A Proposed Solution to the Foreclosure Crisis

With the Conference on The Future of Housing Finance being held in Washington today, do we really expect the government to propose anything that may help support our hosuing markets. I am not optimistic and I am an optimist by nature. I am a big believer in unleashing the power and strength of entrpreneurial minds to address our problems. Why haven’t these minds developed solutions? Do you think that these minds are stifled by the overwhelming presenc eof Uncle Sam? I do. Back to housing and entrepreneurial spirits.

I love when Sense on Cents can provide fertile ground for the free and open exchange of ideas, opinions, thoughts, and analysis on critically important issues of the day. I am deeply grateful when people not only comment here at Sense on Cents but I encourage people to provide written commentary. I can not promise that I will run every commentary that is submitted but I will seriously review and consider running those that I believe are deserving of greater exposure. I appreciate your allowing me to make those judgments. Plus it is my blog.

I have always maintained that jobs and housing are the two great linchpins upon which our economy rests. The government has thrown hundreds of billions of dollars at our housing crisis with no meaningful success….all reports aside. What can be done to solve the foreclosure crisis weighing on our housing market, our economy, and ultimately our nation? A friend of Sense on Cents presented a very interesting proposition to me this morning. I am happy to run this commentary and strongly encourage readers to review, critique, question, and share this commentary. I had a question which the writer quickly answered. I am sure there are many more questions on this proposal. I am happy to provide the forum for truly engaging dialogue and analysis at Sense on Cents.  The fact that ‘people who care’ can communicate in this format is truly awesome. Please engage!! On that note, I humbly submit,

No cost housing stimulus:
Solution to the foreclosure crisis

Because of negative equity most underwater homeowners can’t sell their homes and they can’t refinance. Bankruptcy and/or default is not an option for most homeowners. Especially for homeowners that feel a moral obligation to meet their financial commitments. The unjustness of this predicament extends to all homeowners because about 15 million potential homebuyers are locked-out of a housing market that desperately needs more buyers.

From the mortgage/banking industry perspective; their survival is hinged on the hope that the underwater homeowners will continue to embrace their moral, social, and ethical values in spite of the financial hopelessness of their long term situation.

Until this quagmire is resolved our housing market will continue to suffer because the seller/buyer ratio is drastically unbalanced. Additionally, the number of bank owned properties are increasing which is also forcing serious downward pressure on home values.

Here’s the solution: “Equity Warrants”.

The underwater homeowner could issue an Equity Warrant to cover their negative equity thereby allowing the homeowner to sell their home even though the proceeds may not be sufficient to completely pay-off the mortgage.

This Equity Warrant would grant rights to the borrower’s future equity in any home they own. When, and if, the borrower’s future equity equals the amount of the warrant, the lender would have the right to convert the warrant to a note secured by the home owner’s real equity.

The downside to the borrower is that someday the warrant will be converted to a note that will require interest and payments. The downside to the mortgage holder is that they will not receive full payoffs for existing loans. The upside to the mortgage/banking industry–and our economy–would be a substantial reduction in the number of foreclosures.

However, to soften the impact to the mortgage holder, the warrants could be sold by the mortgage holders. As an ironic twist, instead of trading Credit Default Swaps, Wall Street could trade Equity Warrants.

This system would create millions of potential homebuyers, thereby improving our housing market and home values. Additionally, the underwater homeowners would have a respectable alternative to short-sells and defaults.

What would it take to make this happen? This system would need an act of congress to enact laws requiring mortgage holders to accept Equity Warrants from underwater homeowners.

Example #1:
Suppose homeowner in Florida owes $250K, he sells his home for $210K. He is $40K short so a warrant is issued to the mortgage holder with a face value of $40K. The warrant accrues interest at the 5 year Treasury bond rate of 1.40%.

Five years later the warrant is callable since the homeowner was able to purchase an existing home for $300K. (Which was a really good deal at the time since new construction for a similar home would have been $400K.) In the five years since the warrant was issued the homeowners equity has grown to $150K.

The warrants are only callable after 5 years or 10 years.

The home owner’s note to settle the warrant is $54K ($50K plus interest). The note is serviced by Citibank and is considered a HELOC. It’s a 10 year interest only note at the Treasury bond rate plus 1%.

The original warrant was sold by the mortgage company on the Equity Warrant market for 90% of the face value.

Winner and Losers- The homeowner wins because if he would have been forced to stay in the original home his equity would not have increased as much as the new home increased. Plus he was able to improve his living standard by being able to move into a better home.
The warrant holder wins.
The original mortgage holder wins because a possible foreclosure was adverted.
The housing market and all homeowner’s win because this homeowner and a few million others were able to enter the housing market which helped to push home values up.

Example #2:
Suppose a homeowner in Atlanta sold his home for $300K but owed $500K. A warrant was issued to the mortgage holder for $200K.

Ten years later the home that he purchased for $175K is still only worth $175K. The owner dies. The warrant is expired and worthless.

Example #3:
A homeowner in Indianapolis was $25K short at the closing on his home. Ten years later the homeowner was only able to accrue home equity in the amount of $20K. The warrant is called but only $20K could be recovered. The remainder is forgiven.

Example #4:
A homeowner in Nevada was $60K short at the closing on his home. Two years later the homeowner wants to re-locate to New York. The homeowner was able to accrue $30K in new equity so he converts his original warrant face value to from $60K to $30K after he pays the warrant holder $30K. Eight years later the homeowner is still renting an apartment in NY. However the warrant is called and the remaining $30K (plus interest) is collectable since the homeowner did not fulfill his obligation to become a homeowner during the warrant term.

Please do not be bashful in asking questions and making comments. My initial question was where the equity warrant would fall in terms of credit position. The writer indicated it would by necessity be a second lien. I would have imagined as much.

I commend this writer for laying out this proposal. I think it is certainly worthy of further consideration and analysis. In light of our current situation, what do we have to lose. Can our housing and foreclosure crisis get much worse?

Comments, questions, constructive criticisms always encouraged and appreciated.  Thank you to the writer for sharing his proposal.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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