WillPatching.com

Ok, let’s assume the proposal to spend $700 billion of taxpayers’ future earnings to prop up the sagging US economy will be approved by the House of Representatives even though there are still plenty of people who doubt the effectiveness of the Fed’s solution. Is there a better way to solve this problem?

George Soros has an idea worth considering – an idea that would, of course, allow him to benefit personally.

The Soros plan would probably work too, and while it would help him and his billionaire chums trouser yet more cash it would not help hard pressed homeowners. Not that they seem to be of any concern to the policy wonks in the Fed.

Unfortunately the economic numbskulls who lead the US are ignoring the experts who really understand the nature of this crisis, and have decided instead to turn the situation into a political jamboree: they have watered down the rescue plan and turned it into a general stimulus package that includes incentives for developing renewable energy and the like.

Er, what has sustainable energy got to do with the sub-prime induced credit crunch?

Well nothing.

Inclusion of this and other irrelevant measures are sweeteners to the various lobbyists whose pet politicians are determined to grab a piece of the action. After all there’s $700 billion up for grabs! What do they care that their favoured projects have nothing to do with the financial meltdown we are witnessing? It’s too complicated for them to comprehend anyway…

Or is it?

Delinquent mortgages

Mortgage defaults are the key to this whole mess. Period.

Bankers around the world are scratching their heads over a simple conundrum: they are finding it almost impossible to put an accurate value on the myriad securitized portfolios of US domestic mortgages that were bundled up and sold on to them. The bankers are wondering exactly what these assets are currently worth.

Worse, they don’t know how many of the underlying loans are truly toxic. They can’t say how many of these sub-prime time-bombs will blow up as more and more mortgagees toss the keys and walk away from their homes rather than struggling to pay inflated monthly instalments on assets nose-diving in value.

And with house prices falling so fast the only way to stop this crisis of confidence - and the domino effect that’s toppling banks around the world – is to shore up the value of the underlying asset base: US home prices.

But how do you do that when there is an oversupply of housing, a credit squeeze preventing any upswing in the market, and a likely 15% overpricing compared with historical figures due to the house price bubble still working its way out of the system? Oh, and you have some 10 million mortgaged properties in negative equity already… a figure that could double if the property market drops a further 15% back to ‘equilibrium’.

Looks like Bush was right for once: this sucker’s going down…

Wait a minute though. Forget George Soros and the existing TARP plan… What if the $700 billion dollars was redirected and used for a federally funded partial home purchase scheme for owner occupiers?

What’s that? Sounds complicated…

It is not.

Striking the root cause: stopping the defaults

Here is an example:

Let’s say someone bought a house last year for $300,000 with a 100% loan. The property is now valued at $240,000 and the homeowner has been hit by a hike in interest rates and can’t afford the mortgage repayments. He’s about to walk away.

Suppose the government immediately offers to buy a fifty percent stake in the property from the struggling homeowner by paying off exactly half the outstanding mortgage on their home, regardless of current market value.

No appraisal, no delay, just a straightforward payment to the lender.

So for $150,000 the government (ie the taxpayer) becomes a joint owner of the home, but holds an equity share valued at only $120,000. An instant loss of $30,000 doesn’t sound like a great deal for the taxpayer does it?

But, hold on…

The immediate impact on the homeowner is a reduction in mortgage payments by half. He’s very happy to pay the reduced amount as he would have to fork out rent if he moved elsewhere anyway, and so he decides to stay in his home instead of walking away.

This means there is one less distressed property crashing onto the market. If this scenario is repeated enough times the deflationary pressure on house prices from repossessions will evaporate, halting the downward spiral in home prices – benefiting all homeowners and eventually all taxpayers.

The really good news is that the homeowner still has somewhere to live and an incentive to pay the substantially reduced mortgage as any upswing in property prices will also benefit him – he still owns a fifty percent stake in his home.

Meanwhile, the taxpayer also owns fifty percent of the property. Although there will initially be a paper loss of $30,000 as the house is worth less than the total invested, a recovery in the market will eventually bring the value back up to par. Any capital growth beyond par value will ultimately benefit the taxpayer.

That’s ok for homeowners but does this idea help the banks?

In our example above the lending institution is delighted as it gets $150,000 in cash from the government immediately – ie half the troubled mortgage. What’s more, it does not suffer the huge write down a foreclosure would inevitably bring about – usually 60 to 80 cents on the dollar.

So it’s a double whammy for the banking system: cash now and immediate relief for a high risk loan resulting in a minimized potential write down. What’s more, as the homeowner can genuinely afford the reduced monthly payments the loan is no longer sub-prime.

If this scenario was repeated a few million times over the knock on effect would eliminate the toxic nature of the securitized mortgage portfolios, stabilizing money markets worldwide.

This amount of government money entering the mortgage market would free up seized capital flows, allowing the banks to lend again, thereby underpinning the housing market and easing the squeeze. House prices would stabilize. People would start spending. The economy would rebound rather than tipping into recession-depression.

All this could be done for the $700 billion Paulson wants to spend bailing out his fat cat mates…

Sounds like social housing to me

This is not a suggestion for a fundamental shift in US political thinking but an emergency measure to stabilize the markets. OK, so now the taxpayer owns a fifty percent share in several million properties across the US. Hardly a ‘free market’ solution but a practical one and frankly the recent Fannie, Freddie and AIG nationalisations have rather tainted the free market credentials of the US…

The critical question is really this: how does the government get the taxpayers’ money back – and when?

It will be natural for the homeowner to want to buy his home outright as soon as is practical, so we need a tie-in period to keep individuals from profiteering if there is a quick market recovery inflating property prices.

The minimum term for the equity share could be, say, three years with a maximum of ten. Anytime during that seven year period the homeowner could refinance to raise the cash to buy back the fifty percent from the government at current market price – subject to a minimum repayment equivalent to the sum paid at the outset ($150,000 in our example).

Simple enough?

But what if the homeowner wants to move?

Well, within the first three years the government would have the right to buy the remaining fifty percent by paying off the outstanding mortgage regardless of market value.

After three years the homeowner could sell the house on to a third party and the government would receive 50% of the price paid by the purchaser.

If the market has still not recovered the full value and the sales price would result in the government receiving less than the sum paid at the outset then it would have the right to buy the remaining fifty percent of the property at market price.

Buy the whole property? Then what?

The government would sell the home on to an injured war veteran with a subsidized government mortgage… Who else deserves a helping hand more than them? But of course, that’s an entirely different story.

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