- Jun 6, 2007
- 852
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Its crystal clear Washington needs to fix Americas credit markets and solve the nations foreclosure problem. To fix the credit problem, the toxic assets have to be taken off our nations banks books and they have to be appropriately injected with capital. As for the latter capital injection, the task is obvious, the Treasury and the Federal Reserve Bank are going to have supply it. Getting toxic assets off banks books and bringing about an end to the flood of foreclosures present the bigger but surmountable challenges. In solving these problems the government must zealously adhere to the principle that the bill to fix these problems is not going to be stuck on the U.S. taxpayers which is doable if the government acts with wisdom and character. In crafting solutions to these problems, the government should utilize the fact that the problems are linked, e.g.. many of the mortgages that are in danger of foreclosure are owned by the banks and held in the form of what is called toxic mortgage-backed securities. Another thing the government should keep in mind is that no one can know the total economic losses from all the toxic assets on the nations banks balance sheets, God himself couldnt come up with the numbers because of the variables involved, so put off the complete reconciling of this bill to the banks until ten, fifteen, twenty years or the like from now when these ultimate costs are known. Another thing the U.S. government should remember is that it has enormous power over banks (e.g. their recent actions with Citibank, Bank of America and Washington Mutual clearly show this) it should use that power boldly to solve the industrys problems for the America people not cowering to those that have vested interests in this industry. On the home foreclosure crisis, large portions of the American people and especially leaders of the American people are going to have to accept that quite a high number of American people are going to have to lose their homes because they cannot afford them even with helpful (responsible) government programs in part because they should not have been given their loans in the first place because they could not afford to pay them back and in part because of their permanent wage losses (because of their recession job losses) which causes them to permanently no longer be able to afford their home; Washington needs to be focusing its efforts on creating the environment where these houses can be sold and the displaced Americans can find new housing in what would be described as in a good and expeditious manner.
On the removal of toxic assets from banks books problem, the government should pursue the oft-mentioned Bad Bank idea. The bad bank idea consists of the following. A Bad Bank is created by the government and the government gives it a stake of like $200 billion dollars and authorizes it to sell U.S. government backed bonds so it can raise more money to fulfill its function of taking toxic assets off the nations banks books. Government Regulators go to each bank in the nations banking system, and with or without the assistance of the banks executives, identify toxic assets (or assets in real danger of significant devaluation or causing significant monetary loss to the bank) and bring in the Bad Bank to take these assets off the banks books; the Bad Bank does this by buying the toxic assets from the bank or in the case of assets which are more likely liabilities, like swaps, putting limits on the banks liability. With respect to the commonly raised issue of banks capital levels falling from this action, the government should handle this problem in the following matter. Say a bank has toxic assets with a book value of $5 billion and the bad bank values these toxic assets at $2.5 billion dollars, the bad bank gives the bank $2.5 dollars and buys preferred shares in the bank for the balance of the book value which in this case is $2.5 billion dollars with the yearly interest rate being .75 % higher that the rate the Bad Bank pays on the bonds it issues to raise money and in any event 5.0 % maximum, in this way the bank has the same amount of capital, essentially, in other words the bank is always being made whole. Morover, to alleviate the pressure on the bank from paying the interest on the preferred shares, permit the bank at the banks discretion to postpone the interest rate payment on these preferred shares up to seven years and to avoid the public being taken advantage of require that the bank cant increase the banks shareholder dividend or top executive compensation above the inflation rate during the postponement time. In addition, five, ten, twenty years from now when the Bad Bank knows definitively the actual value of these toxic assets, if the actual value exceeded the paid value for the assets by over fifteen percent, the Bad Bank will pay this exceeded amount to the bank if the actual value is below paid value the bank pays nothing to the Bad Bank. In regard to the Bad Banks challenge of valuing these toxic assets, of course the Bad Bank will try to fairly and accurately determine the practical value of these assets, nevertheless the government needs a mechanism so U.S. taxpayers will not get stuck with the bill paying for these toxic assets and this mechanism is bank equity, recent government initiatives have pursued stock warrants as the means of getting equity, this means suffices. The bad bank should take, subject to bank regulators approval, an amount of equity to insure that the bad bank doesnt lose any money in this cleansing of the banks books and a premium to pay for this whole rescue of the financial industry that has been going on over the past year and clearly is only part way complete. The premium will be set at a maximum of a banks overall equity of something like 5% for big banks, 15% for middle size banks and 33% for small banks. With respect to this non-premium equity when this five, ten, twenty year account reconciling date comes, the Bad Bank can return to the bank any non-premium equity in excess of the value that the Bad Banks needs to cover the costs incurred to cleanse the bank. With respect to toxic assets that are likely liabilities like swaps, the bad bank can do a Citibank and a Bank of America type of solution to these problems limiting the banks liabilities and again the Bad Bank will be getting equity from the bank to cover the ultimate losses it occurs with such assets.
