If Democrats and Republicans really want to save the economy, they should come together on a program to stabil-ize housing as a first step.
A number of proposals have been made and some adopted. But none have been enough to make much of an impact. What is needed is a bold program to get ahead of the curve and stabilize the situation.
The Republicans desperately want to make President Bush’s tax cuts permanent, but have little or no chance of succeeding.
This is too bad. Lower tax rates, particularly those for capital gains and dividends, are good economic policy. Maintaining them certainly won’t save the day. But eliminating them would be a step in the wrong direction.
Rep. Barney Frank and other Democrats have proposed a write-down of mortgages as a way to keep people in their homes. Republicans generally oppose this,it goes against the sanctity of contracts, helps only the chosen few and is much too limited to do much good anyway.
Grand Bargain
I propose a “grand bargain” where the Democrats and Republicans unite and make the Bush tax cuts permanent while enacting a broad, voluntary mortgage reduction plan along the line proposed by Frank, but much wider in scope.
The essentials of the plan:
n Participation is voluntary on the part of the borrower and lender on a loan by loan basis.
n Participating lenders would cut the face amount of the mortgage to 90% of the current market value of the house or building.
n The federal government would guarantee the top 10% of the new mortgages. This means that in the event of the future foreclosure, the government would bear the first loss up to 10% of the mortgage.
n Lenders would eliminate any prepayment penalties and reduce the interest rate to the average current mortgage rates on current Fannie Mae or Freddie Mac loans. These loans would be assumable and nonrecourse to the borrower.
n The lender or servicer would be exempt from any suits or legal challenges for making the modifications. They would not, however, be protected from shareholder suits because they did not make the
modifications.
n The borrower and lender each would pay a 1% fee to the government for the guarantee.
n There would be a special board with the power to make adjustments among the holders of different slices of the mortgages in the event loans are divided into tranches and syndicated. Parties claiming harm and seeking adjustments would bear this burden of proof of harm and have to deposit an upfront fee to cover the board’s costs. The idea would be to discourage claims except in the case where one party had clearly benefited at the other’s expense.
n This program would have a time limit of 18 months to initiate the modifications.
n The program could be limited to owner-occupied, single-family homes but is likely to be much more effective if it included investment properties and commercial real estate.
Such a program would stop foreclosures in their tracks. Lenders of loans in foreclosure would be crazy not to take advantage of this program. They would be extremely lucky to recover 90% or more through foreclosure and the modification would be much quicker and less expensive than foreclosure.
The lender would end up with a good loan on its books as the collateral would now have to drop 20% before it was impaired, and the new payments would be much more affordable to the borrower.
These loans likely would be readily sellable or could be held on the lenders’ books.
In the case where a loan is performing but is for more than the value of the house, the lenders’ self interest is less clear. In cases where the loan is only slightly underwater, and the borrower is relatively strong, the lender may not choose to modify the loan.
In cases where the differences between the home value and loan are greater, the lender would be prudent to take the hit and obtain the guarantee. In most cases, underwater loans already have been written down to less than collateral value.
The federal government or institutions it regulates likely will end up owning a significant portion of these securities through the financial bailout program.
Clear Winner
This program would be a clear winner for all borrowers, with their debts reduced and payments lowered. Even borrowers who still could not afford their loans would be able to sell their properties.
This would not be a costly program for the federal government. As it would be guaranteeing only the top 10% of the mortgages, the government’s potential risk is much less than other programs where it guarantees 100% of these loans.
The government would be receiving a substantial upfront fee of 20% of the amount of the guarantee. With the housing market stabilized, it may end up making a substantial profit. In any event, this program would cost a tiny fraction of the lost taxes if the housing market is not stabilized soon.
The biggest winner from this program would be the American public, who could avoid having to go through much of the forthcoming economic nastiness.
Saunders is a real estate investor and owner of London Coin Galleries Inc. in Newport Beach.
