by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
When successful financiers achieve a certain level of success, they up the ante and practice social engineering. Robert Rubin, Jon Corzine, and Hank Paulson advanced to government service after piling up the pesos at Goldman Sachs (in financial circles, we say those two words with hushed reverence). After decades of whipping and driving the markets, the titans answer the call of noblesee oblige and decide to play with EVERYBODY’s money. While I haven’t risen to the austere positions Messrs Corzine, Rubin, and Paulson have, my friend Nick and I
have a little idea about how to save the American real estate market.
Let’s start with the premise that lenders are taking 20-30% hits on short sales. Then, let’s have the US Treasury loan 30% of the balance, of the aggregate debt, to homeowners whom request it, in order to pay down the first mortgage (or second mortgage). If I have $200,000, in aggregate liens against the property, the US Treasury will lend me $60,000, to pay down those aggregate liens, to $140,000. This reduces the lenders exposure.
What type of loan will the Treasury make to homeowners?
The term can be for the lesser of:
1- the remaining term of the first mortgage
2- 65 less the age of the primary borrower.
The interest rate can be the corresponding term treasury rate, plus .5% (for administrative costs). Maybe we can use some of that “yield spread” to coerce a few mortgage brokers to “originate” this government debt (okay, that was completely self-serving). For a 42 year old, with a 27 year term on his first mortgage, the term of this new government loan (in second position) would be 23 years (65-42=23). If a 23 year treasury bond yields 4.1%, than the note rate for the new loan will be 4.6%.
The borrowers never have to make a payment on this debt; it accrues like a negative amortization loan. In the aforementioned example, the balance would grow to about $168,000, after 23 years. With a first mortgage paid down to $140,000, we’re banking on the future value of the property growing to $308,000, by the year 2031.
When the house is sold or refinanced, the government loan is paid off. We’ve essentially solved the liquidity problem, bottomed the real estate decline, and “helped” real people by using government funds.
What if the borrower skates on the loan or short sells the property? Moreover, what if the real estate market NEVER comes back, and the property is never worth $308,000, in the next 23 years?
1- Make the remaining loan balance transferable to new properties.
2- If that lien is NEVER satisfied, deduct the balance from the year 2031 net present value of the borrower’s retirement entitlements’ account (social security and Medicare).
The program is completely optional.
This act will inspire confidence in the government-sponsored retirement entitlements programs; nobody under the age of 45 REALLY believes those programs will be there for them, anyway.
We can stop the housing price decline, put more discretionary income in the hands of homeowners (to spend us out of the recession), save millions of homeowners from foreclosure, and shore up the financial system of this country, all while inspiring a generation’s confidence in government retirement programs with the Real Estate Bailout Act of 2008.
Memo to Senators Mc Cain, Obama, and Clinton: While I’m certain some Goldman guy would sell this program to the American people more effectively, I’d consider a Cabinet position. Inquire within.
William J Archambault Jr says:
This reeks of age discrimination!
Bill
March 24, 2008 — 9:51 pm
Brian Brady says:
I don’t think so, Bill. You could “cash-out” current entitlement benefits, based on an actuarial figure, for those over 65.
March 24, 2008 — 10:12 pm
Cheryl Johnson says:
That could work …. I hope the Senators are reading here…
Here are a couple more details to address:
1. Would you require a certain “hardship threshold” or would the program be available to every property owner whether in default or not?
2. Primary residence only, or would you allow investment properties and second homes?
March 25, 2008 — 5:04 am
Brian Brady says:
No hardship but the collateral (future value of the entitlements) will most likely dictate that it will only work for one property.
Rather than allow people to “sprinkle” the government loans, the whole ball of wax has to go towards paying down exiting liens, so as to protect the first lienholder.
March 25, 2008 — 6:30 am
Thomas Johnson says:
I said that yesterday. Swapping bad mortgage debt for the treasuries in the Social Security lockbox- bad paper for bad paper-kick it down the road for the grandkids.
Half a point? The Goldman guys won’t go for it unless you can put 10 points in the back end yield spread, rate it AAA and leverage it 30:1!
March 25, 2008 — 7:10 am
Brian Brady says:
“Swapping bad mortgage debt for the treasuries in the Social Security lockbox”
I know you did, Thomas. It moved me to post this crazy idea.
My friend, Nick, a money manager in Houston, actually came up with the idea of accelerating the entitlements’ benefits some 3 weeks ago. I thought it would be better to use them as additional collateral against a govt-sponsored real estate loan.