The one thing that the U.S. government regulators should do immediately and there has been an abundance of commentary about doing it long term, is put immediate restrictions on banks entering into swaps of all kinds whether it be credit-default, currency or index swaps to name a few. Swap investing holds such financially devastating potential liability for a bank; what is the point of recapitalizing the nations banks if they quickly become crippled again engaging in such dangerous activity. It would be ideal if such swap activity could be banned outright, nevertheless, it should at least be limited in so far as the maximum liability a bank is permitted to potentially incur in overall swap investing and on an individual swap. Specifically, the limit should be like a bank is not permitted to hold swaps that pose more of a potential liability than fifteen percent of the capital that a bank can afford to lose and still be a bank in good standing; and on an individual swap, the terms of the swap must maximize liability at twenty percent of whatever the swaps measure is, if its a credit default swap the counterpartys liability is limited to twenty percent of the value of the bond or loan, if its a currency swap when the currency drops twenty-percent in value that is the limit for generating liability, etc.. The reason for the former restriction is obvious and the latter for, in part, to protect banks financial stability (history is showing one groups of swaps going south can dramatically affect the well-being of a bank).
On the foreclosure crisis problem do the following. The specific problems on this matter are that lenders are not modifying their mortgage loan agreements in a satisfactory matter. High numbers of mortgages are not being modified at all. On other mortgages, the modifications are producing a monthly mortgage payment that is too high (onerous) and thus unaffordable. On some mortgages, the borrower is so underwater (loan principle owed higher than the value of the burrowers house) even with the modification there is no incentive on the mortgage burrower not to default on the loan. On many loans, the loan service provider does not have the authority to modify the interest/principle terms of the loan. As referenced earlier there is no responsible solution that isnt going to see a significant increase in foreclosures over the next year because some borrowers cant afford their homes the government should just be seeking here to see the nation through this adjustment period quickly, like twelve months quickly, and get the housing and the connected home construction industries operating normally again.
The solution here is to essentially implement a program idea created by the FDIC, which is have the government create a program where if lenders will modify their loans in a favorable manner the government will split any ultimate principle loss the lender will experience on an ultimate default on the loan. The appeal of this program is not only the loan insurance qualities of the program but also that it will produce affordable monthly mortgage payments for borrowers, immediately or quickly give them equity in the property and as best that is possible tries to compensate and reimburse lenders for the monies they lent the borrower with respect to the loan. The government pays for this program by giving this program a stake of money and giving the government unique equity rights and taxing rights with respect to the homes that enter this program which will allow the government to funnel monies coming from these rights back to the program as the program needs. One key element of this program is that it will require lenders to make a loan modification that results in a monthly mortgage payment that is no greater than 33 % of the borrowers current income (or an adjusted income for qualifying borrowers). The consensus amongst the experts seems to be that this is about the tipping point where mortgages higher than 33% tend to be unaffordable and result in high rates of delinquency. Another key element of the program is that participating loans have to be modified so that the interest rate is fixed otherwise borrowers will experience interest rate resets and thus increased monthly mortgage payment increases and history tells us this causes mortgage defaults. The program will require the lender to waive all past late fees and late penalties incurred prior to entering the program however the borrower will still be liable for any past unpaid mortgage payments that involve interest and principle payments. The program will guarantee that participating loans will be modified so that the borrower will be guaranteed at least thirty percent of the profit when the home is sold. The maximum term on participating loans after modification will be forty years. The program must come up with fair numbers on what consists of fair late fees and penalties and make it mandatory on participating loans. The program must require that on loans where the principle amount is greater than ninety-five percent of the value of the property the lender reduce the loan principle amount down to this ninety-five percent value figure.
