Let's Fix the Problem---Send this to your Republican Candidates

Our Campaign Slogan:
“Let’s get people back to work and back in their homes”
The answer to repairing this economy is more than lower taxes, less regulation, creating an environment for business to expand all sounds good. Growing some employment can develop as some certainty returns to the economy but it is still about access to credit which will not happen until housing values stabilize. The candidate who can articulate how to really fix the economy will sail into the white house. The economy has been damaged in a very unique way and unless this is addressed it will be years before the economy truly recovers. Fifty year ago, if car sales and home sales were good the economy was good. Jobs were plentiful and there was opportunity. Even teenagers could find work and did. Today few products are manufactured here and we have become a service industry. We lost the American automobile industry by failing to innovate and compete. The government has to some extent revived that industry. Home construction and related industries remains one of the largest business sectors and home ownership represents the consumers’ equity and purchasing power.

3 Million Homes
Building 3 million homes for families, who in many cases could not afford them, are at issue and until this issue is resolved there will be a great deal of pain and hardship.
How and why these homes were built makes us study the rise and fall of subprime loans.
To understand subprime loans one must understand how these loans were structured. We have heard all kinds of things about these loans. The usual loan requirements: adequate credit, earnings, debt ratios, and down payment were pretty much abandoned with subprime loans. You were qualified if you could make the first payment. To understand subprime loan structures you also need to appreciate why they went into default. Three million loans, ($780 billion) came on the scene and truly had only 36 month lives, not the 30 years implied in the note and disclosure statement. One had only to review the Bloomberg screens to appreciate the production, $20 to $25 billion per month starting late in 2003, with the rate resetting in 36 months. The monthly payments more than doubled at the reset. By late summer 2007, enough went delinquent to take down the entire financial system. Why and how they got started and why bankers, brokers, regulators, and insurers, not to mention investors did not see what was coming is alarming.



Subprime Loans
There were many subprime loan types, but the common feature was a loan with 36 month teaser rate. The teaser rate was low to permit a low monthly payment, the applicant, often a renter could afford, around 3.0%. Beginning with the 37th month the rate would reset to the 10 year CMT (Treasury) rate plus 6.5%% causing the monthly payment to increase 2 to 3 times. This payment was un-manageable and the borrower unable to refinance due to a decline in value became delinquent and ultimately in foreclosure. It was necessary for the loan packager to structure the loans this way to enable the issuer, originally Fannie a 30 year yield which was marketable.

This mortgage problem must be fixed
The irony is that to solve this mess in any reasonable period of time we will have to go back through the eye of the needle or this will drag on for years. The answer should be something like a 60 month lease option to purchase housing program that most folks can apply for and after demonstrating their willingness to timely pay can move to ownership. It is critical that real estate prices stabilize and these homes are off the market.

Banks will not lend, No Credit, No Growth
With 80-90% of the banks collateral directly or indirectly tied to real estate, banks will not lend until real estate values stabilize. Sheila Bear does not entirely get it, as protecting the depositors also means protecting real estate values. ALL of this is pretty simple, if 80-90% of loans in banks are tied to real estate values and values fall 20% and the capital equates to 6% of assets, all banks are by statute out of business. Because the bank’s assets were not enough to pay off their depositors TARP funding was necessary. Declining Real estate values do not produce an environment for lending and there won't be a recovery until real estate values stabilize. Many of the banks including B of A are waiting for the economy to turn, holding back on foreclosures. Some borrowers have gone two years without making a payment. Merely listing a property for a short sale will defer a foreclosure at many of our major financial institutions. If one only truly understands how we got here then one can begin to appreciate what is necessary to reverse the housing problem. Financial Institutions have been a major investor in mortgage pools for the past 40 years. Fannie and Freddie have always led the way with an implied guarantee of the federal government and an AAA rating. But most importantly any private banks and mortgage operations that modeled its paper after say Fannie with fico scores, geographical diversity, good loan to values, etc. were received in the market with almost equal enthusiasm. And for good reason in 40 years no one had any negative experience with Fannie look a likes.

Home Market Values
The home value anomaly is also important to follow as prices of homes started to rise with 9/11 low rates and some creative lending coming out of Fannie. Seems some fellows there were cooking the books and promoting creative loans. Easy Mortgage money means more can qualify and prices rise with demand. Congress was also discussing an investigation of Fannie and suddenly we have no investigation and everyone can participate in the American dream of home ownership, even renters. Sub-prime is off and running with Fannie unveiling the CDO. Until then subprime and similar products were sprinkled into pools of quality loans. The CDO was marketed like the CMO and carried the implied guarantee of the government and rated AAA. If your investment was the first tranche you could be paid off in as little as 5 years. The CDO pool was the investment vehicle that propelled subprime lending and soaring home values.

The Financial Crisis Inquiry Commission Report says only 38% of the subprime loans were produced by Fannie but Fannie paved the way and as before what Fannie pooled and sold so could others by just pointing to the exact same forms and features. Everyone wanted to be in the business. Banks jumped in almost overnight, buying up mortgage outlet operations for many times their values. With 3 million (unqualified) borrowers added to the market the value of homes in some sectors more than doubled. Brokerage houses used the securities to collateralize money market fund operations. When the delinquencies began to surface the insurance companies sold default contracts to the brokerage houses to satisfy their money fund customers. And why not, the US has 40 years of excellent mortgage payment history; our mortgages are solid as a rock. The dirty deception in all of these loans is that in the 36th month the teaser rate 2.75 to 3.25% ends and starting in the 37th month the rate floats at the 10 year CMT plus 6.50% over doubling the monthly payment. Anyone who understood this structure understands this was just a gimmick to get the loans sold. Their concern for the 3 million families in a moral sense was mean and deceitful.

Back through the eye of the needle
So how can we fix this mess? It surely is not to tighten up credit. That sounds a bit like locking the barn door after the cows have run off. Understanding what happened to the folks is important. They got an opportunity to buy a house way over market at a reduced monthly payment for 36 months. So naturally they bought as much house as they could. Under any normalized scenario they could not have afforded the house. If one graphs the normal appreciation for the average home, about 2% per year from 1998 to the present and then graphs what we have actually experienced in homes prices, one can see that today millions of homes are greatly below that appreciation line.

The Fannie Mae Lease to Purchase Program
Let’s consider a program allowing families to lease an affordable home with the option to buy. This will quickly fill the vacant homes and provide revenue to service mortgage debt. The process can be decentralized with standardized forms and procedures. Realtors and bankers could earn an initial set up and monthly servicing fees, carrying the loans as investments or turning them back to Fannie for pooling. The rates could be set off of the 10 CMT with rates moving no more than 1% in any given year. The rate feature helps the banks and protects the home buyer. Buyers would only need minimal income to qualify. Most banks are flush with money and would be eager to participate. The appraised value of the home to participate would have to be equal or exceed the 1998 to 2003 average value before the funny business started.

Subprime Loan disclosures may be found to be in violation of the law
The flaw or deceit in the loans is apparently receiving attention as Bank of America (Country Wide) and Wells (Wachovia) who have recently settled claims with investors in the billions. My guess is that the loan disclosures will be found to be in violation of federal law as they relate to what happens in the 37th month and with the payment more than doubling.

A program similar to this should be in every presidential candidate’s platform.
“Let’s put the folks back to work and back in their homes.”