The 6% solution to the Housing Crisis

By Jon Hainer

It doesn’t take a Sherlock Holmes to deduce that our lawmakers are focused on the wrong element of the housing crisis. Congress has just created a massive bailout package the details of which are still fuzzy. If only it had included the right provisions. Instead, it did nothing for the consumer, nothing for the individual homeowner, and it did nothing to put a floor under the value of homes which continue to drop nationwide. The bailout package focused on the concerns of those with the most political leverage that have precious little to do with the national emergency as it effects most of us. Rather than worrying about whether top financial executives have earned their golden parachutes, or whether Nancy Pelosi was right about the role of deregulation in this crisis, the Congress, the Administration, and the Fed should have spent time and energy worrying about the little guy. Here’s one modest proposal they could have considered.

Let’s make it a condition of any financial institution accepting government assistance with their illiquid mortgages, or mortgage-backed securities (“MBS”), that it will be required to lower the rates on all of its mortgages to not more than 6% and to fix them there. The problems that individual borrowers have with rates resetting at unaffordable levels would be considerably reduced. For the family with a $300 thousand mortgage that faced a rate-reset to, say 10%, the savings would make a world of difference. The principal and interest portion of their payment would be reduced by $834.06 per month. If their percentage of take-home pay were 50% with the 10% mortgage, it would drop to a much more manageable 34% with the 6% mortgage. Let’s call it the 6% solution.

Not only would this idea help the little guy, it would have a beneficial impact on the entire residential real estate market. Prices would tend to stabilize. Defaults would tend to decline. The supply of new homes coming on to the market through foreclosure would tend to drop. Illiquid MBS do not now trade because no one knows what the flow of funds into the mortgage pools will be will. As the 6% solution stabilizes the payment streams at known levels, those MBS will become increasingly saleable, and the banking system increasingly liquid. The 6% solution would not be a panacea, but it could make a considerable difference just at the cusp, or tipping point, at which I suspect we now find ourselves.

Interestingly, the cost of this little guy bailout would probably be about what the cost of the big bailout that is underway. Bank of America / Countrywide just announced a $8.5 billion dollar package for 400 thousand homeowners. If the bailout were for 40 million homeowners at the same rate the cost would be $850 billion – or almost exactly what the bailout we got is projected to cost. In addition, the Bank of America plan would lower borrower rates to as low as 2.5% and provides assistance to those who are going to loose their homes no matter what the rate.

There are problems with this 6% solution, of course. Owning an undivided interest in a pool of mortgages (i.e. owning part of an issue of a MBS) is not the same as controlling the terms of each individual mortgage. This proposal would tend to hurt holders of the lower-rated MBS disproportionately as less money would come into the mortgage pools. Moral hazard – rewarding risky behavior with public funds – exists with this idea. But isn’t that why we pay those guys in Washington, to figure out the details to such things and craft a workable solution? Tell your Congressman to stop worrying about political posturing and limiting the payout to a handful and to start worrying about putting a hand out to help millions. Even Dr. Watson could recognize this as a more promising avenue of investigation. Can’t anyone think outside of the box anymore? Sherlock, are you there?

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Jon Hainer is a principal with Stern & Associates, a bank compliance firm, and co-author of the book Commercial Loan Review and Audit Manual published by Sheshunoff. He also heads the Economic Strategy Group at the downtown LA law firm of Hicks Park LLP. He may be reached at jhainer@sternassociatesllc.com