There is a quick fix which will both rescue housing and rescue the economy.
Allow EVERYONE to go back to 80% financing of current market value even if they are underwater.
(Okay maybe not everyone limit it to homes of $1 million or less, primary residences, and impose a 31% of gross income affordability test)
1) Lenders should get EVERY loan re-appraised (not BPO’d) upon request of the borrower — and get three appraisals where the middle number applies. If the appraisal comes in at less than loan value the refinancing will pay for the appraisal. if not then the borrower.
2) Where the LTV ratio exceeds 111% (so the property is now worth 90% of the loan) the loan should be refinanced to the new appraised value provided that the borrower agrees to share the equity appreciation (above the appraised value used for the reset) with the lender. The new loan will have three pieces: a loan for 80% of current value (which will be current since the homeowner will pay) on the same terms as the original loan, a zero-interest loan for 20% of current value (essentially the current equity above the 80% loan), and a PARTICIPATION interest in future appreciation. The sharing should be as follows:
a) a lien is created for 25% of the increase in the value of the home above the appraised value calculated as of the fifth anniversary of the loan — this lien is tied to the zero interest (20% of current value) portion of the loan. On the fifth anniversary the lien converts to a zero coupon five year loan with interest calculated at the US Government five year borrowing cost.
b) a second lien is created for 25% of the increase in the value of the home above the appraised value calculated as of the fifth anniversary of the loan. On the fifth anniversary the lien converts to a zero coupon five year loan with interest calculated at the US Government five year borrowing cost. This lien can be kept by the lender or transferred to the US Government in return for a put option on the 80% portion of the loan good at face value on the fifth anniversary date.
3) Lenders should process these refinancings in the same manner as short sales.
4) Lenders must participate in the program on an all or nothing basis regarding their existing loans. The US Government will only take part in the put option program described in 2b above if the lender agrees to approve all qualifying refinancing requests submitted per the rules of the program.
5) Where properties have multiple liens — the first lien holder should be treated as primary debt up to 80% of the current appraised value. All liens in excess of 80% of current appraised value should be treated equally dollar for dollar.
Liquidity is created: the participations can be pooled and sold as securities, the zero interest loans can be pooled and sold as securities, once the 80% loans have either been current for 12 months or have the put option attached they too can be pooled and sold as securities
The net effect would be to remove 80% of the short sales/threatened foreclosures from the market and bring back a healthy real estate market in those areas which have been most heavily hit by the downturn.
It will create a true housing market equity option which can be traded on the open market.
It will allow banks to value loans at current market value without balance sheet disasters.
Immediate benefits: perhaps 2,000,000 homes exit the marketplace, and on those homes the mortgages will become liquid and performing in 13 months which helps the banks which wrote the loans. Housing prices will begin to rise and new construction will be once again viable.
Moral Hazard concerns are dealt with by the simple fact that there is no incentive for a borrower to try and “game” the system. Similarly if a “not-underwater” borrower wants to sell a participation agreement in the future appreciation of their house once the above plan is in place that mechanism will exist. (A 50% appreciation share is estimated to be worth roughly 10% of the current value of the home). Further once there is a liquid market for participations, new home builders and developers can offer buyers of new homes the opportunity to finance 50% of their traditional 20% down payment via the shared future appreciation method.
The traditional concern that banks should not directly hold equity in residences is addressed by the structuring of this solution as two mortgages and a derivative.
This is a BUSINESS solution to a business problem which has been allowed to be corrupted by politics.
Guest author Michael Lissack is the Executive Director of the Institute for the Study of Coherence and Emergence and ISCE Professor of Meaning in Organizations. Mr. Lissack conducts his real estate activities through Michael R. Lissack PLLC.