The AllStreets Bailout Plan: A Unique New Plan to Arrest the Housing and Economic Crisis in 2009
by Dan Stephens, November 25, 2008
(If you like this plan, please recommend it to your U.S. Senators and U.S. House Representative, network it to your interested contacts and contribute to us to support our fight for meaningful mortgage reform and economic rescue for Main Street, Bank Street, Wall Street, State Street, and All Streets!!) You might find it helpful to read the short version of the plan on themotgagenews.info home page.
This article discusses the current housing, financial, credit and economic crises and proposes a broad, simple, fast-acting plan to stop it, and do so in a manner to benefit fairly all Americans, the All Streets Bailout Plan. One of the problems with all of the proposed programs to date, except the tax incentive for first time home buyers, is that they all reward deadbeats and losers, either mortgage deadbeats, lending losers, investment losers and debt insurance losers. To be most effective, and to obtain broad public acceptance, any program needs to fairly benefit all American adults, whether they own property or not, and be simple enough to implement quickly. Here we propose a government lending program to invest in the economy, with benefits aimed primarily at individuals, secondarily at lenders, and spread fairly between property owners, non-owners and lenders.
The economy continues it's sprint towards a true depression due to spreading delinquencies, insolvencies, bankrutcies, foreclosures, job losses and severe contraction of credit availability. The trend is self-reinforcing, spreading from one infected sector to another. Massive lasting damage is being done to the credit qualifications and finances of consumers and businesses. As credit qualify and balance sheets keep deteriorating, lenders keep tightening lending guidelines further, making the collective situation worse. A sufficiently broad and effective economic resue plan has not been implemented and is urgently needed to stop the death spiral, since the consequences of recent financial trends are largely irreversible. The longer the downtrend continues the harder it will be to recover.
The various efforts to date to recapitalize and provide easier liquidity of assets to banks and other financial companies (the TARP funds) do little, if anything, to reverse what was the initial, and remains the most important, underlying, fundamental, worsening problem: the reduced values of residential properties and resulting excess mortgage debt on too many homes. Rescue efforts to date, such as the TARP program, also unfairly affect merely a handful of privleged businesses, instead of providing fair relief to all citizens and lenders. Further, the original, but abandoned, idea by Treasury Secretary Paulson to buy up devalued mortgage securities and consumer debt from investors and lenders is another approach that does nothing to relieve the impaired borrowers themselves. Without consumer debt relief, the problem will persist for many years since consumer finances will remain impaired and the creditworthiness of many will suffer long term damage. Debt relief in the form of handouts to lenders doesn't trickle down to borrowers, lenders just guard their liquid assets and tighten lending standards knowing they still have too many risky loans on the books. Lenders could be drowning in liquidity but can't lend when consumers and businesses don't qualify to borrow due to being over-indebted and even upside-down on secured loans. However, debt relief directly to the demand side will automatically restore a large measure of asset value to the lenders.
(If you like this plan, please recommend it to your U.S. Senators and U.S. House Representative, network it to your interested contacts and contribute to us to support our fight for meaningful mortgage reform and economic rescue for Main Street, Bank Street, Wall Street, State Street, and All Streets!!) You might find it helpful to read the short version of the plan on themotgagenews.info home page.
This article discusses the current housing, financial, credit and economic crises and proposes a broad, simple, fast-acting plan to stop it, and do so in a manner to benefit fairly all Americans, the All Streets Bailout Plan. One of the problems with all of the proposed programs to date, except the tax incentive for first time home buyers, is that they all reward deadbeats and losers, either mortgage deadbeats, lending losers, investment losers and debt insurance losers. To be most effective, and to obtain broad public acceptance, any program needs to fairly benefit all American adults, whether they own property or not, and be simple enough to implement quickly. Here we propose a government lending program to invest in the economy, with benefits aimed primarily at individuals, secondarily at lenders, and spread fairly between property owners, non-owners and lenders.