The program should come up with different set types of loan modification formats. This is part of the crucial value of the program, lenders will have to select one of these set types of loan modification formats which will have fair terms so that everyone is insured there is a fair loan modification agreement being put in place. On all types of loan modification formats, the U.S. government is granted twenty percent of the profit when the home is sold (and no equity by the borrower can be taken out of the home for ten years from the time the loan enters the program and once that action by the borrower occurs this twenty percent of the profits figure is due with the market value of the property at that time being used to compute the profit). One type of loan modification format is the principle reduction format, this is the type where the lender forgives the portion of the principle above ninety-five percent of the value of the property. The lender is compensated for this by the program giving the lender a percentage of the profit from the property when the property is sold. This percentage is the percentage of the amount of the principle forgiven compared to the market value of the property to a maximum of fifty percent of the profits. Another type is the interest reduction format this is the type of where the lender reduces the interest on the loan. The lender should be compensated for this by giving the lender a percentage of the profit when the property is sold. The lenders percentage should be the percentage of the present value of all the interest monies that the lender is giving up over the course of the balance of the loan if the loan agreement was enforced as originally written compared with the current value of the property; for adjustable rate mortgages the government should come up with some average from the history of the U.S mortgage industry for computation purposes.
One important catch for this whole program is that not every borrower will qualify. Only borrowers will qualify where the monthly mortgage payment on the modified mortgage does not exceed thirty-three percent of the burrowers current income (or for qualifying burrowers an adjusted income figure) or if they meet the theoretical requirements which are on a mortgage consisting of an interest rate of 4.5 % fixed, a 40 year term period and a principle equal to ninety-five percent of the present market value of the borrowers home the resulting monthly mortgage payment does not does not exceed thirty-three percent of the burrowers currently monthly income (or for qualifying burrowers an adjusted income figure). An adjusted income participant could be one where the government sets up the following program. For middle and lower economic Americans the government could subsidize their mortgages under the following conditions. One knows that with inflation incomes will increase over time and inflation generally runs around 2.5 % per year so using that 2.5 % figure compute what that burrowers income will be at five years from now and use that income for the threshold analysis. Of course in order for the program to work, the government will have to pay the lender the difference between thirty-three percent of the burrowers actual income and the required mortgage payment for five years, but beginning in January 2011 on a yearly basis the government could require all borrowers to re-qualify and probably many burrowers will have incomes that increased sufficiently so that the required monthly mortgage payment will not exceed the 33 % of their current income so these borrowers will no longer need to be subsidized. For layed-off burrowers the program could defer final decision on their acceptance into the program until after the borrower gets a full-time permanent job in his or her field.
Another catch with this program is one designed to address the fears that people across America will just start not paying on their mortgages to avail themselves loan modification benefits of this program. The catch is that if a borrower participates in the program, when the borrower sells the borrowers home the capital gains tax will be increased by fifteen percent, if the borrower is not eligible for the capital gains tax there will still be a fifteen percent charge on profits going to the government and even if the borrower just rolls over the property there will still be this fifteen percent charge on profits.
The final major points are that if the government through the Bad Bank initiative acquires large scale ownership of mortgages through the toxic asset purchases the government can just mandate the mortgage service lenders servicing these loans participate in this loan modification with back-stop program. Moreover, with respect to the banking, investing and loan servicing entities who have thus far been unable or unwilling to put together good loan modifications, the government (and I am sure it would sail through Congress) can just mandate that the foreclosure process is not open to any lender whose mortgage is eligible for this program and whose burrower agrees to the program. Such actions should bring about large-scale good modifications to troubled mortgages in America and solve Americas problem here.
