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Summary:
All mortgages
issued since deregulation (and any others bundled with
them) are proposed to be nationalized via Fifth Amendment takings,
consolidated into a Federal Mortgage Holding Corporation (MHC), shares
of which are issued to mortgage holders as compensation according to
formulae accounting for initial value and yield (as a proxy for default
risk assessed before the meltdown.) Unbundling becomes trivial,
and credit-default swaps referring only to included collateral are
simply proposed to be dissolved on expiration or terminated immediately
with prorated premium refund from issuer, in either case eliminating
this burden in the financial sector. Defaulted mortgages owned by
the MHC are not sold but instead converted to rentals, whereby downward
pressure on the real estate market is removed; defautees able to afford
market rents are given preference, and may be offered options to
rebuy. Further, conversion to rentals prevents vacancies being
vandalized or gutted and blighting neighborhoods, instead being
properly maintained, whereby this problem for communities as well as
the real estate market is eliminated. The MHC can hold foreclosed
properties for extended periods until they recover their value, being
sold only as market capacity allows. Financial institutions
holding MHC shares are enabled to use these towards their
capitalization requirements without the uncertainties of bundling or
risk assessment, and are thus better able to lend; transparency and
risk reduction eliminates the paralysis of interbank lending due to
interbank suspicion. Financial institutions presently servicing
mortgages may be contracted by the MHC to service MHC holdings,
conditioned on their issuance of new credit. The MHC may adjust
mortgage rates to compensate for deregulation-related abuses and to
reduce foreclosures, reducing asset risk in favor of attempting to
maintain fictional yields, since the MHC is not subject to short-term
pressures faced by financial institutions. Additionally, payment
deferrals may serve as a tool for economic stimulus, with any
associated costs balanced by extending the holding period to realize
greater appreciation after the real estate market has recovered.
Payment deferrals may also be used as a form of unemployment
assistance
(at lower real costs compared to unemployment benefits which add to the
federal debt). Foreclosures not rented to defaultees may be
rented or sold to public sector employees on favorable terms as
incentives or benefits for this type of employment. As real
estate values recover, the MHC may then gradually sell off holdings at
a rate which does not depress values. Various strategies for
making government action less intrusive and offering fair compensation
are included.
Immediate and
ongoing problems resulting from the mortgage meltdown are
uncertainty over the distribution of default risk, the resulting
reluctance of financial institutions
to issue credit and consequent
restriction of economic activity due to lack of credit even for sound
borrowers. Anticipation of continued declines in real estate
values due to high and increasing foreclosure rates further restrains
purchases in this sector; given the large role that real estate plays
in the household wealth and creditworthiness of the middle class, a
halt and reversal of real estate declines would facilitate recovery of
the wider economy including employment, and thus greatly facilitate
reversing the downward economic spiral of defaults, foreclosure, credit
tightening, losses and layoffs. While probably insufficient to
cause economic recovery, rectifying the problems in real estate and the
financial sector are likely necessary to undelayed
economic recovery.
The critical
factor at the root of the mortgage meltdown was
deregulation, a failure of government to restrain excess leverage,
prevent perverse incentives and require sufficient transparency.
Schemes for addressing this crisis generally approach the problem with
a view of government acting as the largest available economic agent
able to expend larger sums of money than any other, rather than as a
non-market actor with capabilities qualitatively different from
financial institutions, and so miss better solutions.
Results thus far
from government efforts directed at reversing the
economic downturn are sufficiently lacking that it appears necessary to
suggest a strategy alternative to those now under public
discussion. In contrast to the proposals of creating a "bad
bank," buying non-performing mortgages
under the TARP, or of nationalizing banks, all of which are uncertain
and
problematic, the present proposal directly addresses the origins and
dynamics of the crisis and takes advantage of the options uniquely
available to government as a non-market actor, able in particular to
take into account and act on long term values and objectives of public
interest in the face of market instabilities, distortions, overshoots,
misvaluations, etc.,.
Deregulation
initiated the crisis, and shaped the ensuing markets for
both real estate and mortgages and so distorted the values of both, and
so it is entirely reasonable to
develop a strategy which embraces the
full breadth of mortgages issued since deregulation. All
mortgages issued since deregulation are proposed to be nationalized and
held by a government created corporate entity, shares in which are
issued to mortgage holders as compensation in a Fifth Amendment taking
(and various formulae may be used to arrive at presumed valuation, vide
infra.) At once the problem of bundling is dissolved, at no cost
to taxpayers.
It is emphasized
that presently non-troubled assets are justifiably
included because a large portion of post-deregulation mortgages were
created and valued according to a distorted market. If economic
recovery is delayed, more of these will in any case become troubled
assets, whereas through the present proposal these form part of the
solution and their inclusion serves to prevent the moral hazard of
informed actors aware of market dysfunction anticipating profit from
crisis. Since a taking is a significant exercise of government
power, certain
alternatives could be offered. First, instead of
MHC shares, mortgage-holders may elect for compensation in cash or U.S.