The economy continues it's sprint towards a true depression due to spreading delinquencies, insolvencies, bankrutcies, foreclosures, job losses and severe contraction of credit availability. The trend is self-reinforcing, spreading from one infected sector to another. Massive lasting damage is being done to the credit qualifications and finances of consumers and businesses. As credit qualify and balance sheets keep deteriorating, lenders keep tightening lending guidelines further, making the collective situation worse. A sufficiently broad and effective economic resue plan has not been implemented and is urgently needed to stop the death spiral, since the consequences of recent financial trends are largely irreversible. The longer the downtrend continues the harder it will be to recover.
The various efforts to date to recapitalize and provide easier liquidity of assets to banks and other financial companies (the TARP funds) do little, if anything, to reverse what was the initial, and remains the most important, underlying, fundamental, worsening problem: the reduced values of residential properties and resulting excess mortgage debt on too many homes. Rescue efforts to date, such as the TARP program, also unfairly affect merely a handful of privleged businesses, instead of providing fair relief to all citizens and lenders. Further, the original, but abandoned, idea by Treasury Secretary Paulson to buy up devalued mortgage securities and consumer debt from investors and lenders is another approach that does nothing to relieve the impaired borrowers themselves. Without consumer debt relief, the problem will persist for many years since consumer finances will remain impaired and the creditworthiness of many will suffer long term damage. Debt relief in the form of handouts to lenders doesn't trickle down to borrowers, lenders just guard their liquid assets and tighten lending standards knowing they still have too many risky loans on the books. Lenders could be drowning in liquidity but can't lend when consumers and businesses don't qualify to borrow due to being over-indebted and even upside-down on secured loans. However, debt relief directly to the demand side will automatically restore a large measure of asset value to the lenders.
By recent estimates the drop in home values has resulted in at least 23% of all home owners, or about 17 million, owing more on their mortgages than the home is currently worth (being upside-down on their properties), and that was before the latest big drops in values recorded in October, November and December. Upside-down owners cannot refinance, and if they sell, they must do a short sale and ruin their credit, as well as impose losses on any lenders against their property. When you consider that it probably takes at least 6% equity in a property to be able to sell it without a loss after transaction costs, and 5% equity to do a conforming loan refinance, the proportion of residential properties that can't be either refinanced to advantage or sold without a loss must be approaching one half. A large number of borrowers might just "walk-away," further fueling the downturn in housing values and adding more huge write-offs or provisions for write-offs by lenders of mortgage loans, and by investors in mortgage backed securities and credit default swaps, and by mortgage insurers. That widely understood prospect continues to weigh on the current values and liquidity of mortgages and mortgage-related securities, and credit availability in general. A new dramatic program is needed to remove a significant portion of mortgage debt from properties and replace it with long-term, low-interest government loans that isn't secured by the properties. Without a large scale plan to greatly reduce the number of bad loans and upside down properties, potential property buyers, mortgage lenders and mortgage investors will continue to hold back, or remain imprisoned by inadequate equity while the inventory of unsold homes will continue to climb. That's a formula for a dramatic financial catastrophe much worse than what has already happened. It is hard to imagine how there could not be vast, long-lasting adverse economic consequences, if the mortgage problem is not arrested soon. If most of the underwater mortgage loans could be relieved, and incentives be provided for residential purchases in a way that increases the qualified pool of buyers, lender and borrower balance sheets would be repaired, unsold inventory would likely stop growing, residential values would likely stop falling, and the credit system could return to some semblance of normalcy.
