by Frank Hill, Telemachus
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.
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.
(Note from Telemacus: 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)
(Editor's Note: Frank Hill's resumé includes working as chief of staff for Senator Elizabeth Dole and Congressman Alex McMillan, serving on the House Budget Committee and serving on the Commission on Entitlement and Tax Reform. He takes on politics from a fiercely independent perspective at the blog Telemachus).
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