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A Simple Bailout Plan for Housing and the U.S. Economy
Now that everybody is busy the budget and the debt limit, we are forgetting that the single clear and present danger for the US economy is the state of housing. As the economy is slowing again, it threatens to trigger more foreclosures. In turn, this would further damage banks' balance sheets and prevent already gun-shy banks from finally loosening credit. If banks decided to hoard even more reserves, it would have disastrous consequences for economic growth and job creation. Yet, this is nothing new: it has been the situation for two years and nothing was done then and since. Worse, it would be surprising if anything intelligent gets done now. Both parties have lost even the slightest perspective on the reasons that brought us here. What would make you think that once August 2nd passes, they will work together to resolve the situation? Some economists, such as Martin, had identified the problem in the fall of 2008. His article, "How to Save an ‘Underwater’ Mortgage", published in the Wall Street Journal in August 2009 was his third attempt to influence policy makers in giving a break to home owners; his first attempt had been made in September 2008 when it was still early in the game. Feldstein also went on Charlie Rose in early 2009 to plead his case with Nobel laureate Joseph Stiglitz who lent him support for the proposal. But to no avail. In spite of the influence of the former head of the Council of Economic Advisers from 1982 to 1984 under President Reagan and former president of the National Bureau of Economic Research, Washington was not listening.
To be fair, the Administrations - both Bush's and Obama's have come up with some loan modification programs to deal with the issue. However, they were so poorly designed and lacked so much in scope that they failed to gain any momentum. To the surprise of many, the Obama administration continued to pamper bankers and concentrate their efforts on saving the banking sector rather than home owners; blind to the fact that the collapse of housing sector is at the origin of the problems that banks had and still have today. Why is the idea of savings households as a way of getting banks out of trouble such a bad proposition? Is it because Washington is too influenced by the ideas of Wall Street?
Yet, read the several articles in which Feldstein outlines his bailout plan and will quickly come to the conclusion that in spite of his bang-on diagnostic of the situation and his good intentions, his proposal suffered from some important drawbacks that limit its application: It would have required changing the law, it reduced monthly mortgage payments very little, it affected only the worst-case borrowers, it would have taken a while to implement and it would have required that banks take some write offs (which, of course, they were very reluctant to do at the time). Finally, it also hinged on the assumption that the parties to any modification could agree on the value of the homes being targeted by the plan; probably the biggest problem when values were falling fast in the Fall of 2008 and the Spring of 2009.
I am proposing below a bailout plan for both housing and banks that dodges all of these limitations. Let me know what you think.
"In the Spring of 2009, US Treasury Secretary Geithner unveiled his plan to save the economy and the banking system. However, the plan still fails to fully acknowledge the negative dynamics of the still deteriorating housing market on the success of his proposal. Admittedly, the government also took steps to encourage lenders to modify loans for people in foreclosure or at risk of foreclosure. However, difficulties in determining who qualifies, and for which amount, will likely severely limit the scope of that proposal. Moreover, the government also proposed that private investors buy toxic assets from banks using government subsidies. However, finding common ground to establish a price for the assets has proven difficult. Equity issues have also been raised by many who fear that the scheme will enrich hedge funds and private equity managers.
"Here is an alternative: Make an attractive offer to all homeowners but tweak the incentives so as to attract only those needing help. Specifically, offer to all existing homeowners (of owner-occupied homes), mortgage relief up to 33% of the value of their mortgage in exchange for the same percentage of equity in their home. As a virtue of being offered to everyone, all individual decisions to accept or refuse the government's offer would provide much needed information about the quality of individual loans. This information would represent the Holly Grail for the financial sector as it would allow banks and investors to finally put a fair value on mortgage pools.
"The opportunity for each individual homeowners to "sell" a portion of their home to the government (in a debt-equity swap fashion) also offers the following: truly significant mortgage payment reductions for borrowers, some breathing room to support consumption and a huge quality improvement in banks' balance sheets. If designed as a simple mortgage pre-payment program, such a plan could be implemented by motivated banking loan officers within six months.
"Consider a homeowner who bought a house in 2006 for $250,000 with a $240,000 mortgage ($10,000 down payment). This homeowner may now be contemplating foreclosure as the value of his home is likely closer to $200,000 today and/or his monthly mortgage payments too high. Under the proposed plan, the homeowner could choose to accept mortgage relief for $60,000 (25% of the original $240,000 mortgage) in exchange for a 25% equity stake in his home. By selling the property for $300,000 in 7 years (assuming a reasonable 6% annual nominal appreciation), the homeowner's share of the house would then be $225,000; $35,000 above the $180,000 modified mortgage. Not bad for a $10,000 initial investment, largely under water today! The government would get back $75,000; enough to recoup its capital and protect against inflation.