There is no reason to believe that the housing market will recover on its own any time soon in absence of such special action, and many reasons to believe it can't. Most of the causes of the loss of home equity are irreversible, and even with special large scale government action housing values won't necessarily rise, but the government plan can at least create conditions to stop the radical deterioration of housing values, lending and economic activity. Since early 2007, when the housing values began to slide, there has been a massive loss of access to financing for those who might have qualified for a mortgage then. Hundreds of lenders are either out of business or impaired in their ability or willingness to lend. Entire categories of loan programs no longer exist for new originations for all practical purposes, including subprime loans (thankfully, perhaps), second mortgages for more than 80% of current appraised value, Alt A loans, and stated income loans previously used widely by property investors. In addition, lending guidelines for all conventional first mortgage loans and for mortgage insurance have been dramatically tightened by all lenders, especially for investment properties, and the tighter guidelines have removed a major portion of potential demand. By my guesstimate, there are probably no more than 50% of borrowers qualified now compared to 2006. It is very unlikely that any of the lost lenders or loan programs, or significantly easier lending guidelines, will return any time soon, if ever. Furthermore, even many of the qualified are currently trapped solely by being upside down on a property. If they sell short, their credit rating will be ruined and they won't qualify for years, unless the government imposes special rules on credit scoring bureaus and lenders.
Not only are the ranks of qualified borrowers greatly diminished, but they continue to dwindle as unemployment skyrockets. In addition, stiffer mortgage pricing charges have raised the costs and rates for loans (with the exception of FHA and VA loans). Also, under current financial market conditions, interest rates for almost all types of mortgage loans, especially jumbo loans, and any kind of ARM, are enormously higher than what would have been indicated in the past by current U.S. Treasury rates or LIBOR lending rates. There might also be dwindling numbers of qualified individuals who are interested in buying a home as their stock investments and job prospects slide and they watch home values continue to collapse. Most of these factors are irreversible in the near term even with dramatic improvement in the status of lender balance sheets plus significant prospects for unsold housing inventory to stop growing and housing values to stop sliding. But those improvements could at least stop the self-reinforcing deterioration, and to achieve them will take special action by a powerful force outside of the housing market per se, namely the federal government.
Furthermore, millions of borrowers who currently have adjustable rate mortgages ("ARMs") and can't refinance for various reasons, are at risk for increased payments that could worsen the problem greatly. That just adds to the increasing risk that many borrowers will be forced to walk away from their homes or do a short sale. Consequently, the values of mortgage loans and mortgage securities are severely impaired and will remain so, or decline even more, unless something significant is done to restore the values of the homes, or to reduce the balances of mortgages. If nothing is done, there will be several years of growing loan losses, foreclosures, short sales, bankruptcies and ruined consumer credit, with the consequent increasing depression of the economy. The damaging process is self-sustaining in absence of dramatic action to stop it.
Since nothing can directly change the values of homes, the only logical points of attack are the balances of existing mortgages and the purchasing power of prospective homebuyers. The secured mortgage balances must be reduced so that homeowners can refinance or sell without further damaging themselves or lenders. This can be accomplished by providing a government loan program to displace most of the excess mortgage balances with loans not secured by the properties. If government steps in to solve the problem, the program also needs to be fair to those who don't have mortgages or don't own homes by providing similar benefits. This can be accomplished by government provided secured second mortgages to enhance purchasing power of those without mortgages to purchases homes. Think of it as the government stepping in to replace the private second mortgage market that has virtually disappeared for financing over 80% of property value. For those who choose not to purchase a property, they can use the government loan program for other authorized purposes.
Most likely, even with dramatic government action, the problem cannot be completely solved in a short time frame, since too many borrowers had little equity in their homes when home values peaked in about March, 2007 and began to slide, and because the variety of available loan programs with reasonable rates and costs is not likely to return anytime soon. However, at least the growth of inventory of unsold and foreclosed homes can be arrested quickly, and government-enabled purchasing power can be provided to replace the second mortgage market that has essentially disappeared, and those factors might stop the price declines, if not reverse them. The proposed U.S. government loan program outlined here is designed to replace a portion of mortgage debt with debt borne equally by lenders and borrowers, and not secured by the properties, and to simultaneously stimulate purchases by those who don't have a mortgage with secured government loans, and to give citizens who don't have a mortgage or plan to buy a property similar access to government loans. The details can be debated, but the general approach is sound and will not cost taxpayers anything in the long run, since the loans will be repaid with interest. Also, all loans created by the program, whether they are the secured mortgage type or the unsecured business and individual loan types, could be packaged into government-guaranteed loan securities and be sold by the U.S. government to private investors, so that the government could quickly recover its investment funds.