When the S&Ls went down, in the late 80s, the RTC stepped in and securitized all the “bad paper”. Rates came down and banks got healthy- they just needed to buy some time. This idea could have similar consequences.
Your comment moved the idea along, Thomas. That’s what I love about BHB.
March 25, 2008 — 7:43 am
Sean Purcell says:
Brian,
Every now and then I smell smoke coming from over by your office, but I pay it little mind. Is this the result? Absolutely great idea
The housing market is saved, liquidity comes back to the market and those of us that believe the government safety net is full of holes can act on our belief. All summed up in a few paragraphs.
You better hope that your office never actually catches on fire, everyone will just assume you are solving the third world debt problem…
March 25, 2008 — 11:43 am
Matt says:
Your forgetting one vital thing, that shows a vital misunderstanding of bond markets. The government has to issue significant amounts of debt to pay for this program. The bond market gets one wiff of it, and it’ll ramp treasury costs through the roof as participants (particularly foreign participants) head for the hills. You want to see how fast we can go back to 8% yields on the 10 year?
March 25, 2008 — 12:05 pm
Doug Quance says:
It’s definitely an interesting proposal.
Obviously out-of-the-box.
March 25, 2008 — 12:17 pm
Brian Brady says:
I knew someone would bring that up, Matt. Remember, I used to trade these debts, in my former life. Think back to the positive effect the RTC bonds had on the Treasury market.
The opposite of what you suggest may happen. Why? Removing deferred liabilities from the Treasury’s balance sheet may suggest that the SSI deficit (expected in the 20s) is cured. Think of this plan as a “early retirement buyout”, like we’ve seen in the private sector.
Shoring up a balance sheet can be viewed as FIGHTING future inflation. We could see rates decline, then, like the RTC bonds issuance.
March 25, 2008 — 12:25 pm
Brian Brady says:
Remember, Matt- markets are discounting mechanisms.
March 25, 2008 — 12:27 pm
Matt says:
Wow, if that coming from a former debt trader the ignorance is truly stunning…
You would not see a positive reaction this time around, you have a VERY different dynamic in the market than you did 15 years ago. The US treasury market was not even remotely as reliant on foreign capital as it is now, and the amount of outstanding debt was not nearly to the scale it is today.
We’re already seeing a significant flight away from treasuries from by foreigners. The last three treasury auctions have been dismal failures. The last one of which only saw 5% of treasuries being sold to foreigners, compared to previous auctions where the majority was.
The reason yields have been compressed down is both a flight to safety, and the realization we’re actually up against some significant deflationary pressures, rather than inflation. There is a massive flight away from all types of paper (ABCP, ARS, agency, mbs, even muni paper) into treasuries resulting in widening yield spreads. As soon as the bond markets got one wiff that now treasuries are being backed by toxic waste (like they are in your plan), US treasuries will find themselves on the shit list. You’ll see a rapid exit of capital to non US debt, ramping US debt costs and crushing the dollar, even more than it already is.
March 25, 2008 — 12:40 pm
Matt says:
Brian, I’ll give you that, it is an innovative plan, much farther outside the box than most people are thinking. But it just wouldn’t work.
The problem is what we are facing right now, just can’t be made to “go away”. Markets have to bring themselves back into balance, which will include home prices dropping substantially from where they are now. Any attempts to intervene will simple make the final result worse.
March 25, 2008 — 12:47 pm
Brian Brady says:
Are you saying the future SSI/Medicare benefits are “toxic waste”, Matt?
March 25, 2008 — 2:58 pm
Brian Brady says:
Be patient with my last question, Matt…my ignorance must be showing
March 25, 2008 — 3:00 pm
Robert Kerr says:
So, the choices are:
a) Assume a neg amort from The Fed for the entire upside down $, which, if unpaid, will reduce your SS payments (a unequivocal lender bailout)
b) Walk away, let the lender eat the loss and take the FICO hit.
I just don’t see many people choosing a).
And I don’t agree that we should stop the price decline. In fact, we should be encouraging the reversion to mean to restore sustainable growth and health to the market.
March 25, 2008 — 4:14 pm
Phil Caulfield says:
Brian,
I’ve got some crazy ideas also that I posted on my blog on November 30th. My financial advisor friends said I was nuts back then, but I have heard some talk on CNBC about similar ideas.
