Equity provision for residential real estate lenders

Following is an unpublished letter to the Editor of the New York Times submitted on Sunday, October 26, 2008. The impetus for this particular letter is a total absence of discussion in the financial media of what I believe to be an obvious solution to the competing interests of institutional lenders and retail borrowers stuck in nonpaying Subprime/Alt-A mortgages.

Editors:

We now have hundreds of billions in mortgage relief authorized at the Federal level ('TARP'). Here's a simple and logical implementation, which helps those who have bought a home in good faith while simultaneously protecting both lenders and the banking system.

• Keep people in their homes via a reduction of monthly payments to something "equitable". Establish a 'going rate' at a given household income level, and a principal reduction concomitant with a particular neighborhood. For example, borrower pays 25% of after-tax monthly household income based on a principal reduction of 20% of the outstanding mortgage balance.
• This is the key provision: Lender takes anywhere from 20 to 80% of the equity appreciation going forward (with a buyout/paydown proviso if borrower finds him/herself in a better financial position in the future). The exact percentage would depend on the particular level of relief applied to each original mortgage/monthly payment. Why is this essential? It serves two important purposes. 1. It avoids mass-foreclosure -- entire communities with boarded-up houses and its attendant negative social consequences; and 2. Borrowers who carry a bit too much of an outstanding mortgage do NOT get to participate in the eventual recovery of property values several years hence. This is an essential component for political expediency (deflects anger from the 'my taxes should not fund someone's grab at a high lifestyle/outsized home' crowd), and it simultaneously protects lending institutions/federal government from locking themselves solely into low-rate returns into the future by giving them an equity kicker.
• There will be a bunch of people (probably in the low hundreds of thousands) who DO deserve to face foreclosure proceedings because they either lied about their income or took on WAY more (not a little more) than they could handle. All of those people will have to suffer the consequences of their greed/poor decision making, excepting the case of Lender fraud or deception.

More typically, we are talking about a family with household income of maybe $100K who got a 500K mortgage when they really should have a 375K mortgage. They would clearly fall under my 'plan'.

I believe that such a framework will serve all three constituents (borrowers, lenders, and taxpayers footing the rescue plan) fairly.