The approach of the program is to reduce the balances of mortgages for both borrowers and lenders and replace them with long-term, low-interest U.S. government loans. The vehicle for the process we'll call a "U.S. Housing and Economic Recovery Certificate" ("HERC") that is issued to individuals and is converted to low-interest (say 3%), long-term (say 30-year) U.S. government loans when redeemed to pay down a mortgage or other personal debt, pay to purchase a one to four unit residential property, or for business or personal purposes, when not used for debt reduction. The assumption is that it is not possible to directly raise the values of homes, but it is possible to reduce the balances of existing home loans enough to significantly increase the likelihood of feasible refinances when necessary, and reduce the likelihood of, short sales, foreclosures or walk-aways. That will reduce the number of distressed properties coming onto the market, and, therefore, stabilize housing values. It will also directly replace existing or potential losses on lender balance sheets with immediate cash partly offset by long term low-interest government loans, which presumably will enable more of them to lend again at reasonable rates. For individuals who do not have a mortgage, a Certificate can be used to purchase any residential property, or to pay off credit card debt, or as business financing, or to convert half of its value to an unsecured personal loan.
The mechanism of the program is to issue one non-transferable HERC to the owner of each and every one to four unit residential housing unit (including second homes and investment properties), plus one for every U.S. citizen age 18 years or older who has a social security number and does not own any residential property. Each Certificate would be valid until December 31, 2013. The value of each Certificate will vary for each property or each property- less individual, and the valuation issue is discussed in detail below. If a recipient has a mortgage, the HERC must be submitted to a lender to pay down the balance. If a recipient does not have any mortgage, or the value of the Certificate is greater than the mortgages held, it may be used as government-lent second lien mortgage funds to help purchase a home, or to pay off other debt, or to fund a licensed business, or to convert half the value to an unsecured, low-interest (3% perhaps), long-term (30 year) personal loan.
Owners of multiple properties would receive one Certificate for each property owned, including all investment properties and second homes which are a major part of the problem of unsold supply and a major potential source of future demand. Probably the new Federal Housing Finance Agency ("FHFA") acting thorough one of its Government Sponsored Agencies ("GSE," Fannie Mae or Freddie Mac) would be the logical administrator of the program while the Social Security Administration ("SSA") would be in charge of issuing the Certificates. For present purposes let's assume that Fannie Mae will be the actual lender for the loans, since they already have access to lots of data on existing properties and mortgages and existing processes and channels to create loans. To minimize the risk of counterfeiting, blank Certificates would be printed by the U.S. Mint similar to paper money having anti-counterfeiting features, and the SSA would be in charge of imprinting the property identification, if any, and the name and address of the recipient and the value of the Certificate, which would vary as discussed below. SSA would rely on Fannie Mae, Freddie Mac, HUD, state governments and property insurers to obtain lists of residential properties, mortgage existences, individual property values and median price property information needed to determine the value of Certificates for property- less persons in the area where they live.
How are the Certificates used? If a property has a mortgage, the Certificate must be used to reduce the principal of the mortgage and for no other purpose, unless the person does not have mortgages totaling the full value of the Certificate, in which case the excess value may be used for other authorized purposes. We considered the option of having the government simply pay mortgagees directly to start the process, but there are many properties with more than one mortgage, and the borrower should have a choice of which mortgage to pay down. It also adds government administrative burden to the process to identify mortgagees, or multiple mortgagees for each property, and to contact the mortgagee being paid.
In the case of an existing mortgagor who is not refinancing or selling, the borrower submits the Certificate to a mortgage servicer to pay down an existing mortgage. Next the servicer submits the Certificate to the government and receives the cash value to pay down the mortgage while the mortgagee (lender) becomes obligated to the government for one half of the value on a low-interest, long-term, unsecured loan. The borrower's loan is reduced by the full value of the Certificate, and the borrower also becomes obligated to the government for one half of the amount with an unsecured, low-interest, long-term loan. In these cases it would be an added benefit if the law required that the payments on the remaining mortgage balance be recast to reflect the amortizing payment over the remaining term of the loan, unless the loan has a remaining period of an interest- only payment feature.