On the removal of toxic assets from banks books problem, the government should pursue the oft-mentioned Bad Bank idea. The bad bank idea consists of the following. A Bad Bank is created by the government and the government gives it a stake of like $200 billion dollars and authorizes it to sell U.S. government backed bonds so it can raise more money to fulfill its function of taking toxic assets off the nations banks books. Government Regulators go to each bank in the nations banking system, and with or without the assistance of the banks executives, identify toxic assets (or assets in real danger of significant devaluation or causing significant monetary loss to the bank) and bring in the Bad Bank to take these assets off the banks books; the Bad Bank does this by buying the toxic assets from the bank or in the case of assets which are more likely liabilities, like swaps, putting limits on the banks liability. With respect to the commonly raised issue of banks capital levels falling from this action, the government should handle this problem in the following matter. Say a bank has toxic assets with a book value of $5 billion and the bad bank values these toxic assets at $2.5 billion dollars, the bad bank gives the bank $2.5 dollars and buys preferred shares in the bank for the balance of the book value which in this case is $2.5 billion dollars with the yearly interest rate being .75 % higher that the rate the Bad Bank pays on the bonds it issues to raise money and in any event 5.0 % maximum, in this way the bank has the same amount of capital, essentially, in other words the bank is always being made whole. Morover, to alleviate the pressure on the bank from paying the interest on the preferred shares, permit the bank at the banks discretion to postpone the interest rate payment on these preferred shares up to seven years and to avoid the public being taken advantage of require that the bank cant increase the banks shareholder dividend or top executive compensation above the inflation rate during the postponement time. In addition, five, ten, twenty years from now when the Bad Bank knows definitively the actual value of these toxic assets, if the actual value exceeded the paid value for the assets by over fifteen percent, the Bad Bank will pay this exceeded amount to the bank if the actual value is below paid value the bank pays nothing to the Bad Bank. In regard to the Bad Banks challenge of valuing these toxic assets, of course the Bad Bank will try to fairly and accurately determine the practical value of these assets, nevertheless the government needs a mechanism so U.S. taxpayers will not get stuck with the bill paying for these toxic assets and this mechanism is bank equity, recent government initiatives have pursued stock warrants as the means of getting equity, this means suffices. The bad bank should take, subject to bank regulators approval, an amount of equity to insure that the bad bank doesnt lose any money in this cleansing of the banks books and a premium to pay for this whole rescue of the financial industry that has been going on over the past year and clearly is only part way complete. The premium will be set at a maximum of a banks overall equity of something like 5% for big banks, 15% for middle size banks and 33% for small banks. With respect to this non-premium equity when this five, ten, twenty year account reconciling date comes, the Bad Bank can return to the bank any non-premium equity in excess of the value that the Bad Banks needs to cover the costs incurred to cleanse the bank. With respect to toxic assets that are likely liabilities like swaps, the bad bank can do a Citibank and a Bank of America type of solution to these problems limiting the banks liabilities and again the Bad Bank will be getting equity from the bank to cover the ultimate losses it occurs with such assets.
The one thing that the U.S. government regulators should do immediately and there has been an abundance of commentary about doing it long term, is put immediate restrictions on banks entering into swaps of all kinds whether it be credit-default, currency or index swaps to name a few. Swap investing holds such financially devastating potential liability for a bank; what is the point of recapitalizing the nations banks if they quickly become crippled again engaging in such dangerous activity. It would be ideal if such swap activity could be banned outright, nevertheless, it should at least be limited in so far as the maximum liability a bank is permitted to potentially incur in overall swap investing and on an individual swap. Specifically, the limit should be like a bank is not permitted to hold swaps that pose more of a potential liability than fifteen percent of the capital that a bank can afford to lose and still be a bank in good standing; and on an individual swap, the terms of the swap must maximize liability at twenty percent of whatever the swaps measure is, if its a credit default swap the counterpartys liability is limited to twenty percent of the value of the bond or loan, if its a currency swap when the currency drops twenty-percent in value that is the limit for generating liability, etc.. The reason for the former restriction is obvious and the latter for, in part, to protect banks financial stability (history is showing one groups of swaps going south can dramatically affect the well-being of a bank).
On the foreclosure crisis problem do the following. The specific problems on this matter are that lenders are not modifying their mortgage loan agreements in a satisfactory matter. High numbers of mortgages are not being modified at all. On other mortgages, the modifications are producing a monthly mortgage payment that is too high (onerous) and thus unaffordable. On some mortgages, the borrower is so underwater (loan principle owed higher than the value of the burrowers house) even with the modification there is no incentive on the mortgage burrower not to default on the loan. On many loans, the loan service provider does not have the authority to modify the interest/principle terms of the loan. As referenced earlier there is no responsible solution that isnt going to see a significant increase in foreclosures over the next year because some borrowers cant afford their homes the government should just be seeking here to see the nation through this adjustment period quickly, like twelve months quickly, and get the housing and the connected home construction industries operating normally again.
