A couple of weeks ago I put up a post about a mortgage concept called SwapRent. It’s the creation of Ralph Liu, a highly accomplished financial technician.
Since then the subject of mortgage modifications and the success or lack thereof has come back to the front burner and with it a lot of proposals that aim to try and get a meaningful effort up to speed. For example, Martin Feldstein had an article in this week’s Wall Street Journal in which he stressed the need to attack the problem of underwater mortgages as a critical part of any meaningful loan modification effort.
Feldstein proposed that loans with LTV’s in excess of 120% should be written down to that level (he contends that most borrowers that are underwater by that amount or less will stick with their houses) with the banks and the government splitting the cost of the writ-down. In return the homeowner would have to accept a non-recourse loan that could not be discharged in bankruptcy.
Aside from the problems inherent in persuading Congress to alter the bankruptcy statutes to such an extent, I think it might be very difficult to persuade a borrower to get on the hook for a loan from which they could never escape. Even though it might solve an immediate problem, most homeowners are right now acutely aware of how badly things can go wrong and might be very wary of opening themselves to the sort of liability proposed by this plan for the duration of a new loan.
That brings me back to SwapRent. The concept is somewhat along the lines of a shared appreciation mortgage in which the homeowner gives up a piece of the equity in exchange for something from the lender. It could be a lower interest rate or in the case of underwater borrowers, a reduction in principal as well as a lower rate. The problem with shared appreciation mortgages is that they are not flexible and problematic from the banks’ point of view.
SwapRent in its simplest form monetizes the future appreciation of the home. A homeowner sells all or part of the future appreciation for, say a period of five years in exchange for an upfront payment. The amount he sells and the duration of the term is negotiable and the prices for the future appreciation are transparent. In the case of an underwater borrower, the upfront payment can be used to bring his LTV down to a level he considers manageable.
Since SwapRent contracts can be undone prior to maturity, the inflexibility inherent in the shared appreciation concept is erased. Moreover, shared appreciation is not a market oriented program and thus at best relies on guesstimates about the future value of the equity. SwapRent relies on the market to set the price.
SwapRent also relieves the bank of the obligation to wait to cash in on its equity participation. Since it can be sold in the open market the bank can monetize its investment fairly easily. In fact, it is not necessary for the lender to be a participation in the transaction at all, since the contract can be negotiated directly between the homeowner and the investor.
With respect to loan modifications, SwapRent has the potential to substantially eliminate the cost of reducing the cost of writing down the value of mortgages. Rather than the government or the bank absorbing the entire cost, monetizing the future appreciation provides the fund to pay down the mortgage balance. To be sure the homeowner receives no gift from the taxpayer and does sacrifice some future appreciation but in return, he receives a loan that fits within his budget and once the SwapRent contract has been paid off can collect any future appreciation on the property. A small price to pay for the benefit, in my opinion.
Ralph Liu has a number of variations of the SwapRent concept. One that he calls FARM ((Flexible And Reversible Musharakh) has been devised for Muslim countries and he has also adapted the concept for Western societies. Briefly, it splits the economic costs of renting and owning and allows the homeowner to vary his interests between the two. It has interesting applications for making housing more affordable as a homeowner can start out as a renter or tenant and as his or her economic circumstances change and improve the renter can transition to ownership. It’s a bit complicated at first but once you spend some time studying the concept it really is relatively simple.
Ralph has a concept that I think deserves a hard look from the government. His ideas could easily help with the current foreclosure crisis and as this country engages in a discussion about what our mortgage industry should look like going forward, he should have a seat at the table.
I’ve embedded a couple items with this post. One is a set of slides that Ralph prepared that go through his concepts and the other is a copy of some correspondence with government authorities in which he puts forth some of his concepts. By the way, it is not his first go-round with the authorities.
Take a look at the embedded documents if you have an interest in learning more about his program. If you have questions or need elaboration just let me know. I’ll get Ralph to give us both answers.