A Bad Fix for Housing

 | Jan 19, 2012 | 5:00 PM EST
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Last week, I wrote about the impending debacle for housing if the SAVE Act and EPA regulations requiring the shuttering of coal-fired power plants are implemented.

Today I will discuss another housing fiasco being considered: shared appreciation mortgages (SAMs).

Prominent housing analyst Laurie Goodman has proposed a way to resolve the negative equity situation in the residential housing market: Restructure mortgages by reducing the outstanding principal balances of negative equity mortgagors and providing the mortgagee with a shared equity stake in future appreciation.

This idea has apparently gained support from well-known economist Nouriel Roubini and others.

Let me be very clear: This is an idiotic idea that would accomplish the exact opposite of the stated goal. It would drive the housing market for both existing and new homes into an even steeper decline.

Before going further, this idea is not new, nor is it new to me. I've been involved in real estate finance for over two decades, in multiple capacities. I was lecturing on the radio about the impending housing crisis long before subprime began to tank in 2007, and I have since written and lectured on the asinine and counterproductive series of loan modifications that have been promulgated by the federal government.   

I communicate and counsel economists, mortgage lenders, mortgage brokers, title companies, local banks, attorneys, lobbyists, bond traders, hedge fund managers, money managers, builders and many others on the ongoing issues concerning the housing market, the proposed corrective actions and their prospects for success.

My patience for the seemingly never-ending series of inane and insane measures being proposed and pursued by "experts" is beginning to wear thin.

Laurie is right in her assessment of the housing crisis' threat to the real economy and the increasing seriousness of that threat, contrary to what you hear from many financial market and political commentators.

For that she is to be applauded, but shared appreciation mortgages are not a viable corrective measure, period.

If SAMs are made available, many will participate, and the initial reaction will be very positive, as mortgagors' immediate anxieties about losing their homes will have been relieved.

Shortly thereafter, however, they will become disgruntled about having to foot the entire bill for a house that their lender has a passive equity interest in. They'll stop doing preventive maintenance, upgrades and even corrective maintenance.

Their relationship with the property will turn from that of a homeowner to a renter, and, ultimately for some, akin to that of being a squatter.

The failure to maintain properties will cause values to decrease. Lenders will discover that they must implement a regularly scheduled property inspection program in order to protect their interest. This process will antagonize the relationship between lenders and borrowers and be counterproductive for both.

Most lenders, recognizing this, will attempt to sell their equity stake in what is known in the financial world as factoring. This is similar to what happens when a doctor's practice sells its accounts receivable or a credit card company sells its "late pays" and its defaults.

In those cases, however, there is an immediate amount due, and there are existing ways of determining the current value of the paper. That would not apply to SAMs.

SAMs are essentially five-to-20-year zero-coupon lottery tickets, and they will be given no value by private buyers. This would defeat the purpose of protecting bank balance sheets by swapping debt for equity.

The only potential way of carrying the banks' shared equity with some kind of value is for it to be allowed to be sold to the Federal Reserve or to Fannie Mae or Freddie Mac at whatever the amount of the discount to the outstanding mortgage balance was.

Those organizations would then be tasked with managing the program, and that presents insurmountable problems of its own. Every property title, upwards of 10 million or more potentially, would have to be changed in local and municipal real estate records showing the bank or assignees as equity owners.

At just $200 per new title registration, the cost of just doing that would be $2 billion. The borrowers can't pay for that, and private investors won't, and that leaves the U.S. taxpayer.

The SAM portion owed to the lender could be made forgivable over time, say 1% to 2% per year. But that still leaves program management issues, accounting systems to develop and the title issues already mentioned. And the Internal Revenue Service will have to rule on the program.

And if that program is successful, the only thing that would have been accomplished is that the lenders spent even more money to manage a program to allow them to lose money! Brilliant!

There is much more that should be said, and for those interested in discussing this in the comments section, I will participate.

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