Via Poor and Stupid, TCS Daily has a free (or at least free-er) market solution to bailouts for struggling mortgage borrowers.
The idea? “[A] debt-for-equity swap with sub-prime borrowers.” Borrowers would give up 20% of their downstream equity in their homes in exchange for 20% debt and therefore payment relief:
To implement the swap plan, government would create an agency to buy equity from troubled borrowers. Call this new agency Bailie Mae.
When a borrower swaps with Bailie Mae, the borrower’s monthly payment of principal and interest immediately falls by 20 percent. Instead, Bailie Mae provides the other 20 percent of the monthly payment. The borrower still has to pay the full cost of other components of the mortgage payment, such as taxes and insurance.
As long as the borrower makes the new monthly payment, he stays in the home. When the home is sold, 20 percent of the gross proceeds go to Bailie Mae. At that time, Bailie Mae will be responsible for repaying 20 percent of the outstanding balance on the mortgage loan.
For example, suppose that the outstanding balance at the time of the swap is $100,000, and the borrower’s monthly principal and interest is $800. With the swap, the borrower’s monthly principal and interest payment would drop to $640, and Bailie Mae would pay $160 per month.
Several years later, the borrower gets a job in a new city and sells his home. By this time, the outstanding loan balance is, say, $90,000. Bailie Mae is responsible for 20 percent of that, or $18,000, with the borrower responsible for the remaining $72,000. If the home sells for $110,000, then 20 percent of that goes to Bailie Mae, which means $22,000. Another $72,000 is used by the borrower to pay off the loan, leaving $16,000 to go to the borrower.
Suppose that the house is sold for only $80,000. In that case, Bailie Mae gets only $16,000 even though it still has to pay $18,000. The borrower gets nothing, and $62,000 goes toward paying off the loan. The cost of the remaining $10,000 shortfall in paying back the loan is borne by the responsible lending party–perhaps a bank, perhaps a mortgage insurer, perhaps another financial market participant involved in trading credit derivatives. If there are large, widespread losses, they will be borne mostly by the original investors, and only somewhat by Bailie Mae.
Many economists are pessimistic about the outlook for home prices. If they are correct, then the swap plan will spread the losses around. Most of the losses will be borne by investors on the lending side. Some of it will be borne by homeowners. And some of it will be borne by Bailie Mae.
Other economists (well, Kevin Hassett and me) think that home prices are close to bottoming out. If we are right, then nobody has to take a big loss. Bailie Mae could fail to live up to its name and actually make a profit. In the meantime, it enables stretched homebuyers to make the monthly payments on their loans.
More:
The swap plan gives the government, in the form of Bailie Mae, some risk exposure relative to housing market performance. If house prices climb rapidly enough, Bailie Mae makes a profit. If house prices are sluggish or fall, then Bailie Mae absorbs some losses, but homebuyers and lenders bear most of the cost. If there is a big decline in house prices, the largest risk remains with the lenders, which I believe is where it belongs.
The beauty of the swap plan is that it keeps government involvement proportionate to the size of the problem. Suppose that the crisis is real, meaning that house prices need to fall sharply in order to restore balance in the market. In that case, the swap plan will put some of the burden on taxpayers, while leaving most of the burden on investors. On the other hand, if the housing market is close to reasonable balance today, then the swap plan will cost little or nothing. It would ease my worry about enacting an expensive solution for a non-existent crisis.
The best thing the government can do is nothing. Everything it does will prolong the problem. Even so, this is much closer to a hand up than a hand-out, so it’s more likely to result in responsible behavior over time.
Technorati Tags: real estate, real estate marketing
RE Investor says:
I believe if they enacted something like this, we would reach a real bottom. A lot of this is pychological. Most potential home buyers are watching all the news and feel they are better off renting than catching a falling knife. The reason housing is dropping so much more than it should is because of forced foreclosure. Cut down or eliminate some of that, and it will tighten the market right away, and then the market will again be based solely on fundamentals. That is a great idea, however will never happen because as we all know, good ideas rarely come from Washington. I would say if this is going to happen, it would happen from a private corporation or large investor.
September 5, 2007 — 3:47 pm
Chuchundra says:
Why don’t the lending institutions do this? It’s better for everyone than cramdown or foreclosure and they at least have some chance of recouping their investment.
September 5, 2007 — 5:23 pm
Ed Grant says:
It sounds like an unsecured second that would help qualify an unqualified purchaser. The purchaser would appear to have 20% down on the house and the bank would have full unencumbered first.
I guess that is going on right now. The purchaser has an 80 ltv first and the remaining on the second. In this scenario his payments are not affordable but where does it really get you. Right now if the homeowner wants to sell he spends a couple of days negotiating with the bank. If approves the short sale the seller walks away with no equity. The second gets whatever is left after the retired first. The second will analyze the deal and make sure it is clean. Its their money they are giving away.
