So right now there are a ton of houses out there that are actually worth less than the debt that people owe on them. Since lenders arnt seeming to restructure the mortgages, why wouldn’t people default on their loans if they are expected to pay back more than the house is worth.
Possible solution:
Since the choice of lenders is really to take a small loss by restructuring mortgages or be stuck with property, a wide spread resturcturing needs to occur.
What if the FED came in and bought all these restructured Mortgages. Then bundled them up and sold them, but not how they are being sold now. The buyer of these bundles will recieve all capital gain on the sold house. The owner of the house gets back all equity that he put into it, and the owner of the security gets all the gains. The home owners would probably agree to this because its either this or their house gets forclosed.
And large institutions, that are fine witha very long term investment, would take these bundles because a possibilty for very large gains, housing market will rebound eventually.
Obviously this is a very general solution. What does everbody think?
This is a theory my corporate finance teacher had. He explained it very well in class, and everything anybody said he quickly proved on how this would work. I didnt do a great job explaing it, but feel free to respond with faults int he system and Ill see if I can answer them how my teacher answered.
March 20th, 2008 at 10:12 am
Sure: You’re saying the Fed buys up the mortgages, so in a simplistic sense it buys Mortgage A valued at $400,000 where the house is only worth $300,000. The fed rewrites the loan for $300,000 (the $100,000 loss is covered by printing new money which means society takes the loss) then resells the mortgage of $300,000 with the stipulation that the homeowner must give all capital gains on the house to the loan buyer. Is this correct?
If so, my question is, what happens if the home price continues to fall below $300,000?
March 20th, 2008 at 10:24 am
Well the house is worth 300k and the mortgage is 400k, and while this is going on the home owner can not afford his payments. The bank restructs the mortgage for 300k and takes a loss. Obviously, not all the looses will be in the hundreds of thousands of dollars. Then to protect the banks who still own these mortgages the feb buys them at the new amount of 300. Then virtually sells the rights to the profits of the house to protect itself. The fed will get the interest/principal payments, the homeowner will get his equity back once he sells the house. And the owner of the profits will get the profits.
March 20th, 2008 at 10:25 am
I’m with Mark on this one. If house prices are will keep falling down the fed just keeps printing money and you don’t get any where. If you are the home owner and the fed just picked up a portion of your mortgage then why would you sell at all? You can now afford to pay for your home. In principal I agree that the fed needs to do something to help out the home buyer but I don’t think your professor’s idea will work just because home prices will start going down.
What about just giving homeowners really low fixed rates and completely making ARM loans illegal?
March 20th, 2008 at 11:57 am
Novel idea, for sure Vadim. So if I have you correctly, the Fed holds onto the mortgages themselves and sells the owners right to capital gains to some third party buyer? So now I’m wondering how you price this right, where the profits from selling this right go, and what the bank gets out of the deal after it restructures?
Now if I anticipate you to say the bank loses on the restructured deal, but gains the rights to the cap gain, I think the issue comes down to pricing risk. Indeed, house prices would have to appreciate annually (on average) by the rate of inflation plus the premium to recoup losses just for the bank to break even. Thus, if prices rise at an annual average of 4% (a hefty sum!) the banks would about break even.
–As an aside, I too have a novel idea. How about we restrict the ability to charge a rate of interest above the rate of inflation? We’d immediately shrink our national debt, we’d shrink all credit debt, and the money would come from the profits of bankers whose only product is free money from the fed. Raise the reserve requirement to 100% thus not allowing anyone to leverage up. Business could only borrow funds in relation to the amount of available funds a bank has backed by deposits, and would have to finance the rest with equity. Banks would have to offer higher savings rates to attract funds for loans. Individuals would see a rise in the value of their purchasing power and wouldn’t need million dollar (after interest costs) loans to buy land.
March 20th, 2008 at 12:22 pm
Mark i think your novel idea just killed all growth.
March 20th, 2008 at 12:58 pm
If by ‘growth’ you mean inflation, then yes, I will have killed growth by inflation. However, if by ‘growth’ you mean progress/innovation, then no I surely have not. I have merely restrained the ability for a bank to loan out dollars it does not have, thus flooding the marketplace with excess capital. The very nature of supply and demand, my friend, rests on the notion of LIMITED SUPPLY. Our current monetary system has a virtual UNLIMITED SUPPLY. Think about it.
March 20th, 2008 at 2:22 pm
If there is only so much money to go around then not all of the projects that need to be will get done. Slowing down inovation. Think about it.
March 20th, 2008 at 2:39 pm
1> Ever heard of EQUITY FINANCING?????????
2> Ever heard of SUPPLY AND DEMAND?????? What makes you think any business will suffer? Higher savings rate offered = higher percentage of Americans saving money = higher amount of loanable funds.
March 20th, 2008 at 2:59 pm
1) Ever heard of Equity financing being a lot more expensive then debt?
2) Ever heard of Japan where people do nothing but save money and make everything expensive?
3) Leverage is what lets you make more money.
Agree to Disagree
P.S. Get to work!