"A simple example would also convince the reader that the offer would be rejected by homeowners with enough home equity. This means that each individual decision to reject the government’s offer would also send a strong signal to the market as to who would repay their mortgages in full without government help.
"In the previous example, if the house were to be sold early for $220,000, the outstanding bank mortgage ($180,000) would be repaid first to the bank and the balance of the proceeds from the sale ($40,000+) would go directly to the restructuring government entity. The balance of government equity ($20,000-) would then be converted into a fully recourse loan yielding 3%. The conversion of the equity into a full recourse loan would provide a disincentive for the owner to sell his/her house early or to enter foreclosure. This would help stabilize the housing market by keeping more homes off the market until prices have appreciated enough. Moreover, the full recourse conversion would also deter borrowers with no prospect of ever repaying their loans from entering the swap agreement; providing much needed information about which loans which should be definitely written off. Moreover, the relief effort would focus on making sure that only troubled, but salvageable, borrowers are turned into viable homeowners.
"Assuming an average mortgage relief of $60,000 for the 12 million homeowners with little or marginally negative equity today, the total cost of the plan would be $720 billion. However, as we saw, most of this money could be recovered, once the homes are sold. Moreover, if banks were forced to first write down each mortgage by 5% before being entitled to the debt-equity swap money, the initial funding for the scheme and the ultimate cost to taxpayers could be substantially reduced.
"Allocating the bail-out money directly to American homeowners would be a politically superior strategy than buying up banks or let hedge funds and private equity investors buy the toxic waste; not least because it would allow many families to stay in their home. Banks, on the other hand, would be much closer to assessing their loan portfolios at values that might actually reflect their true worth under more favourable market conditions. This prospect alone would promote the strong support of banks which in turn would speed up implementation and thus could help avert bank nationalization.
"By taking an equity position in homes, the government insures a certain fairness as it extracts something (i.e. equity) from over-leveraged homeowners, without passing moral judgment, rather than trying to determine administratively who should get it. Finally, as the leverage is transferred from over-leveraged owners to the government most able to support it, the risk to the economy is also considerably reduced."
Isn't this simple enough? This is not a new idea. I wrote this plan in the Fall of 2008, just after the collapse of the market in late October that year. See my entry I tried to get it published in the Winter of 2009 but no newspaper would touch it. I finally published this short version on August 12th 2009 in The Sceptical Market Observer. I even talked about it, during a visit at the White House, to the Chief economist of the Council of Economic Advisors a little later.
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Morning Luc,
What are your thoughts on Krugman's latest, The President Surrenders? Also, I posted this interview with PIMCO's Mohamed El-Erian in my last comment on smoking some bad debt dope:
jobs!
Holy smokes. What an elaborate plan. The homeowner is supposed to do a debt-for-equity swap with...the Government??
Look, I hate to break it like this, but there is one and only one answer for this. Market prices fall, assets (homes) get liquidated. Banks suffer broken loans. Some companies go out of business. Then, and only then, can economically viable investments can be made.
1) Liquidate malinvested assets at "real" market prices
2) Ban - forever - fiat money
Or we could just devalue the debt.
http://www.wcvarones.com/2010/07/devaluation-is-only-way-out.html
Another bailout plan for the housing market?
Fanny and Freddy are still to be expected to cost the US taxpayer another 160 billion in the next 2 years. ISN'T THAT BAILOUT ENOUGH?!
JUST STOP BAILING OUT ANYBODY!
IF IT WAS MEANT TO DEFAULT, YOU LET IT DEFAULT!
IF YOU CAN'T PAY YOUR DEBT, SETTLE!
NOT EVERYBODY HAS TO PAY FOR SOME OF THE PEOPLE WHO INVESTED BADLY.
Actually, sadly when debt goes bad somebody really does lose, that does not mean they all have to be made whole, there is a reason rewards come to those who take risk on, and reward used to adequately compensate for risk. But, when large debts go bad somebody looses big and probably had insurance on the deal so they will have to be made whole, which of course means someone still looses big, the insurer. When millions of large debts go bad at the same time a huge number of people face financial extinction, and no amount of insurance can cover the losses, hence government bailouts, because remember those that had the money to risk by lending it are also the ones that have ALL of the power in our society.
Of course this sucks and should not be, most of us agree it should never have been allowed to happen in the first place. This is why we had regulations against such practices and why we had rigorous enforcement until the republicans/neocons figured out that they could absolutely rape the USA many times over if they just looked the other way while stoking housing and consumer credit bubbles. I am withholding judgment as to the extent of the damage they have done until it is all booked and realized, so far we have only seen less than a dime on the dollar in real write offs of bad debt. A fraction of a penny if you include derivatives. The day the full shock wave of republican theft has yet to break on our shores but it will, when it does we will envy the material security of Mexico, not to mention the relative honesty of their leaders.
And don't forget the imminent student loan collapse.
And the new credit card collapse
And the new car loan collapse.
