– Yet instead of taxpayers making a cash gift to lenders to temporarily cut borrowers' repayments, the government would effectively 'buy-out' or refinance 25 per cent of the reset traditional loan by swapping that portion of the debt with a taxpayer-funded 'shared equity' loan (this could be achieved by simply having the borrower pay down 25 per cent of the reset traditional loan with the funds they receive from the government).
– Importantly, the shared equity loan carries no monthly repayments whatsoever during its maximum 30 year life. In exchange for the shared equity finance, taxpayers would receive half of the property's future capital growth in lieu of interest when the home owner elects to repay the loan either on refinancing or sale of the property (this contrasts starkly with the Administration's program where taxpayers currently get nothing in return for their $75 billion bailout). However, the shared equity lender (viz, taxpayers) formally own no legal interest in the home since the instrument is structured using a traditional mortgage contract; the owner therefore retains control over what they do with the property in the future as they would under any other loan.
– The traditional lender is now left with a dramatically lower (and hence less risky) 75 per cent LTV. They are also directly paid 25 per cent of the face value of their reset loan by the government and hence get the benefit of a significant cash injection – which, as I show below, is worth about $77 billion – onto their balance-sheets (this constitutes a much needed recapitalisation for the banks).
– The borrower is now only paying a full rate of interest on a home loan that is just 65 per cent of its original value. Thus they benefit from a permanent 35 per cent reduction in their interest and principal repayments over the 30 year life of the loan package. In contrast, the reduction in repayments realised by borrowers under the Administration's current proposal only lasts five years – after which rates are ratcheted back up, thereby once again raising the risk of 'redefault'.
– Assuming that overall house prices increase at a rate no greater than nominal GDP during the next 30 years, which given the recent 25 per cent correction seems like a defendable expectation, taxpayers could expect to earn an 5-10 per cent annualised, ungeared rate of return on their equity investments, which is dramatically superior to the 100 per cent losses that they will realise on their $75 billion 'gift' to distressed borrowers under the Administration's current plan.
– How much would this cost? According to the Mortgage Bankers' Association, 6.6 per cent of the circa $11 trillion of US home loans are currently estimated to be in 60 days or more arrears. Assume that half of these borrowers will go into foreclosure and need to access this new debt for equity swap program. That gives $363 billion worth of loans in extreme distress. If the average LTV is 115 per cent and the lender wears a 15 per cent write-down then the total value of the reset debt would be about $309 billion.
– A 25 per cent debt for equity swap program would therefore cost taxpayers roughly $77 billion, which, coincidentally, is almost exactly the same amount of money that the President has set aside for his housing package.
– The unique benefits of the plan include the fact that once the properties are sold and the shared equity loans repaid, the government can recycle the capital to assist new households in distress.
– That is, the $77 billion housing equity fund could be used by the government on a recycled basis to reduce the risk of families facing foreclosure in perpetuity (as opposed to the current once-off 'cash splash'). And since traditional lenders are avoiding foreclosure and the associated losses, there is an argument for them to contribute to the plan in the longer-term.
– The performance of this first generation equity portfolio would help build the foundations for the development of a wider market in private equity finance that could reduce the risk of excessive household leverage in the future. In particular, the returns realised on these loans and the timing of the cash-flows would resolve many questions that have prevented these markets from emerging previously. And definitive resolution of the tax and legal treatment of these instruments as part of the plan would remove one of their key impediments in the US.
Private and publicly-funded markets in housing equity now exist in Australia, NZ, and the UK. Indeed, Australian research and practical experience have been explicitly used as a guide for several billion dollars worth of government investment in public-sector shared equity initiatives in the UK and NZ, which are helping thousands of families deleverage.
Combined with the fact that leading US academics, including Ian Ayers and Barry Nalebuff at Yale, Luigi Zingales at the University of Chicago, Edward Glaeser at Harvard, and Andrew Caplin at NYU, have all recently made similar calls for the US government to help borrowers swap a portion of their housing debt for equity, it is hard not to acknowledge that there is immense merit to this plan.
Nobody has a monopoly on good ideas. And nobody would begrudge the Administration for seeking to refine their solutions to this calamity. I just hope Larry Summers, Shaun Donovan, Timothy Geithner and Austin Goosblee have the humility and foresight to listen. Because guys, what you are currently proposing to implement will almost certainly set the US economy on a long-term course towards permanent irrelevance.
If truth be known, I feel helpless because I doubt very much whether they will listen. I have been told by influential US stakeholders that it is all too late. And it distresses me deeply to see the much-vaunted Obama Administration make precisely the same ill-conceived and vested missteps as its predecessors.
But let me be clear – the debt for equity swap program outlined above is the only hope US policymakers currently have of marrying long-term relief for distressed families with much more fundamental reform.
Christopher Joye is managing director of research group Rismark International which produces the RP Data-Rismark Hedonic House Price Indices. He recently presented to the Obama Administration at the Transforming America's Housing Policy summit in New York. Thanks to Adam Gordon for assisting with the development of this proposal.
(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).
1
1
1