In the case of an existing mortgagor who is refinancing or selling, the lender being paid off would accept the full amount of the Certificate up to the balance of the loan and submits the Certificate to the government to receive funds to pay down the mortgage; in return the government pays the lender the full value of the Certificate and creates a low-interest, long-term, unsecured loan from the government to the lender for one half the value, and another similar loan to the borrower for one half the value. Of course, sellers who would net revenue from the sale in excess of mortgages and transaction costs could choose to pay down or pay off the government loan anytime with those extra proceeds without penalty.
For those who don't own property, or don't have any mortgage, a Certificate provides a low-interest incentive to purchase a residential property. If used for a purchase transaction, the purchaser's Certificate would be submitted to any lender of the purchaser's choice to be processed as a secured purchase money loan from the U.S. government like any other mortgage loan, however it would be subordinate to any other non-government mortgages in any case where the buyer would be using such non-government loans for the purchase. The lender submits the Certificate to the government to obtain cash for the closing in and amount equal to the full value of the Certificate and loan papers to obligate the borrower to the government for the full value of the Certificate on a loan secured by the property. The lender would submit the government loan papers and funds to the closer as is done for any other mortgage loan. Once closing is scheduled, the government wires funds to the closer in an amount equal to the full value of the Certificate and records a loan in the full value to the borrower.
All lenders who process Certificates would be paid a flat fee by the government for processing the loan, say $800. All government loans would be serviced initially by the lender handling the origination. The same lender would act as a servicer of the mortgage, or the servicing rights could be sold to another lender.
The net result for existing mortgagors is that the borrower receives one half the value of the Certificate as a 100% tax-exempt loan reduction and one half as a personal loan. For a purchase transaction the borrower benefits by receiving the full value of the Certificate as inexpensive mortgage financing. In a refinance or sale of a mortgaged property, a lender benefits from immediate cash in the amount of the lesser of either 100% of the Certificate value, or the remaining principal of the loan, and becomes obligated to the government for a low-interest, long-term loan equaling only one half of the used value of the Certificate, thereby significantly improving its balance sheet. That creates an improved liquidity positions enabling the lenders to make additional loans. In general the program uses the power of government to replace lost home equity in the overall economy with low-interest long-term loans that are not secured by housing assets, and to spur purchases of residential properties with low interest loans. The program frees up many borrowers from untenable mortgage positions, frees up bad loans from lender balance sheets and restores much of the purchasing power that has been lost in the economy due to the loss of home equity. The government provides long term debt to obtain near term recovery of housing and the general economy.
One issue that arises is how to achieve fairness to Americans who do not currently have a mortgage, don't own property and don't wish to purchase a home. To address that, we suggest they should be allowed to use the value of the certificate either to pay off other personal debt, to fund a registered business owned by the Certificate holder (with recourse on the loan to the Certificate holder), or to alleviate credit card debt with a process similar to that for paying off mortgage debt, or to use one half the value of a Certificate for a low-interest, long-term, unsecured, government-guaranteed, personal loan issued by any local bank. We suggest half the value only in order to reduce incentives for those without mortgages to simply convert the Certificate to an unsecured personal loan and then use the funds for purchasing real estate. Certificates should be used first to reduce housing and other debt or to purchase housing.
Notice that no free cash is given out with this program. Instead, the government provides long-term, low-interest, unsecured loans, similar to the manner in which it has provided some student loans. The government deficit isn't increased since the funds are used create loan assets on the government balance sheet. The interest paid by a borrower to the government would be tax-deductible as mortgage interest to the extent the loan was used to pay off mortgages or to buy a home. Note also that we are not suggesting direct cash payments to homeowners, since that can be more equitably accomplished through separate economic stimulus legislation, if deemed desirable, and because there cannot be any guarantee that such payments would be used to reduce debt or purchase homes. Finally, note that this program would be in addition to the $7,500 tax credit loan that was created recently for home purchases. That tax credit is available to all prospective home buyers, but is useful only if a person does purchase a home, and is not necessarily as fairly allocated as the values of HERCs would be.
