The housing crisis would be over by now if we took Mr. Grosfeld’s advice:
From NYTimes.com
November 17, 2008, 3:13 pm
Solving the Securization Problem: The Jim Grosfeld Plan
By JOE NOCERA
Jim Grosfeld, the former chief executive of Pulte Homes, and a board member at BlackRock, the investment firm, has become one of my regular correspondents. Along with a small handful of others, he has spent much of his time recently trying to come up with ideas to help homeowners avoid foreclosures, which remains the country’s most pressing economic problem. Until the rate of foreclosures slows, the crisis simply will not come to an end (though you would never know that from the government’s appalling lack of urgency). Continued foreclosures hurt housing prices for everyone — and that, in turn, will mean continued multi-billion write-downs on Wall Street, further jeopardizing the financial system.
And the gnarliest problem when dealing with struggling homeowners are those who hold mortgages that are trapped in securitizations. As I wrote in my column on Saturday, because of the iron-clad contracts that exist between the mortgage servicers and the bondholders, it is usually impossible to modify mortgages without violating the contract. That is why servicers have done so little to help homeowners, despite the jawboning of Congress and the administration. And yet it is precisely the mortgages held in these toxic securities that are the most likely to default — because that is where the majority of subprime and alt-A mortgages are held.
There are ideas floating around that would solve this problem. One is Dan Alpert’s Freedom Recovery Plan, which I’ve discussed many times in this blog. And a few days ago, Mr. Grosfeld sent me a plan that he has devised for dealing with the securitization problem. He sent it in an e-mail message, which I am reprinting here:
Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, is right when she says that there are 3,000,000 homeowners in trouble. She agrees that most have risky mortgages — subprime arms, option arms and alt-A loans. The F.D.I.C. program uses reductions in monthly payments, not principal reductions, in order to make mortgages more affordable and thereby reduce mortgage foreclosures and stabilize house prices. However the F.D.I.C. program involves mortgage-by-mortgage qualification and will therefore take years to implement. This is precisely the same flaw in all the loan modification programs announced in recent days by a number of banks — loan-by-loan modifications only after requalification procedures, which will take a long time to implement, and deny more affordable mortgages to millions of homeowners.
I’ve thought about an alternative program. This program can be easily and quickly implemented because there is no new qualifying or underwriting procedures, and no principal reductions. It costs taxpayers very little, especially in the context of rescuing 3,000,000 homeowners. It can be easily understood by Congress or Treasury. It provides mortgage relief to homeowners by reducing monthly payments It increases the value of bonds and whole loans held by investors. And it provides affordable mortgages to homeowners whose mortgages are trapped within securitizations without violating contractual obligations to bondholders.
Congress or TARP should provide this entire class of 3,000,000 distressed homeowners with risky loans — subprime arms, option arms and alt-A loans — a five-year interest rate subsidy, which homeowners will experience as five years of reduced monthly payments.
This program can be implemented simply and quickly. All that happens is that a servicer receives a monthly payment subsidy from TARP or Congress. That subsidy is used to reduce a homeowner’s monthly payment. The homeowner continues to pay but at an amount reduced by the subsidy. For example, if the original monthly payment is at a 7 percent yearly interest rate, and the subsidy is at a 2 percent rate, then a homeowner pays 5 percent and Congress or TARP pays 2 percent.
This program can be swiftly implemented because existing mortgages are not modified, just subsidized. There is no need to qualify homeowners to receive these subsidies and no need to reduce the principal amount of mortgages — other than to eliminate any negative amortization accumulated in option arms so that homeowners only pay interest on the original mortgage amount. The program only works if it is implemented on a mass basis to promptly reduce monthly payments for homeowners burdened by these risky loans. It will not provide broad mortgage relief if homeowners have to qualify for these subsidies, or if new appraisals are required, or there are reductions in the outstanding principal amount of mortgages. Those conditions requirement mortgage by mortgage treatment which entails endless work and delay.
The subsidy is inexpensive, especially in the context of helping millions of homeowners. The subsidy amount can vary but it must be enough to substantially lower monthly payments in order to reduce foreclosures. Let’s assume that taxpayers provide a 2 percent interest rate subsidy for all 3,000,000 homeowners with these highly risky mortgages, and that the average outstanding principal amount of these mortgages is $150,000. The annual cost to taxpayers is only $9 billion — $450 billion of mortgages x 2 percent each. The maximum cost over five years would be $45 billion— assuming the worst, namely, that all mortgages stay outstanding for 5 years. That is unrealistic since there will be homeowners who move or refinance their loans. The cost can be reduced further if the subsidy is reduced in the latter years, such as lowering the subsidy to 1 percent in years four-five. Again many of these homeowners will refinance their mortgages over time as property values rise.
The idea is simple to understand. A 2 percent subsidy for a five-year period to help up to 3,000,000 homeowners at a minimal cost to taxpayers of $9 billion per year.
The subsidy helps to keep these distressed homeowners in their homes, and thereby reduces foreclosures. For example if an existing mortgage has a 7percent interest rate, a 2 percent subsidy reduces the monthly payment from approximately $875 to $625 — a 29 percent reduction. A subsidy of 3 percent reduces that payment from $875 to $500—and 43 percent reduction, and costs approximately $13.5 billion annually.
Moreover, it increases the value of whole loans as well as bonds issued as part of securitizations. Whole loan and bond prices will go up immediately upon the introduction of this program — and they will rise quickly and substantially, thereby creating, for the first time, liquidity for a market that has had none. Why all these benefits? Because better mortgages produce fewer foreclosures and lower pool losses. That increases the value and the prices of whole loans and bonds.
Accordingly this program is a win-win for both homeowners and investors. Simply put, there is no risk, inexpensive and powerful leverage from reducing interest rates.
This program provides relief to all homeowners who are burdened with these risky mortgages. It helps those whose mortgages trade as whole loans. It helps homeowners whose mortgages are collateral for mortgage backed securities, and therefore are trapped within securitizations. The latter are the loans Congress and regulators have been complaining about, but unable to modify due to existing contracts for the benefit solely of bondholders — and to the detriment of homeowners.
Mortgage subsidies offer an inexpensive method of providing affordable mortgage financing to homeowners whose mortgages are otherwise trapped within securitizations. And it does this without modifying mortgages and without violating contractual obligations to bondholders. Mortgage servicers as a group would obtain these subsidies for homeowners, and they would not be violating any contractual terms by doing so. Bondholders would receive exactly the same interest rates that they would receive in the absence of these subsidies. The only difference is a benefit to bondholders, namely, that they own more valuable mortgages. Homeowners who pay lower monthly payments will be less likely to default. Bondholders should welcome these subsidies.
To summarize, we need to give lower monthly payments, at least for an extended period, to distressed homeowners burdened by the most risky and unaffordable mortgages ever issued, and which were issued by reason of an admitted and catastrophic regulatory failure. And we need to give this relief on a broad scale and quickly if we are to avoid further declines in home values, lower consumer spending, and a very deep recession, or worse. It’s inconceivable that Congress and financial experts all agree that declines in home prices are at the core of our financial calamity, and yet nothing of substance on a mass scale has been done to help homeowners. As a nation, we can do better.
