How The Government Can Save The American Homeowner (From The Government)

I like that Jennifer Monastero is thinking about how the government might intervene in the housing/lending crisis and stop the bleeding.

I was surprised that few people actually had an opinion about her ideas.  It seems that bloggers (and commenters) love to point out what is broken but shirk from the burden of HOW we might fix this problem.  I commend Jennifer for starting such a discussion.  Here’s what I’m thinking.

Specifically, I love the idea of her third suggestion:

Allow borrowers to refinance their homes without requiring an appraisal.

The challenge will be to get lenders to act upon it.  Most lenders will look at each other, like children about to dive off a steep cliff, and say “You go first.”  In general, I think that government is a problem rather than a solution to market forces, so…

Here’s a little idea I had about how to alleviate some of the pressure the American homeowner is feeling. I conceived this plan about ten months ago, on Bloodhound Blog.  Essentially, it allows the Government to lend any homeowner up to 30% of his outstanding liens…WITHOUT disrupting the balance sheet of the US Treasury.  An excerpt:

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.

How is this a zero-sum proposition for the US balance sheet?  Read on; there ain’t no such thing as a free lunch.  You have to bet that the real estate market is going to appreciate 30%, over the next 20-30 years. If you’re wrong, you may forfeit your social security benefits:

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.

In which do you place greater confidence?  A real estate recovery equivalent to 1-2% per annum or the reliability of the social security entitlement program?   More importantly, do you think you should be entrusted to make the proper decision with your retirement money or does the Government know what’s best for you?

Read the whole article on BloodhoundBlog; the comments offer a most interesting discussion.

January 12, 2009