The proposed HERC program primarily benefits existing homeowners and lenders whose situations are dire and are the main part of the national economic problem, but, so far, have been almost completely left out of emergency housing legislation. The existing programs to bail out insolvent banks and investors by buying bad mortgage securities and making equity injections, and to give taxpayers new incentives to buy a home in the future do not directly or effectively address the most important and intractable problems with housing, an are not equitably available to either individual lenders or to the general populace.
The proposed HERC program primarily benefits existing homeowners and lenders whose situations are dire and are the main part of the national economic problem, but, so far, have been almost completely left out of emergency housing legislation. The existing programs to bail out insolvent banks and investors by buying bad mortgage securities and making equity injections, and to give taxpayers new incentives to buy a home in the future do not directly or effectively address the most important and intractable problems with housing, an are not equitably available to either individual lenders or to the general populace.
A difficult issue is what value to establish for each Certificate. We considered four different general approaches:
(1) a fixed amount to every person regardless of property ownership, property value or mortgage balances;
(2) a percentage of the existing principal of mortgages;
(3) a percentage of the decline in value of each property from early 2007 to the date of the law, say 80%; the difference in value could be established using either:
(A) taxable value for 2008 property taxes (typically determined as of Jan 1 2007), versus taxable value for 2009; or
(
appraised value as of the time frame in 2004-2006, if an appraisal is available, versus current appraised or taxable value (tax value would be much easier to administer); or
(
appraised value as of the time frame in 2004-2006, if an appraisal is available, versus current appraised or taxable value (tax value would be much easier to administer); or (C) a portion of the percentage decline in a housing value index for the area of the property; in all cases an owner should be able to appeal the valuation if a different change in value can be established with actual appraisals or other sound evidence; or,
(4) a formula including a flat amount plus a percentage of the decline in value of the property and/or a percentage of mortgages; or
(5) for persons who do not own any property, a percentage, say 10% of the current median price of homes in the area they live, subject to a flat minimum of say $5,000.
The approach of simply a flat amount per person is certainly the simplest, but is the least effective to provide sufficient relief for borrowers and lenders having high mortgages on expensive properties. Using home values, or a change in home values, might be the fairest and most relevant approach, but it would require a more intensive data crunching process to establish the appropriate value for each recipient. We favor that approach since it most directly addresses the prime objective of relieving upside down mortgage situations. For citizens who don't own property, the value can be set as a percentage of the decline in median home value in the area they reside, perhaps with a minimum, say $5,000, or as a flat percentage of the value of a new home they purchase, say 10%.
If home values, or changes in home values, are used, how are the values determined and what percentage of the value or changes in value should be used? The resulting values of Certificates need to be large enough to rescue a significant portion of upside down loans, or provide sufficient incentive to purchase a home. If a flat percentage of value were to be used, that would leave too many borrowers and banks upside-down, since the reduction in values of homes is much greater in certain areas, notably California, Arizona, Nevada, and Florida at the very least. Probably up to 80% of the decline in value might be necessary in such areas to meet the intended objective, and that could translate into 30% of current value in many cases. That argues strongly for using a proportion of the decline in value subject to a minimum floor amount to determine the value of a property-related Certificate. To determine values there are various sources of data that would need to suffice, including the Housing Price Index report by the new Federal Housing Finance Agency (FHFA), the S&P/Case-Shiller Housing Index, the Census Bureaus's Constant Quality Home Price Index, and state and county property sales records and assessed values. In our estimate of the potential amount of investment needed to fund the program discussed below, we assume that 80% of the estimated decline in a home value is used, or 10% of median current values for certificates not tied to a particular property.
