Sharing Risk Could Save the Economy

Consider A Five-Point Plan For Getting Our Industry And Economy Back On Track

Revised 1/10/09

John Shaw

As published in Scotsman Guide's Residential Edition, December 2008.

Market speculation seems to run rampant these days. Although various legislative efforts have passed, the system is far from fixed. In fact, the lines are now blurred between the private and public sectors.

In assessing where we go from here, we must consider solutions that spread risk between the government and the banking industry.

In other words, we're all in this together, so let's act like it. Here's a plan for getting back on track.

Understanding The Real Issues

The solutions presented thus far for the mortgage crisis are all flawed in that they all include a "writing down" of the value of the troubled asset.

The problem when you do that is that you are ignoring the chief engine of our economy for the last 20 years>> the "Value of Our Homes". Since returning to an economy that supports itself without this aid will take another generation of investment and prudent policy, to ignore its main engine NOW shows a lack of understanding. I have put together a 5 point plan from the perspective of a "Financial Adviser" that will fix this crisis without writing down our personal and national wealth. From a strictly business point of view, would you invest in a "company" that told you in advance that they were writng down the value of their stock by 30% or more?

A five-point solution

Along with placing a moratorium on all future foreclosures until the problem is fixed, I believe the following five steps can help to fix the mess we're in:

We already have the infrastructure to implement this plan. It's called FHA.

1. Reform Federal Housing Administration (FHA) loans: I believe that a standard FHA loan should guarantee 30 percent instead of the 20 percent it guarantees today. Today's risk models call for the larger guarantee. So-called FHA loans are overlaid with lender requirements. This basically changes an FHA home loan from a program that's friendly to first-time homebuyers to a hybrid, conventional loan that isn't open to as many as 60% of past qualified borrowers. Under this plan, lenders that use FHA-guaranteed programs would be required to follow true FHA guidelines. This includes restoring the recently eliminated down payment-assistance programs and no minimum credit scores.
2. Help distressed homeowners: For homeowners who are already in trouble with their mortgage but not yet in foreclosure (i.e., 30 to 90 days late), this plan would require the U.S. Department of Housing and Urban Development (HUD) and FHA to guarantee 40 percent of the mortgage. This effectively refinances the would-be foreclosures. Any FHA-approved broker or lender would be able to refinance these troubled loans, thus they get refinanced as quickly as possible.
3. Assist foreclosed-upon borrowers: Similarly, for homeowners already in foreclosure but still in their homes, HUD and FHA would guarantee 50 percent of the mortgage. When the homeowners refinance again or sell their homes, FHA would then receive an equitable exchange of value or refund from any of the homeowners' profits, starting at 50 percent for the first year and decreasing to a minimum of 25 percent after five years. The equity-sharing model would apply to the 40-percent and 50-percent guaranteed loans only.
4. Amend bankruptcy laws: Bankruptcy laws should be amended to allow all nonmortgage debt to go into temporary Chapter 7 bankruptcy and to allow all such debt to be eliminated to a total debt of 40 percent, which the mortgage industry considers a manageable debt load. This will help borrowers accomplish personal liquidity and keep their mortgages intact. Borrowers must undergo debt counseling to take advantage of this.
5. Buying the millions of foreclosed homes: For the millions of foreclosed homes needing homeowners, HUD & FHA will guarantee 50% of loans to families who have already been foreclosed upon. These individuals will be given a choice of only other foreclosed bank owned homes that are more affordable. The homes will be sold for full price of either the appraised value or the last loan amount which ever is greater. All who take part in this program will have a hit to their credit the equivalent of a bankruptcy & foreclosure ( assuming they have not already filed such ). This allows for the families to take part in a mandatory credit counseling program from which they will pay for, helping them to see where they went wrong in the use of credit. This will help to stabilize the market and keep home values where they should be. American wealth and a general feeling of well being is generally expressed in the equity of their homes.

With this five-point plan, we likely won't have to worry about home values dropping and banks making huge write-offs that will bring further financial instability. You will also not further contribute to lower home valuations or depreciation because refinances will not be based on value, but on current loan amounts. Homes will be refinanced based on what is owed and will thus keep lenders from losing their shirts.

I believe these initiatives can fix the economic engine. When the economy is again on firm ground, these provisions can be reined in as needed.

Why this plan can work

To fix the problems in our economy, we must recognize where they originated. Although the mortgage industry has indeed contributed to them, the problem actually started about eight years ago, when jobs started to disappear and wages went flat. Over the course of 8 years if you take into account a 3.5% inflation rate American’s spent 28% more year over year for the same items over that eight year period that wages stayed flat. If a spouse lost their job even for 3 months, they were then never able to catch back up.

This “shared-risk based solution” can keep the government from taking on all the risk and responsibility of failed mortgages. By sharing the risks and benefits of the risk, you could take the $700 billion bailout and expand it tenfold.

If the bleeding doesn't stop on foreclosures, then the $700 + billion infusion will look like a small down payment on the problem, and the U.S. could be headed for junk-bond status when it's looking to borrow money in the future. Not to mention having foreign investors watching our country’s wealth erode at an unprecedented pace makes future investment less likely. America’s ability to attract foreign investors to buy our 10 year bonds have kept our 30 year fixed rate mortgages at a low rate. Think of how much worse things would be if the bond market collapsed and long term interest rates ( 30 year mortgage rates ) were again in double digits.

Implementing Our Proposal

Our proposal is that a Non Profit ( NGO ) be set up that will allow public and private sector funds from both the government ( local and or national ) and banking institutes so that this plan may be implemented immediately. This can be set up on a state wide basis at first as a demonstration of the proposals validity.

John Shaw is a financial strategist, author and mortgage planner. He has served in the mortgage and service sector for more than 25 years and has owned and managed his own mortgage companies during that time. His Web site is www.mtgbuy.com. Reach him at (336) 345-9306 or john@mtgbuy.com.