The criticism of the Obama administration’s rollout of the financial system recovery plan, as presented by Sec. Geithner, focused on the "lack of details" and that it left too much "uncertainty" in play with respect to the mortgage-backed securities and their derivatives that have been made "toxic" by the avalanche of foreclosures and potential foreclosures throughout the country.
Below, I propose a plan that, I believe, has the potential to:
- Give strong incentives to both borrowers and lenders involved with underwater mortgages to avoid foreclosure in a way that still exacts substantial accountability for their financial decisions;
- Create a means to compute a market valuation for these mortgages and the securities which derive from them;
- Offer a means whereby a lender can immediately mark-to-market (for investor transparency) while reducing its asset base more gradually;
- Help prevent millions of mortgages from reaching foreclosure will still requiring borrowers to pay 100% of their borrowed money back;
- Offer a chance that the taxpayers might accomplish all of the above at a profit.
Create the Federal Mortgage Resolution Trust (FEDMORT) whose task is to service at-risk mortgages from any lender in the country, using modified terms that are voluntarily agreed upon by both lender and borrower. It will have special programs to service: 1) at-risk mortgages (defined to be those at 95% Loan-to-Value, using actual current market appraisal); and 2) current mortgages whose LTV ratio is less than 95%. These programs are described below. Additionally, FEDMORT will have the authority to buy and sell real estate under specified conditions and to act as landlord for its owned real estate.
At-Risk Mortgage Program (ARMP). The at-risk mortgage remains owned by the lender, but with a new servicing agreement with FEDMORT.
- FEDMORT will give the Lender a receivable (an IOU) for the difference between the book value of the mortgage and its newly appraised value and will guarantee the payment of 2% interest on the entire book value of the mortgage for the lifetime of the agreement between FEDMORT and the lender.
- The Lender will be allowed to count the FEDMORT IOU as an asset for purposes of calculating the reserve requirement.
- In exchange for the FEDMORT assets, the Lender agrees to forego the interest in excess of 2% for the mortgage until the LTV ratio (actual market valuation) is below 90%. Furthermore, they agree that all payments to principal made by the borrower via FEDMORT will first be deducted from the FEDMORT receivable before being applied to the mortgage.
- Once established the relationship with FEDMORT cannot be terminated unilaterally unless one of three situations occur:
- the LTV ratio drops below 90% (where "loan" represents the combined total of "mortgage" plus "IOU" and where the value represents the actual market value of the real estate.
- the real estate is sold to another buyer, in which case the remaining mortgage value is paid-off by the buyer and the remaining IOU is written-off as a loss by the lender.
- a foreclosure proceeding occurs
- In the event of a foreclosure, FEDMORT will purchase of the real estate for 90% of its current appraised value, if the Lender cannot find a better price. Foreclosed properties purchased by FEDMORT can be 1) resold to a new buyer with or without their own, new mortgage; 2)leased back to the defaulted Borrowers (who will have priority as tenants if certain provisions are met by the Borrowers); or 3) leased to new tenants.
- The Borrowers would be responsible for paying for the property appraisal needed to begin the program. Additionally, they would be responsible for paying any existing monthly escrow payments without change.
- The Borrowers would fill out an up-to-date financial statement for FEDMORT, from which FEDMORT would determine, using a formula, the principal and interest payments during the program’s length. Interest would be somewhere between 0% and 2% per year, and the principal would be calculated so that, at a minimum, the total PITI payment is no lower than the going market rental rate for the property for the Borrower.
- The Borrowers would pay a monthly service fee of 3% of the total PITI payment to offset administration costs at FEDMORT.
- Upon receipt of the monthly payment from the Borrower, FEDMORT would pass-through the Escrow payments for Taxes and Insurance, pay the Lender the principal and interest collected, supplemented if necessary to bring the effective annual interest up to 2%. FEDMORT and the Lender would reduce the Receivable (IOU) by the amount of the principal payment.
Not-At-Risk Mortgage Program (NARMP). This is offered for a limited period of time, say 12 months, or until certain real estate metrics indicate that a healthy market has been reestablished.
- FEDMORT pays off the current mortgage and refinances the property for up to 90% LTV with a 4% mortgage (borrower can qualify for either 10, 15, or 30 year mortgages).
- Taking cash out at refinancing will not be available with these mortgages, although borrowers can arrange for a separate, private 3rd party HELOC if they can arrange it.
- An option to consider: Disallowing the mortgage interest deduction for a portion or all of the interest paid to FEDMORT for one of these new 4% mortgages. This may make the new mortgages relatively more attractive to lower-income borrowers, for whom the MI deduction is worth less. This option may also offer a competitive opportunity for private mortgage industry to come in with a higher interest rate, but with the MI deduction intact. On the downside, this option may render the entire program unattractive to enough borrowers to accomplish the goal of recapitalizing the credit markets.
The immediate effect of this proposal would be to give the credit markets a sense of a floor being established with respect to the foreclosure problem. The NARMP should see money flowing into credit institutions around the country to pay off their mortgages and, because these institutions will be losing the interest income from these still-solid mortgages for awhile, they will have an incentive to put their capital to work and get the credit markets flowing again. The ARMP should create incentives for both borrowers and lenders to not enter foreclosure and to as rapidly as possible reduce the principal balances of the underwater mortgages. Under ARMP, the lenders are essentially allowed to write down the mortgage assets over time at the cost of interest income, even though investors in the lenders or in their mortgages will be able to transparently value the risk of the remaining mortgage. The ratio of the remaining FEDMORT Receivable compared to the remaining Mortgage Receivable would give a least a starting point for valuation throughout the mortgage derivatives world.
This proposal could work in concert with other initiatives already on the table. The ARMP and NARMP should be initiated as soon as possible, in concert with Secretary Geithner’s "stress tests" for lenders. To the degree that the toxic assets clogging up the credit markets depend upon a large number of underlying, underwater mortgages, these proposed programs should put a floor under the risk for these assets and gives those assets some kind of reliable valuation. The proposed programs won’t necessarily "save" the over-leveraged derivatives markets, but it can help to put them into a rational recovery mode and make it reasonable for some investors to hold some of these derivatives because they can be valued more transparently. Many financial institutions may still need to be placed into FDIC receivership and many bondholders may lose their investments, but implementing the ARMP and NARMP should give some of the less-leveraged institutions a fighting chance at survival.
This proposal will probably help prevent millions of mortgages from reaching foreclosure will still requiring borrowers to pay 100% of their borrowed money back. The taxpayers may actually make money in the long run on these programs. The proposed programs don’t preclude other, more expensive, actions on the part of the Treasury Dept. and Fed, but might make these other actions less necessary and less expensive.