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Following is an unpublished letter to the Editor of the New York Times submitted on Sunday, October 26, 2008.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.

Editorial on deleveraging and linkage to the depth of recession‏

Following is an outline for an editorial submitted on Sunday, October 26, 2008 to two major national financial publications. The impetus for this particular discussion is the total dismissal by the financial media (Print, TV, Internet) of the possibility of a modern-day depression.

No one is making this connection, and I think it is both intuitively obvious as well as vital for an understanding of why a modern depression scenario (definition: 10% peak to trough reduction in annual GDP) isn't out of the question.

1. Everyone agrees there is massive worldwide deleveraging in all financial organizations (notably banks, dealers, HFs) across the entire investment spectrum: commodities, equities, CDOs, CDS, and all manner of securitized Real Estate/consumer lending vehicles. As many pundits have already noted, US Equity markets (and to a large extent, most major Foreign marts) have already unwound every single dollar of gain since Spring of 2003.

2. Everyone further agrees that GDP over the past five years, at the margin, has benefitted from a not-seen-in-decades upsurge in real property origination, construction, and sales - with its attendant trickledown into the materials/industrial sectors, as well as home improvement/furnishings sectors via aggregate lending of multi-trillion $ worth of HELOCs/second mortgages. Government statistics indicate, conservatively speaking, a 29% cumulative increase in Nominal GDP from FY03 to FY08 (depends where Q4 comes in).

3. Everyone agrees that profits from (2) as well as consumer funds borrowed against the real estate bubble and (in the case of NY, CT, Chicago, and Calif) massively outsized financial services/HF compensation (I'll cuff that at a conservative figure of an incremental $150 Billion per year) has goosed GDP numbers over the past 5 years vis a vis previous 'normalized' patterns of personal income and spending.

4. If (1), (2) and (3) are essentially true, can there can be any other conclusion but that some significant portion of GDP growth over the past five years has been a one-off illusion? Since the entire economy is now in serious spending-retrenchment mode, and increasing unemployment is a given for the next 3 or 4 quarters, is it so far-fetched to believe that this recession could rewind the economic clock back to something close to 2003's figures?

And, just to put the icing on the cake -- unlike the deflation of the internet bubble in 2000-2002, we will not be subsequently pumping up the economic base artificially via a new bubble due to the fact that Leverage in all capacities is soon to be subject to stringent regulation. Hence, the runup from 8,000 to 14,000 on the Dow was, at its core, pretty much a Fake rally achieved on the back of systemic leverage throughout the investment chain.

Investors tend to psychologically 'anchor' themselves to the most recent results in any tradeable market and make a presumption that said recent highs (Dow 14K a year ago) or lows (Dow 8K at the last bear low in 2003) are reflective of a 'normal' level. Unfortunately, an anchor mentality only serves to obscure those future equity returns which may be realistically achieveable - to say nothing of the potential level of the low point of the Dow/SPX in this particular cycle.