And the possibly-imminent theft by government of (contributory) 401Ks and (contributory) private-sector pension benefits.
This is not communism. It is a way to ensure that incentives (to "behave" responsibly) remain after the government writes you a check. Up to now, I have only seen politicians write blank checks to everyone in sight. That is what the communists did ... that is until they went belly up.
A few points:
1. Blanket proposals are easy, drafting something complicated is very, very difficult. Drafting a complicated law is virtually impossible to do in a reasonable and accurate manner, having sufficiently contemplated loopholes and moral hazard. This is a complicated proposal;
2. You've left out a very key ingredient... paying off loan principal on a mortgage DOES NOT REDUCE YOUR MONTHLY PAYMENTS. Your proposal requires an ancillary remedial measure, payment reduction...;
3. For the sake of getting flamed into bolivia, please add phase outs for levels of income and/or note balances... If you're going to intervene in the markets, please do something to address the wealth gap; and
4. By choosing to eliminate benefits for those persons who are renting because they prudently saw the housing bubble, you are eliminating all legitimacy of your proposal (not that it ever had any). While this may not be communism, per se, it is all kinds of uncle fucked.
I agree with you and I question motive and agenda.
I would also like to supplement a #5, which is that these properties are going to be owned by the government anyway for pennies on the dollar... while the process takes many years to complete, these properties are likely in default on real estate taxes. These properties will be certified to their respective states and auctioned. In short, why would the government want to pay 33% for something it can get for much less, albeit the federal government and not state government... hence why property issues of this sort are best left to their respective locales... (because states will take their pound of flesh, one way or the other).
Actually they are not. When a house is taken in foreclosure the escrow account continues to pay the taxes, and eventually the insurance, though the insurance they do buy in your name is triple what a homeowner policy costs and covers only their financial losses should your house be destroyed. Banks do not like funding the escrow accounts themselves, it commonly runs to a couple thousand per year per foreclosed property. Yet, as in my case they simply don't sell. It really makes no sense and I am beginning to wonder if it is incompetence or if they have some sort of diabolic scheme up their sleeve. I moved out May of 2010 after ceasing payments in January, they foreclosed July 15 and were supposed to sell the house on the courthouse steps April 2011, but the sale was cancelled, and now when I call and ask I am told the foreclosure is also cancelled. I got a notice saying that they have purchased a policy on the house for over 1500 which covers their loss in case the place is destroyed, but no liability or such, and I would seriously consider just moving back in till they decide to renew foreclosure efforts or at least rent it out, but I really hated living there and I just filed a form with the IRS for forgiveness of the 7,500 tax credit under the BushCo home buyer incentive. If I did move back I would owe the IRS 7,500 again for a house I have no intention of owning. I cannot begin to rebuild damaged credit till this albatross is gone from my neck and it has now been years since foreclosure started with no sale, now no foreclosure also it seems.
Anyway, nobody is going to be picking up these residences for pennies on the dollar or back taxes, even in the case of a badly vandalized house where addicts have stripped out the copper and such they will still be paid for either by insurance or a government/GSE program. My loan for example is 100% guaranteed by the USDA Rural Development program, in the event of default the bank liquidates the house and submits a bill to the USDA for the difference between auction proceeds and what they claim I owe. Why they have not done this is a complete mystery to me. I wish they would so I can get on with my life.
If you go to your respective state's land commissioner's website, I promise you will find many properties certified to the state with interested parties listed who are financial institutions/lenders/mortgagees. One of the things you have to remember is that in the world of packaged and assigned loans, the only parties of record no longer have a dog in the fight... any notices for delinquent taxes aren't even sent to the present purported holders... should have thought of that before they started dickering with ancient laws.
The banks simply do not have enough cash flow to keep plugging the tax bills on their shadow inventory. While they may keep a non-performing asset on the books if their interest rate is low enough on the money they borrowed from the FED et al, shelling out the taxes each year for each property is a whole other ballgame. This is where states take over.
Also, anything equal to or less than 80% LTV probably isn't going to be escrowing anything... while the escrow function may be an intricate part of the government's guarantee on the rural development loan program, non government expressly guaranteed loans (the typical; although it should be noted they're virtually all guaranteed after the fact) are fair game... Further, I'm curious as to how much the bank would net on the foreclosure proeeds + guarantee... seems like unless there was some problem to which only they are privvy, they would want to collect that government scratch.
Also, why do you have to pay back the $7500? It's only supposed to click off at $500/year... if you sell the place for a loss, then you don't have to repay the FTHBC to the extent of the loss... and, in the scheme of losses with houses, $7500 is a drop in the bucket. Contact your accountant for advice in this regard. Without doing more research, I would say roll up in that bitch and set up camp... no sense in paying another mortgage or leasing when you have a perfectly good free abode.
Communism is not the answer.