The solution here is to essentially implement a program idea created by the FDIC, which is have the government create a program where if lenders will modify their loans in a favorable manner the government will split any ultimate principle loss the lender will experience on an ultimate default on the loan. The appeal of this program is not only the loan insurance qualities of the program but also that it will produce affordable monthly mortgage payments for borrowers, immediately or quickly give them equity in the property and as best that is possible tries to compensate and reimburse lenders for the monies they lent the borrower with respect to the loan. The government pays for this program by giving this program a stake of money and giving the government unique equity rights and taxing rights with respect to the homes that enter this program which will allow the government to funnel monies coming from these rights back to the program as the program needs. One key element of this program is that it will require lenders to make a loan modification that results in a monthly mortgage payment that is no greater than 33 % of the borrowers current income (or an adjusted income for qualifying borrowers). The consensus amongst the experts seems to be that this is about the tipping point where mortgages higher than 33% tend to be unaffordable and result in high rates of delinquency. Another key element of the program is that participating loans have to be modified so that the interest rate is fixed otherwise borrowers will experience interest rate resets and thus increased monthly mortgage payment increases and history tells us this causes mortgage defaults. The program will require the lender to waive all past late fees and late penalties incurred prior to entering the program however the borrower will still be liable for any past unpaid mortgage payments that involve interest and principle payments. The program will guarantee that participating loans will be modified so that the borrower will be guaranteed at least thirty percent of the profit when the home is sold. The maximum term on participating loans after modification will be forty years. The program must come up with fair numbers on what consists of fair late fees and penalties and make it mandatory on participating loans. The program must require that on loans where the principle amount is greater than ninety-five percent of the value of the property the lender reduce the loan principle amount down to this ninety-five percent value figure.
The program should come up with different set types of loan modification formats. This is part of the crucial value of the program, lenders will have to select one of these set types of loan modification formats which will have fair terms so that everyone is insured there is a fair loan modification agreement being put in place. On all types of loan modification formats, the U.S. government is granted twenty percent of the profit when the home is sold (and no equity by the borrower can be taken out of the home for ten years from the time the loan enters the program and once that action by the borrower occurs this twenty percent of the profits figure is due with the market value of the property at that time being used to compute the profit). One type of loan modification format is the principle reduction format, this is the type where the lender forgives the portion of the principle above ninety-five percent of the value of the property. The lender is compensated for this by the program giving the lender a percentage of the profit from the property when the property is sold. This percentage is the percentage of the amount of the principle forgiven compared to the market value of the property to a maximum of fifty percent of the profits. Another type is the interest reduction format this is the type of where the lender reduces the interest on the loan. The lender should be compensated for this by giving the lender a percentage of the profit when the property is sold. The lenders percentage should be the percentage of the present value of all the interest monies that the lender is giving up over the course of the balance of the loan if the loan agreement was enforced as originally written compared with the current value of the property; for adjustable rate mortgages the government should come up with some average from the history of the U.S mortgage industry for computation purposes.
One important catch for this whole program is that not every borrower will qualify. Only borrowers will qualify where the monthly mortgage payment on the modified mortgage does not exceed thirty-three percent of the burrowers current income (or for qualifying burrowers an adjusted income figure) or if they meet the theoretical requirements which are on a mortgage consisting of an interest rate of 4.5 % fixed, a 40 year term period and a principle equal to ninety-five percent of the present market value of the borrowers home the resulting monthly mortgage payment does not does not exceed thirty-three percent of the burrowers currently monthly income (or for qualifying burrowers an adjusted income figure). An adjusted income participant could be one where the government sets up the following program. For middle and lower economic Americans the government could subsidize their mortgages under the following conditions. One knows that with inflation incomes will increase over time and inflation generally runs around 2.5 % per year so using that 2.5 % figure compute what that burrowers income will be at five years from now and use that income for the threshold analysis. Of course in order for the program to work, the government will have to pay the lender the difference between thirty-three percent of the burrowers actual income and the required mortgage payment for five years, but beginning in January 2011 on a yearly basis the government could require all borrowers to re-qualify and probably many burrowers will have incomes that increased sufficiently so that the required monthly mortgage payment will not exceed the 33 % of their current income so these borrowers will no longer need to be subsidized. For layed-off burrowers the program could defer final decision on their acceptance into the program until after the borrower gets a full-time permanent job in his or her field.
Another catch with this program is one designed to address the fears that people across America will just start not paying on their mortgages to avail themselves loan modification benefits of this program. The catch is that if a borrower participates in the program, when the borrower sells the borrowers home the capital gains tax will be increased by fifteen percent, if the borrower is not eligible for the capital gains tax there will still be a fifteen percent charge on profits going to the government and even if the borrower just rolls over the property there will still be this fifteen percent charge on profits.
The final major points are that if the government through the Bad Bank initiative acquires large scale ownership of mortgages through the toxic asset purchases the government can just mandate the mortgage service lenders servicing these loans participate in this loan modification with back-stop program. Moreover, with respect to the banking, investing and loan servicing entities who have thus far been unable or unwilling to put together good loan modifications, the government (and I am sure it would sail through Congress) can just mandate that the foreclosure process is not open to any lender whose mortgage is eligible for this program and whose burrower agrees to the program. Such actions should bring about large-scale good modifications to troubled mortgages in America and solve Americas problem here.