Basically, my idea is to give a dollar for dollar tax credit to first time buyers for the size of the down payment. This will be a huge incentive to purchase and to encourage equity in the property ( I know this goes against most “mortgage planning” ideals, but I am approaching this from the perspective of getting the real estate market going again.
My other idea is to eliminate the cap on mortgage interest deductions. This will encourage buyers to trade up, especially in the higher cost areas.
There are a lot of political mine fields with these proposals, but we are helping the “little” guy with the tax credit and the “rich” with the elimination of the deduction cap on interest.
March 25, 2008 — 4:51 pm
Paul says:
1. If I think my house is going to double in value over the next 23 years, why would I put myself in the hole another $160k? Why not just let the house appreciate till I’m made whole and not even worry about being upside down?
2. Wouldn’t this plan basically nail you down in the same house for the next 23 years?
3. The new loan doesn’t dispense the old one, right? I’m still on the hook for paying off the original (new) principle balance of $140k PLUS the new, continually accruing one at 4%. Or am I misunderstanding something?
4. What happens if values continue to collapse AFTER I’ve gotten my Fed loan? Can I get a second one to make up the (new) difference?
March 25, 2008 — 5:30 pm
Brian Brady says:
Paul:
“1. If I think my house is going to double in value over the next 23 years, why would I put myself in the hole another $160k? Why not just let the house appreciate till I’m made whole and not even worry about being upside down?”
You’re not, the loan would be used to pay DOWN the existing liens.
“2. Wouldn’t this plan basically nail you down in the same house for the next 23 years?
Nope- reread paragraph 7”
“3. The new loan doesn’t dispense the old one, right? I’m still on the hook for paying off the original (new) principle balance of $140k PLUS the new, continually accruing one at 4%. Or am I misunderstanding something?”
The new loan pays down (or off) existing liens- The total indebtedness, against the property, wouldn’t change.
“4. What happens if values continue to collapse AFTER I’ve gotten my Fed loan? Can I get a second one to make up the (new) difference?”
The new first mortgage should be affordable while the new gov’t second defers. If the market collapses, and never appreciates over the remaining time (until you’re 65), you lose your SSI benefits (or have them reduced)
Again, this plan would be optional.
The new loan pays off or down the existing liens
March 25, 2008 — 7:36 pm
Brian Brady says:
Phil-
Please link to your 11-30 posts.
March 25, 2008 — 7:37 pm
Brian Brady says:
Robert-
Do you think residential real estate will be in a 15-20 year decline?
March 25, 2008 — 7:38 pm
Phil Caulfield says:
Here is a link to my 11/30/07 post.
http://jumboloanblog.com/?p=1
March 26, 2008 — 8:52 am
Robert Kerr says:
Do you think residential real estate will be in a 15-20 year decline?
Certainly not.
But I don’t think that’s the right question to be asking.
March 26, 2008 — 10:28 am
Brian Brady says:
“But I don’t think that’s the right question to be asking.”
Okay, that’s fair. How about this one (for everyone)?
Why can’t a borrower voluntarily access his gov’t-sponsored retirement account, today? Where’s the “moral hazard” in liberating HIS money, from the gov’t, today, so he can do what he wants with it?
March 26, 2008 — 1:02 pm
Robert Kerr says:
Why can’t a borrower voluntarily access his gov’t-sponsored retirement account, today? Where’s the “moral hazard” in liberating HIS money, from the gov’t, today, so he can do what he wants with it?
Well, for starters, the money’s not there. But, even if it were, do you want people blowing their retirement stipends?
What do you do when a few million elderly with no money and no retirement benefits hit the streets? Do you think society has the stomach for that kind of social suffering?
March 26, 2008 — 3:37 pm
Brian Brady says:
“Well, for starters, the money’s not there”
That’s the real answer, isn’t it? Everything you’ve said, after “BUT”, is immaterial.
Society WILL have to accept the fact that a generation will be living without their retirement stipends. If they were going to be there, only a true pessimist could argue against this plan. I’ll admit that I wrote it to paint the pessimists in a corner.
The only way it wouldn’t work is if both:
a- real estate didn’t appreciate at a 1% per annum clip, over the next 20 years.
b- the additional collateral; a 40 year old’s retirement stipend, won’t be there.