Treasuries, in which cases corresponding MHC shares become possessions
of the U.S. Treasury and entail value backing issued Treasuries or
printed money. Second, one implementation option would permit
mortgage-holders to be given the option of exempting assets from taking
if and only if they can document the proper assessment of their risk,
that they have sufficient capitalization (by pre-deregulation
standards) to meet this assessed risk going forward or obtain
sufficiently capitalized insurance from a private third-party going
forward--in essence, meeting pre-deregulation requirements--and in
addition with explicit disclaimer of future government insurance or
assistance connected with exempted assets. It is not expected
that a large fraction of post-deregulation mortgages will be exempted.
In the foregoing,
non-failed banks are not nationalized, but both
liabilities and assets connected with the mortgage meltdown are removed
from their books. This removes the hazard of socializing costs
while privatizing profits, but leaves them in business with whatever
capitalization they otherwise have. In general, takings
compensation can be either in shares in the MHC based on outstanding
principle or if in cash equivalents start from a discount based on the
presumed arbitrary market-wide default rate, say 20%, adjusted in
either case for particular mortgages according to the purported yield
of mortgages before the meltdown, which reflects the options available
to borrowers at the time loans were made and thus is a reasonable proxy
for initial risk. (Note that the presumed default-rate discount
should be arrived at through extensive market analysis, not attempted
here.) Since sound borrowers could obtain more traditional, lower
rate fixed mortgages, these are presumably the least risky, while high
rate or exploding mortgages and other exotic instruments obviously
carry greater risk and should be valued lower. Given the
proportion of homes presently valued at less than their outstanding
debt, and the fact that the present economic crisis is turning sound
borrowers into default risks, in the foregoing example accepting MHC
shares would likely attractive to mortgage holders.
Although there
will no doubt be some complaints about any valuation
lower than face value, in practice this solution offers lower losses to
most mortgage holders than could be expected from other proposals
presently being discussed, and successful management of the MHC could
yield a long-term results approximating full face value for all but the
most risk-laden mortgages, which deserve no special favor.
The government
mortgage holding corporation (MHC) may then do what
banks can't, namely hold these assets as long as it takes for the real
estate market and mortgage securities markets to recover whether or not
borrowers perform--selling off assets at any market price no matter how
depressed is not necessary to meet short-term cash flow in this
case. Here it is noted that the average home purchased in 1929 in
the U.S. before the market crash recovered it's purchase value within
20 years, which is less than the term of conventional mortgages.
As the mortgage owner, the MHC may adopt a number of financially sound
measures banks would be reluctant or unable to take but which would
both serve public aims and help resolve the crisis.
First and
foremost, sale of foreclosed properties into a collapsing and
undervalued market may immediately be halted, and instead of vacant
foreclosures being looted or vandalized or falling into disrepair and
leading to blight or worse, they may immediately be converted to
rentals, with a preference for rental to those defaultees who can
afford to pay reasonable rents, who may also be offered options to
rebuy some number of years hence. Extended holding periods avoid
problems seen in the Resolution Trust Corporation unwinding.
The MHC would
preferably contract mortgage servicing to banks with
experience in this field, but with eligibility requirements such as
active issuance of new credit, whereby an incentive to unfreeze the
credit market is created. As for foreclosed properties converted
to rentals, instead of direct government management, one option is to
contract management to private sector entities, letting tenants chose
the management company from among eligible management companies in a
region for a fixed term, and with compensation for management based on
direct costs and realizing savings targets for the MHC. Tenants
are given the ability to rate their management company's service so
that ratings create reputations informing choices in this rental
market. In such an arrangement, tenants have market-type choice
to enforce reasonableness on management, which must be selected by
renters in order to get business in the first place, while management
has an incentive to reduce costs to government.
The remaining
issue seldom discussed in various approaches to the
crisis concerns an implied threat by the People's Republic of China to
cease purchase of U.S. Treasury Bills if mortgages purchased by Chinese
institutions which were purported to be as secure as U.S. Treasuries
are less than secure. A sudden cessation of such purchases would
pose significant problems for the U.S. This is a matter governed
not only by economic considerations but impinged upon by considerations
of national security and foreign relations; unfortunately, to address
these challenges requires that not all mortgage owners be treated
equally. Provided that the foregoing proposal is effective and
halts the economic downturn (which has already had deflationary
impacts) it is probably feasible to make up devaluations of Chinese
owned mortgage assets from par by payments made by the U.S. Treasury
effectively increasing the money supply, either by issuing Treasury
Bills or printing money. Most simply, Chinese-held mortgages may
be traded at full non-defaulted mortgage value for U.S. Treasuries
instead of MHC shares, which for the corresponding assets go to the
U.S. Treasury and provide value to back Treasuries created for this
purpose. This could be compensated by or conditioned on
commitment to future purchases on U.S. Treasuries, and such
arrangements could in fairness be offered to other large purchasers of
U.S. Treasuries. MHC holding periods may be extended to realize
greater long-term appreciation to offset any resulting real costs, and
since most of the money or securities created by the Treasury are
backed by the long-term value of the MHC shares involved, this
operation is not particularly inflationary.
With these
aspects of the financial crisis addressed, the credit system
is no longer encumbered and can play its proper role in economic
recovery, and stimulus measures can be more effective than they would
be if the economy continues to be saddled with mortgage
meltdown-related liabilities.
©2009 Hard Times Survival Corp.