In order for the program to have sufficient effect as intended, and for fairness, it is absolutely essential that all one to four unit residential property owners benefit for every property they own, whether the property is a homestead, vacation home or investment property. The property related Certificates should be based primarily on properties, not individuals. A huge number or the bad loans are those of property investors and vacation property buyers. Many people think that property investors were speculators and must not be bailed out. However, if property buyers are expected to have known that housing prices would collapse, and are, therefore, considered undeserving speculators, then it's reasonable to think the lenders should have known even better, and must also be considered speculators. Furthermore, one could argue, as many have, that the top experts about real estate and economic trends are in the government, especially the bank regulators, and they should have been the best forecasters, but apparently did not forsee it either, at least until it was too late, since they did little or nothing to prevent or stop it. So, we can hardly expect lenders and property buyers to have anticipated the problem. But the issue is not who were the worst speculators, but how to restore the numerous innocent bystanders, the vast majority of citizens, who have been severely damaged by whoever might be blameworthy, if anybody, and to rescue the economy from a drastic situation. It simply isn't possible to rescue the lenders, securities investors and housing values in general unless the program includes second homes and investment properties. The problem is real estate in general, not just homesteads.
In any case, the program doesn't let lenders or property owners off the hook for their debts. It just rearranges the debts and makes lenders and borrowers equally share losses. Taken together borrowers and lenders who benefit will still owe the government the full value of all mortgage debt extinguished, the new debt just won't be tied to the devalued properties they were related to, or be tied to the unsupportable mortgges the new debts replace. The new debt will be far more manageable and will free up properties for potential refinances or sales without the consequences of short sales or foreclosures. Compare this approach with the loans that are now being made directly to lenders and investment firms, under the most recent emergency housing legislation. Those investments don't provide any direct relief for the homeowners whatsoever, don't get lenders or borrowers out from under loans that will fail, and the benefits are not being equitably distributed among all the distressed lenders either.
In any case, the program doesn't let lenders or property owners off the hook for their debts. It just rearranges the debts and makes lenders and borrowers equally share losses. Taken together borrowers and lenders who benefit will still owe the government the full value of all mortgage debt extinguished, the new debt just won't be tied to the devalued properties they were related to, or be tied to the unsupportable mortgges the new debts replace. The new debt will be far more manageable and will free up properties for potential refinances or sales without the consequences of short sales or foreclosures. Compare this approach with the loans that are now being made directly to lenders and investment firms, under the most recent emergency housing legislation. Those investments don't provide any direct relief for the homeowners whatsoever, don't get lenders or borrowers out from under loans that will fail, and the benefits are not being equitably distributed among all the distressed lenders either.
What would HERC cost? Actually, little or nothing, since the U.S. funds used would be an investment and not an expense. Invested funds would be repaid with interest over 30 years, or the loans can be packaged and sold immediately by the government to private investors threby totally eliminating taxpayer risk. The total value of Certificates initially issued will be large, but the total is not a cost in the usual sense, it's an investment that will be repaid with interest, less any defaults, or can be sold to private investors. An estimate of the amount needed to be invested is given below. Default rates will likely be very low. In the case of the portions of the Certificates that become loans to lenders, the loans would not default any more than the general future failure rate of lenders. Bank lenders would be subject to oversight by regulators who could require performance as a condition of continued good standing. In any case, whether the Certificates are used for secured or unsecured loans, the law could specify that the debt may be recovered as if it was a tax debt, so that the IRS could collect payments by withholding income tax rebates, garnishing wages, or seizing assets in the case of default. That would guarantee very low default rates.