The plan isn’t inflationary. While demand for gov’t debt would rise, it’s paired off by reducing a future obligation, from the gov’t, to the borrower. What Matt doesn’t understand is that the expected liability (millions of pensioners), is already built into the yields offered in the long-term T-bonds, today. The market already knows about these retirement obligations.
The plan isn’t unfair nor does it create a great “moral hazard”. It’s the borrower’s money; his retirement money. He can pledge it as collateral for lump-sum gov’t loan, today.
It’s completely optional. Appropriate “scare disclosures” could be given to the borrower, advising him of the risk of a flat real estate market and gov’t mismanagement. The borrower either accepts that risk or he doesn’t.
I’m afraid I’ve painted the pessimists into a corner; they have to admit their pessimism (or realism). American real estate is on a long-term decline or the gov’t will be bankrupt, and unable to meet its obligations, in 2030.
In your case, Robert, you’ve stated that the answer to the former question is “Certainly not”. So I’ll follow up with this question:
Do you think the US gov’t will be bankrupt in 2030?
There is one other answer we haven’t considered. Jeff Brown brought it up 3-4 months ago. Bubble bloggers and pessimists have a compulsion to be correct; they WANT this economy to fail. Often, it’s because they were cautious while everyone else was being feckless. In Matt’s stated case, it’s because he’s betting on a real estate decline:
http://activerain.com/blogsview/392679/Selling-and-renting-your
I tended to agree with the pessimists…somewhat:
https://www.bloodhoundrealty.com/BloodhoundBlog/?p=2223
Today, I’m not so sure that I want to be right. Millions are suffering from this real estate market. Lenders have stopped lending. Two generations are doubtful of their retirement. If we can inspire confidence in our banking system, alleviate our neighbors’ misery, and assure 2 generations of the government’s stability, with little or no effect on the long-term health of our economy, doesn’t it make sense to set aside our personal pessimism?
March 26, 2008 — 4:58 pm
Robert Kerr says:
Ahh! You tricked me!
I thought you were going in a different direction with that. That’s an interesting viewpoint, Brian, even though I’m not on board with the intermediate or final conclusions.
Good job.
March 26, 2008 — 5:59 pm
sean carr says:
“Why can’t a borrower voluntarily access his gov’t-sponsored retirement account, today?”
Well, Washington panned on the idea of allowing us to exercise control over the investment of even a portion of our retirement funds, so allowing us to cash out seems a stretch. Will those of us who managed our finances a little better also be allowed to liberate our gov retirement money as well for investment? I would give up the rights to all future gov benefits simply in exchange for no longer paying in so that I could invest the savings. Amazingly, I believe I can outperform our astute representatives.
Why not simply let the market correct? It seems most of these toxic products originated during about a five year period. Let the market value them and we can all move on. Home values don’t need to be saved, home values need to be what the market will bear and what the fundamentals support. Can we really come up with any plan that will stop that from occurring eventually?
Additionally I think Matt is on target in that if the flight from the USD wasn’t bad enough already, what new pressures would the dollar face by pulling treasuries (further) into this mess? That’s an unknown not to be taken lightly.
One other comment; great post Brian and also excellent comments on this thread. This is certainly one of the more interesting proposals I’ve read, but also a good discussion on just how quickly the waters become murky when we start thinking about market manipulation.
March 26, 2008 — 6:02 pm
Brian Brady says:
Robert:
You get the big picture; always have.
Sean:
Good points. Let me try to give you my thoughts:
“Why not simply let the market correct?”
It has and it’s ugly. Lenders and Wall Street investors are getting hammered. One response is:
Tough crap. We aren’t here to protect Wall Street. I bought into that until I thought of the other possibility…which is
If Mama ain’t happy, ain’t nobody happy. Lenders are getting clipped for 30% of their principal ON WHAT WAS SUPPOSED TO BE A SAFE INVESTMENT. How are we going to get these guys to start lending money, again, if we let them fail, today?
“what new pressures would the dollar face by pulling treasuries (further) into this mess? That’s an unknown not to be taken lightly.”
Ehhh, really? Is it that bad? What’s really changed? Canadians are buying Arizona properties? Chinese toys are more expensive? Japanese gamblers stay in the Presidential suites in Vegas instead of an Iowa farmer?
…and I don’t buy the weaker dollar theory of this idea. Again, I think it’s a zero-sum game. We’re just taking money from one pocket and putting it into another; we’re accelerating the deferred liabilities.
March 26, 2008 — 6:54 pm