G-20 Series: Economist and 'The Big Picture' Blogger Offers Bold New Mortgage Plan
Big Think recently approached top economic thinkers from around the world for policy recommendations that could catalyze the needed structural changes to pull the global economy out of recession. Included here are ideas from Barry L. Ritholtz.
The inspiration for a series on global economic policy solutions came from Dr. Takenaka, who in 2002, acting as Japan's economics minister, successfully tackled Japan's banking crisis with his Plan For Financial Review, or, as it is widely known, the Takenaka Plan. His measures were largely successful after he convinced reluctant banks to write down billions in bad assets.
Barry Rithholtz writes The Big Picture, a blog dedicated to financial analysis and criticism visited by 35 million readers that the New York Times has lauded as "trenchant economic commentary." He is a regular guest on CNBC's Squawk Box, Power Lunch and Fast Money and he is oft-quoted in leading financial newspapers and magazines. When not blogging, Mr. Ritholtz serves as CEO and Director of Equity Research at the online equity resarch firm Fusion IQ. His proposal for restructuring the American housing market are as follows:
"...Instead of the massive Paulson bailout plan, let’s consider a different type of solution, one that can be effectuated by a combination of policies and actions via Congress, banks, and private equity, with the loan servicing industry participating.
I call it the "30/20/10" solution to the credit crisis:
30: Takes up to 30% of any current delinquent mortgage and separates it from the “main” mortgage; it goes into a 2nd, interest free-balloon mortgage, and stays on the books of the present mortgage holder;
20: The plan’s goal should be saving at least 20% or so of the current delinquent and potential foreclosure properties; Of the 5 million homes that may be late in making payments, (the first step along the road to delinquency, default and foreclosure) the process should make 20%, or 1 million homes eligible;
10: The Balloon payment comes due in 10 years, and will be treated as a 2nd mortgage, with interest charges only accruing as of October 1, 2018; it can be refinanced or paid off in full.
The 30/20/10 option allows the lending entity (or its equivalent) to pull aside up to 30% of the mortgage as a separate interest-free balloon payment. The remaining mortgage is refinanced at a fixed rate for 30 years. The balloon payment will "restart" fresh in 10 years. Between now and then, there will be no interest costs or penalties for this separate loan.
Consider the advantages of this plan: It would prevent a significant number of foreclosures from further roiling the markets; it takes bad loans and avoids the write down so long as thy are performing; and it allows many people to stay in homes they can afford. Moral Hazard poses no problem in this plan.
Here are additional specifics: At least 70% of the existing mortgage becomes a new, refinanced, fixed rate, 30 year traditional mortgage. And, a loan payment for up to 30% of the original mortgage, not accruing interest, with repayment of principal and interest due beginning 10 years hence, makes the present house affordable. In other words, this would look like an ordinary mortgage plus a balloon payment, one that would not begin accruing interest until year 10.
Congressional action is required to exempt the balloon payment from causing a tax issue, as this is essentially an interest free loan might be a taxable event.
The securitization of mortgages creates its own additional difficulties in attempting to resolve defaults and delinquencies. Residential mortgages get bundled into RMBS, which were then sold and resold to various Wall Street purchasers. One of the current problems in resolving the situation is identifying who is the actual owner of the mortgage in question. This can be resolved with a clever little act changing notification provisions, requiring further Congressional approval.
Any entity that identifies a potentially problematic mortgage, i.e., delinquent and in risk of default, can start the process by evaluating the property value and the borrower’s ability to repay the loan. If they believe a mortgage would be suitable for a 30/20/10 workout, they would then send notice to the current recipients of the mortgages interest and principal payment. This entity would have 30 days to reject the workout, and failing to do so in that time Is deemed to be an approval.
In our solution, it is the financing party – a private equity firm, a real estate fund, or even a US capital pool created for this purpose – that can make this request for a 30/20/10 solution. Notice is sent by to the current loan servicer, i.e., the firm processing the mortgage payments, and forwarding them to the mortgage owner. The servicer is in the best situation to send the 30 day notice, and if no written objection is received, from the whoever currently owns the mortgage – be it bank, mortgage pool, or other securitized owner – the refinancing process begins.
Instead of a foreclosed property, the former mortgage holder is left with an interest free, 10 year balloon on up to 30% of the mortgage. They also have a lien on the property, and no writedown on the delinquent mortgage for at least 10 years.
There are other details that need to be worked out — the priority in case of sales, what happens if there is an eventual default, how to avoid fraud, etc.
The end result of the 30/20/10 workout would be the following: Homeowners who can afford to make payments on the refinance home get to continue living in them. Neighborhoods are spared the negative impacts that Foreclosure has on property values and the blight of abandoned houses. Lenders get to avoid writing down up to 30% of suitable but problematic mortgages. The balloon payment stays on the books as a liability, but it is not written down until, if and when it defaults 10 years later.
The upside of this proposal is that it serves a variety of interests with a minimum of congressional market interference. Those homeowners that can afford to stay in their house with a little bit of help avoid foreclosure. Banks and mortgage holders get to avoid writing down delinquencies that could be avoided. Neighborhoods are spared the negative impacts that Foreclosure is known to have. Loan servicers can expand their business to process saying the 30/20/10 workout papers. I would expect a variety of private equity funds will leap into the void and begin looking for mortgages to rewrite as 30/20/10s.
Congressional action required would be to 1) Eliminate the tax issue for the interest-free portion of these loan; 2) Create a Legal standing and guidelines for this notification and waiver policy. The goal here is to insure that the complexities of determining who actually owns a a mortgage dozen not interfere in its work out; 3) Create any required exemption for banks and lending entities to avoid taking a write-down during the period of the 10 year in balloon forbearance.
Weaknesses and criticism: I would expect several objections to be raised to this proposal. From those representing homeowners who face potential foreclosure, the complaint will be that this plan fails to save more than 20-30% of those who might lose their homes. For the various funds and investors that own the underlying mortgages, there will be a complaint that notification provisions are insufficient. Lastly, given the enormous size of the Federal free lunch proferred by the Treasury Secretary, the banking industry will be reluctant to embrace any such workout that might be perceived as interfering with their ability to feast at the public trough to the tune of a trillion dollars."
Big Think extends special thanks to Mr. Ritholtz for contributing his comments.
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