Obama's last hope on housing

Make no mistake: President Obama’s $75bn housing plan is a policy disaster. It merely treats the symptoms of the calamity in an extremely costly manner via short-term interest rate relief and remarkably does nothing to prevent the next generation of borrowers experiencing the same problems.

The administration’s response also exacerbates the underlying dysfunction that is the root cause of the US’s housing market woes by, for example, offering defaulting borrowers scope to wriggle out of their contracts through the judicial system.

This will only undermine the enforceability of US mortgages and embed a new risk premium that will inevitably lead to higher interest rates and likely funding uncertainty.

By reinvigorating Fannie Mae and Freddie Mac without genuine reforms, the administration has demonstrated that it does not understand the fundamental flaws inherent in the US financing system, which precipitated this crisis in the first place.

There remains, however, hope that the more thoughtful decision-makers will search for superior long-term reforms. In this context, I was fortunate enough to be able to present a tractable solution to the US’s housing market problems at a summit in New York for Obama administration officials.

The plan I presented directly cauterises the US’s housing market dysfunction, delivers far greater and more permanent interest rate relief for distressed borrowers, allows banks to immediately recapitalise their balance-sheets with a $77bn cash injection, and costs taxpayers much less than the administration’s initiative. On all objective counts I feel that it is an unambiguous improvement on the administration’s alternative.

As I’ve noted previously, one of the most critical lessons from the global financial crisis has been that many households had far too much leverage, particularly in the US where the average borrower’s mortgage is now worth an astonishing 95 per cent of their home. The only genuine policy solution to the desire to deleverage is the development of external markets in housing equity – or ‘shared equity’ – which borrowers can use synergistically in combination with traditional debt finance.

Here’s how a government ‘debt for equity swap’ programme would allow distressed US borrowers to radically deleverage their balance-sheets:

Assume that the average ‘distressed’ borrower’s loan-to-value ratio is, say, 115 per cent. Under the debt-for-equity swap, the traditional lender would only write off 15 per cent of the value of their loan to bring the LTV back to 100 per cent (as opposed to writing off most of the loan). A similar write-down is anticipated in the administration’s scheme.

Yet instead of making a gift to lenders to temporarily cut borrowers’ repayments, the government would refinance 25 per cent of the reset home loan by swapping it with a taxpayer-funded ‘shared equity’ loan (this could be operationally achieved by having borrowers pay down 25 per cent of the reset loan).

Importantly, the shared equity loan carries no monthly repayments during its maximum 30-year life. In exchange, taxpayers receive half of the property’s future capital growth in lieu of interest when the home owner elects to repay the loan either on refinancing or sale of the property. The lender also owns no legal interest in the home since it is structured using a traditional mortgage contract; i.e. the owner retains control over what they do with their property.

The traditional lender is now left with a dramatically less risky 75 per cent LTV. They are also directly paid 25 per cent of the face value of their reset loan by the government and thus get the benefit of a significant cash injection – which is worth about $77bn – onto their balance-sheets.

The borrower is now only paying a full rate of interest on a home loan that is 65 per cent of its original value. They therefore benefit from a permanent 35 per cent reduction in their interest and principal repayments over the 30 year life of the package. In contrast, the lower repayments realised by borrowers under the administration’s proposal only last five years – after which rates are ratcheted back up, thereby raising the risk of ‘redefault’.

Assuming that house prices increase at a rate no greater than nominal gross domestic product during the next 30 years, which given the recent 25 per cent correction seems defendable, taxpayers could expect to earn a 5-10 per cent annualised, ungeared rate of return. This is patently superior to the 100 per cent losses that taxpayers will realise on their $75bn ‘gift’ to distressed borrowers under the existing plan.

How much would this cost? According to the Mortgage Bankers’ Association, 6.6 per cent of the circa $11tn of US home loans are in 60 days or more arrears. Assume that half of these borrowers go into foreclosure and need to access the programme. That gives $363bn worth of loans in distress. If the average LTV is 115 per cent, and the lender wears a 15 per cent write-down, a 25 per cent debt for equity swap would cost taxpayers roughly $77bn, which, coincidentally, is almost exactly the same size as the administration’s package.

Importantly, once the shared equity loans are repaid the government can recycle the capital to assist the next generation of households in distress. The $77bn equity fund could therefore be used to reduce the risk of families facing foreclosure in perpetuity. And since traditional lenders are minimising their foreclosure risk, they could ultimately contribute.

Successful private and publicly markets in housing equity now exist in Australia, NZ, and the UK. Combined with the fact that leading academics such as Ian Ayers and Barry Nalebuff, Luigi Zingales, and Edward Glaeser have recently made similar calls for the US government to help borrowers swap their debt for equity, it is hard not to acknowledge that there is immense merit to this plan.

Nobody would begrudge the administration the opportunity to refine their response to this calamity. I just hope they have the humility and foresight to listen.

Well, it's not a new proposal. I guess he just finally got someone noteworthy to listen to him.

129+ views before a reply. It is a little difficult to digest.

This strikes me as similar to a reverse mortgage with a little push from Uncle Sam.

yitbos

After wasting vast money we don’t have, the crooks, losers, and idiots will STILL be in default of their mortgages.

Insane. Totally insane.

The looney thing about all this mortgage handout tripe is: these people have no equity in these houses!!

There are 10 million condos and apartments waiting to be rented.

yitbos

taxpayers receive half of the property’s future capital growth in lieu of interest

So, taxpayers are given half of a blue-sky pipe dream?

Is this anything like sending some money in to have a star in the Milky Way named after you?

There is no solution to any of this without the natural pain delivered by the markets and of the logical consequence of a breach of contract requiring foreclosure.

"I didn't know what I was signing," is not a defense and to allow such madness to gain a foothold is to undermine our entire system of commerce.

There is no quicker way to destroy the commerce of the world than to undermine the enforceability of contract law.

This plan still punishes success and rewards failure.

That is the whole idea.

Why is Washington trying to "figure this out" and "help" Obama see reason. Reason is dead.

Obama wants the world to go into a Global Depression. He is seizing power now with Europe in a "Global New Deal."

He see race in everything, and wants to give many blacks a free ride on mortgages.

He wants everyone dependent on him, and subjugated to him. He wants to squeeze every penny from anyone who has, and dictate who he gets to give it to. When it all collapses, he will enforce his will at the point of a gun.

The clinton admin. killed the Glass- Stedgall banking act of 1934. that kept the S&Ls and comm. banks seperate and allowed this mess to occur. And also the community redevelopment act under carter and expanded under clinton. This is the root cause of everything that is occurring today. Check it out.

What happens when the house declines in value?

Our (governments) equity share becomes a loss.

Many people would see this as a way to sell there house and not have it cost them money.

This could lead to house prices dropping even faster.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.