We know the second scenario isn’t working. The capital markets are crashing. Psychologically the first scenario has a few serious flaws.
In scenario 2 the second can only be defined as unsecured debt. This debt does not affect the first’s strength in anyway. You have now created a derivative that does not feel like ownership but a version of rent control.
Now put this idea into the hands of the mort brokers and realtors and watch what happens in just a few months.
The fedly Medley Loan.
Realtor. You could buy that house for 100k but why. I can put you into the one across the street for 120k for the same monthly payment, let me show you how.
Broker
Yes by adding Fedley medley you can pay the same monthly payment as the other house but also something better. In a couple of years if the market doesn’t look good we suggest that you stop taking care of the house and sell the appliances for a few bucks. Whatever isn’t nailed down take? We are not sure if you can take the plasma screens but why not.
Up side: you keep the house it goes up in value and you sell it for a profit,
Downside you party like a rock star trash the place and leave. Don’t worry we can keep finding the opportunities for you but we would like to see you stay at least a couple of months.
Potential scumbag buyer.
Sounds good I am in. you do the paperwork and make sure the house has high-end appliances and a bunch of plasma screens. We need to get moving on this I want to be on my next one in Miami for the winter.
Government intervention on the scale described above just gave him 20% better odds at the blackjack table. Something tells me that when there is less risk there are more players. The Fedley Medley table might fill all of Vegas. It has almost already.
The next time you see a thousand people with concrete shoes on in the bottom of the ocean do this. Either buy an aircraft carrier pull them all out, feed cloth and house them. Or throw some flowers in the water say a prayer
If you keep yelling at a retard for drooling who really is the idiot.
Why not just try. This is a house you can afford. We suggest 20 % down on a 20 or 30 year mortgage.
September 5, 2007 — 9:38 pm
Robert Kerr says:
Interesting idea, but in the end, the target group is still holding a massively leveraged, depreciating cash furnace with little or no equity, or negative equity.
A staggering number of subprime owners are just walking away. And why not? You can rent for one-third to one-half the monthly nut of owning.
Plus, a foreclosure doesn’t do much harm to a 550 FICO score.
September 5, 2007 — 10:07 pm
Thomas Johnson says:
OK, real slow for the Texan. How would you debt for equity swap with multiple CDO’s(who is “the bank” these days) where the first lien and the second lien are sliced into interest only and principal only and slow prepay and long prepay and whatever else, all AAA rated, tranches? I can see it now. The Germans get the garage, the French get the kitchen, the Chinese get the central plumbing and the Saudis get the air conditioner. The pension plans would get…the lot? Don’t forget the 10 points on the back end for our buddies at Bear Stearns and Merill Lynch. Gotta keep those billion dollar bonus pools solvent.
I have a listing in a short sale situation. Today I called the second lien holder for instructions. They told me that they were in the 3rd lien holder position. Guess what? There are only 2 loans on the property. I imagine this is not a single solitary happening. If “the bank” doesn’t know what they are owed, maybe I can refi the Brooklyn Bridge!
September 5, 2007 — 11:46 pm
Jeff Langholz says:
Yes, equity sharing has a lot of potential in the current market. It can work for buyers as well as sellers, and can take a lot of different forms. For example, we are matching up co-owners every day on our website, providing the “online marketplace for real estate co-ownership.” (www.HomeEquityShare.com) Real estate investors, first-time buyers, and troubled owners, are signing up every day. In a time when full home ownership is difficult, it seems that partial ownership may be a good temporary solution for many people.
September 6, 2007 — 8:38 am
RE Investor says:
Jeff,
I like the concept of (www.homeequityshare.com), but that is really only for new homebuyers. The problem is with the existing homebuyers that are upside down, and have mortgages they cannot refi out of, and they cannot sell for what they owe. They are only left with one way out, and that is foreclosure. Kind of sad, because from what I have seen, some of these borrowers are trustworthy, and live in areas that will appreciate in the future. They just are dealing with a banking system that does not even seem to care about their own self interest or that of the borrower.
September 6, 2007 — 9:43 am
Jeff Langholz says:
RE Investor: Thanks for your comment. I agree that many of the existing homeowners are in a sad situation, especially when a foreclosure looms. We’re pleased that a large percentage of the folks using our website are exactly this kind of person. They can’t sell 100% of their house given the slow market, so they sell a percentage of it to an investor partner. This gets the owner’s monthly payments back down to an affordable range. The owner can sleep at night instead of worrying about losing his/her home. There’s a risk of predatory practices here by unscrupulous investors, so we provide free tools to make sure the co-ownership arrangement is safe and fair. This isn’t a solution for everyone, but it sure can help a lot of folks out of a jam.
September 12, 2007 — 9:32 pm