How much needs to be invested in such a program? Following is a crude estimate. According to the American Housing Survey 2007 (HUD) conducted April-September, 2007 in the United States there were about 98,000,000 one to four unit residential housing units (the only ones that are eligible for residential mortgage financing), not including about 7 million mobile homes. However, that total includes some two to four unit properties owned by only one individual, so there are less than 98 million properties owned that would receive Certificates. According to Federal Reserve statistics, in the second quarter of 2007 home equity was about $19 trillion equaling about 50% of total home values. That implies 98 million 1-4 unit U.S. housing units were worth an average value of $194,000 each. According to the November, 2008 Housing Price Index report by the Federal Housing Finance Agency the values of homes in September, 2008 averaged over the entire U.S. was 7.9% below the April, 2007 peak values in nominal dollars, and close to 13% in inflation adjusted terms in just the previous 12 months. Since values dropped 7.9% on average housing units were worth about $178,700 in September, 2008. So an average Certificate would need to be worth about $15,300 to replace all lost equity to September, 2007, a total of $1.50 trillion for all housing units. Let's assume that values have continued to fall and that values could be 10% lower than April, 2007 by the time the program is implemented. Then that implies about $19,400 average per housing certificate to replace all expected lost equity, and that implies $1.9 trillion for property related Certificates. But probably it isn't necessary to replace all of the lost equity to effectively deal with the problem. So lets assume that about 80% of likely total lost equity is invested, and guesstimate that property assigned Certificates would average about $15,500 each for a total of about $1.5 trillion invested with property owners. Since not all properties have mortgages, less than $750 billion of property-related Certificates would end up as loans to lenders, and more than $750 billion would end up as unsecured personal loans. Some would end up as secured second mortgage debt to the extent that property owners used Certificate value to buy properties.
In addition, a Certificate would be issued to each citizen having a Social Security number who is age 18 or older and doesn't own any residential property. The U.S. population is now about 305,000,000 and about 75% of it is age 18 or older, so there are about 230,000,000 citizens age 18 or older; presumably nearly all have a Social Security number. However, about 50,000,000 of those residents now have mortgages, so let's say about 180,000,000 residents don't have mortgages and would get Certificates (actually fewer, since not all are citizens, and not all have SSNs). If the Certificates average $16,000 each, then that would total $800 billion. However, recall that only half of the value of a Certificate could be converted to a personal loan, if it wasn't used to purchase housing or pay down credit card debt or to finance businesses. So let's say about $600 billion would be used. Then the gross total value of exercised Certificates would be about $2.1 trillion, or about three times the $750 billion of funds committed to the current bailout program that to date has been used only to replenish bank capital and to rescue AIG. Of the $2.1 trillion needed for the RHRC program, $350 billion could come from the uncommitted funds in the existing bailout plan, so no more than about $1.8 trillion additional funds would be committed. That's not a lot when you consider that the Federal Reserve expanded free reserves in the banking system by a whopping $2 trillion in just several weeks in October and November, 2008, and another $300 billion or so was authorized for the FHA for the earlier housing rescue plan that has had little effect or applicability and likely won't be used to any significant extent. The HERC approach would almost completely substitute for what that plan was trying to do, but would do it more swiftly and with much more beneficial effects on lenders and borrowers alike.
In order for the HERC program to work effectively, it is also very necessary that action be taken by Congress, or by the President under his emergency economic powers, to directly modify the terms of all subprime ARM mortgages (defined as those with adjustment margins greater than 3.00%), which were dangerously defective products. That's necessary to stop the trend of foreclosures on subprime ARMs which would continue even after the HERC plan had paid down subprime debt. The world financial community is rapidly going broke as more subprime ARM financed properties go into foreclosure or short sales while waiting for lenders or mortgage services to modify the loans on a case-by-case basis, which has proven to be too slow and ineffective to solve the problem. Separately, we've provided a detailed program to identify such loans and modify their terms to greatly improve the chances that they will not default. -END-
Posted by The Mortgage News at 11/25/2008 7:37 PM 
Categories: bank bailout, Housing Values, Credit Crisis, foreclosures, foreclosure crisis, Mortgage Legislation, Freddie Mac, Fannie Mae, mortgage delinquencies, government bailouts, Hope Now Alliance, mortgage modification, AllStreets Bailout Plan
Categories: bank bailout, Housing Values, Credit Crisis, foreclosures, foreclosure crisis, Mortgage Legislation, Freddie Mac, Fannie Mae, mortgage delinquencies, government bailouts, Hope Now Alliance, mortgage modification, AllStreets Bailout Plan
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