car, a new frig, and even travel to Disney World. His mortgage will adjust up or down as the economy and interest rates change.
ChaseCitiBankofAmerica no longer carries on its books a loan which was of dubious value (certainly not $400,000) and receives monthly income of $800 on its ‘new mortgage bond’, which it holds as capital. The bank has written off $200,000 in net value (which many have done so already). However, thanks to generous tax and Fed treatment, it would only cost the bank $100,000 – for a bad loan made on a bad property. The stockholders will share some pain, but will have some reality-based stock prices return once again.
Fast forward to 2020 and Mr. X is ready to sell his home. Because the 'Great Real Estate Reset of 2011' has stabilized housing prices, and the Boomers have come back to Florida to retire in the sun and fun, Mr. X is able to sell his home for $500,000. He repays his loan of $200,000 and the balloon note of $300,000 is split $100,000 each for Mr. X, the US Treasury, and the bondholder, ChaseCitiBankofAmerica.
Everyone benefits.
Sadly, Mr. X’s neighbor, Mr. Smarty-Pants, who also bought a house in $400,000 in 2004, made all of his mortgage payments and even paid off his mortgage early because he recognized his moral obligation to do so. 1/3rd of all mortgages have been paid off and these ‘honest Americans who played by the rules’ shouldn’t be put at a disadvantage. When he sells his home for $500,000, he would walk away with $100,000 all of his own to keep. We think we should eliminate ALL federal income tax on commercial and residential property for those who played by the rules.
So, this would:
1) Stabilize the housing market;
2) Make the banks, the homeowners (‘renter’) and the Fed share the pain and share the gain;
3) Restore the credit markets;
4) Allow housing prices to rise a bit to the benefit of even the long-suffering play-by-the-rules-minority.
Why not try some different? The last 3 years certainly have not worked well.
The rule of law would be trampled by his suggestion. If he wants to regulate prospective loans for such an outcome, so be it. NOT
ReplyDeleteretroactive.
On an overall economic analysis, the market is already essentially doing what he suggested. Let it continue. The government is not the solution. More government is the problem. Massive government intervention like he
suggests would stall healing while the policy is being deliberated, frustrate
healing while being implemented, and probably have significant unintended consequences (e.g., impact future bank lending because of uncertainties surrounding the rule of law).
As a technical matter, banks with losses may not get a tax benefit. They do only if there is sufficient income in a carryback year or income in future years. Many banks with a lot of losses do not get any tax benefits (and losses generally do not transfer to a buyer in a distressed sale). Now, if a bank could sell these tax benefits, that would be significant federal assistance to bank capital, but that is a different objective (but that did apply to the Wells Fargo acquisition of Wachovia)...
About going after the fraudulent loans. In many cases the "fraud" is not readily identifiable as an overt action by the lender. I am in a similar business and know "the game", Loan "officers" are paid per closed loan. At the end of the month or year they may receive a substantial bonus for the number of loans closed OR if their job review reveals that they didn't meet the banks goals they can lose their job or be demoted. This perfect storm promotes "creativity" in the lending process. (It is the same in the life insurance business). The "liars" as in "liar loans" are not necessarily the borrower but the guy on the other side of the desk who asks just the right questions, or the questions in just the right way, or glosses over key points, or simply answers them without actually asking.
ReplyDeleteSomewhere in the process there may be a certain dollar amount to lend that doesn't require intense scrutiny and he may suggest a larger down payment to keep the loan within that guideline. Meanwhile the consumer just figures he's doing what is in everybody's best interest.
As Willy Lowman said "there is no end to what a man doesn't know if it comes to preserving his job" and getting bonuses to lie, I might add.
This is a hard situation to address because it is the age-old nature of "sales" culture. How do you provide incentive without promoting "fraud"? In the life insurance business I know an agent who makes his goals every year by selling tons of $25k to $45k policies- easy issue because they are non-med. At $50k a doctor has to verify all the med questions answered with positive responses, and maybe not even asked of the client, by the agent. He figures, sale = bonus and job security and nobody is going to check up on him- especially his manager because his manager stands to benefit also and on and on up to the CEO (who is insulated by the minions and can claim no knowledge of these practices if put to task).
Unfortunately the industries won't police themselves on these issues so some type of government intervention is required. When companies can't act morally, then legislation becomes necessary. I don't know what that may be. Make it illegal to fire people for not meeting corporate goals if a review finds that the goals are not realistic and the "worker" has been actively trying to meet them? I don't have an answer, but I know the problem well.
I am hesitant to consider programs like this that involves heavy and long term government intervention and intercession in private markets (like we have seen recently). Having said that I think we need a spirit of thoughtful consideration (like the comments above demonstrate) rather than the extreme partisanship that we have experienced over the past decade especially.
ReplyDeleteWhere I would want additional information would be on the following. (1) potential total impact on bank capital must be calculated. (2) In addition, many mortgages that have been originated by banks that are underwater may be housed in securitizations whose holders could be state pensions, company pensions, foundations, endowments, companies, funds, etc. Those places are where the write-downs may take place. We would need to estimate the impact of those writedowns. (3) Also, sounds like there would need to be even bigger gov’t to monitor this program and ensure there is no fraud. (4) What would the budget impact be of the elimination of gains taxes of the honest taxpayers in future? (5) artificial floors can be difficult - estimating total impact of the above versus long term impact of a "market" resolution must be calculated.
Anonymous said...
ReplyDeleteCould be interesting - where I would want additional information would be on the following.
(1) potential total impact on bank capital must be calculated.
(2) In addition, many mortgages originated that are underwater may be housed in securitizations whose holders could be state pensions, foundations, endowments, companies, funds, etc.
Those places are where the write-downs may take place. We would need to estimate the impact of those writedowns.
(3) Also, sounds like there would need to be even bigger gov’t to monitor this program and ensure there is no fraud.
(4) What would the budget impact be of the elimination of gains taxes of the honest taxpayers in future?
(5) artificial floors can be difficult - estimating total impact of the above versus long term impact of a "market" resolution must be calculated.
Ok, I'll try again to remmber by pithy spot on responses. First, if you ask the GM bondholders, you will find that we have from the outset of this crisis foregone any pretense of following a rule of law -- just ask the GM bondholders. (Hell, if we cared about the rule of law we would have let all the banks go into bankruptcy and left all those bond holding Middle East Oil Shieks wallpaper their tents with defaulted US mortgages.)
ReplyDeleteAS to bank taxes, I guess you are correct that they wont have any tax liability for years to come, so maybe if everyone jumps in the pool at the same time and writes off the fictional assets and end up with strong capital that would be enough incentive to undertake this kind of program.
As to the revenue loss to the feds from eliminating capital gains on housing for 'good borrowers' too bad -- #1) It isnt the government's money; 2)it's probably a lot less then the revenue loss from the 12% unemployment we have now.
My college buddy Steve is right about fraud -- on wonders why there have been so few (any?) cases brought against mortgage and banking fraud -- I guess the DOJ is too busy going after folks like Ted Stevens and other public officials.