The Economy Is A Mess – What’s Going On?

Are we in a recession yet? How will we know? Will things get as bad as they were during the Great Depression? What’s going to happen, and who’s to blame for getting us into this mess in the first place? Was it the greedy fat-cats on Wall Street that sold each other piles of what their dogs left behind? How about the Democrats in Washington who were convinced that their friends Fanny and Freddie should make sure everyone in America could buy a home, whether they could afford it or not. Or maybe it was the Republicans who wanted to deregulate everything they could get their hands on, thinking that we were all better off if Gordon Gekko could just save us all the trouble and watch over himself. We all have questions such as these that over time will be answered in a hundred different ways – one catered to the opinion of each individual author. Right now there are plenty of people offering their judgment about who we should blame for our problems, and over the next 100 years tons more people will do the same. I’m not interested in doing that. I want to figure out how we can solve our problems, and I’m asking you to help me.

Let’s look at what has been done so far. After much groveling by Secretary Paulson and Fed Chairman Ben Bernanke, and a bunch of worthless add-ons in the form of “pork barrel spending” and ridiculous tax breaks for random companies, Congress finally passed the Emergency Economic Stabilization Act of 2008. As everyone now knows, the main initiative set forth in this bill was the creation of the Troubled Assets Relief Program (TARP) – a $700 Billion bailout plan initially created to purchase Mortgaged Backed Securities (MBS’s). I don’t know about you, but if these assets are part of what got us into this problem then I’m not too happy about the government spending so much of our money on something that no one else wants to buy. If we are going to spend that much money on something, can’t we find a better investment then what the “financial experts” have all decided are worthless securities? So now after watching European governments give it a try, TARP is going to try purchasing preferred equity shares in various banks. This will help to provide immediate assistance to the lending institutions that are going through a liquidity freeze, but is it enough to help save the economy? Haven’t we forgotten something? We took care of the commercial banks and the investment banks, but isn’t there someone else we were supposed to help?

Let’s start from the beginning, how did this all start again? Oh, that’s right, people bought homes that they couldn’t afford and now they can’t make their payments. These properties are going into foreclosure and families are being evicted from their homes. To address this problem, it seems as if their plan is to purchase these mortgages from the banks and reduce the loan value. Since the banks wouldn’t voluntarily revalue them for fear of having to take losses, our taxpayer dollars will be given to the banks to make up the difference between the old and new value of the loan. But didn’t we already help the banks by purchasing the additional equity shares? And so now we are giving them more money, but this time we are getting nothing in return? I’m all for helping out the homeowners, but isn’t there a way to do so without just giving money to banks and having nothing left to show for it?

Well, maybe there is! I think I have figured out a way to help the homeowners and the banks, and maybe make a profit for the taxpayers at the same time. At very least it will cost us a whole lot less. This is why I’m posting this blog – to lay out my plan for all to see. Think about it, talk about it with your friends, pass on the word that this plan is out there, and most importantly tell me what you think. I have no grand delusions that I or my plan is perfect, but it is a better idea than the rest and it’s a good starting point. I’m counting on all of you to help me make this plan better. So let’s get started…

 

 

Should we help homeowners or mortgage brokers?

An alternative plan to “assist homeowners” has been proposed by the National Association of Realtors (The NAR). The NAR is lobbying congress to set up a program costing $100 billion to “artificially” lower mortgage rates for new home purchases. To do this, the $100 billion will be used to purchase points for new homebuyers, which would effectively lower the purchaser’s loan rate by 1%.

This is not a plan to help homeowners; this is a plan to help mortgage brokers. They are lowering the rates for purchases of new homes while doing nothing to prevent foreclosures. The government should not focus on boosting the sales of new homes. I’m sorry but after watching the events of the past year unfold, anyone who is buying a home right now should have the financial ability to do so. If that extra 1% of interest will make or break your decision to buy – don’t buy the house.

In my opinion there are enough opportunities to invest TARP’s money and allow taxpayers a return on their investment. This plan has nothing in it for taxpayers, once the money is spent it is gone for good. What do you want them to do with your money?

Go here to see an article in TIME magazine about the NAR’s proposal: http://www.time.com/time/business/article/0,8599,1857470,00.html?xid=site-cnn-partner

 

Why California Needs The MAP Fund!

The housing meltdown is impacting the entire economy but some states have been affected more than others. California’s economy has been devastated – one out of every 88 households in CA is facing foreclosure giving it the second highest foreclosure rate in the country (Florida being number 1). According to the Real Estate Section of MSN.com there were over $2.2 million foreclosures filed in 2007. 481,392 of these (approximately 22%) were reported in CA, triple the amount in 2006. According to a report by Barbara Boxer (link provided below), it is estimated that it will cost Californians $67 billion in lost property values as a result of these foreclosures. 

This trend cannot be allowed to continue for obvious moral reasons, but we must also be concerned about the related societal impacts such as higher crime rates and health care problems that accompany rising homelessness. The National League of Cities reported that nearly half of cities surveyed saw increases in the need for food shelters and other public services. Areas of Riverside, CA have entire blocks of boarded up homes that have become breeding grounds for mosquitoes which can transmit the deadly West Nile Virus, according to county officials.

With the largest economy in the nation, it will be hard for the country as a whole to get through this crisis without California’s economy turning around. Given the strains that rising homelessness is putting on CA’s state budget, it is hard to see how this can be accomplished without stemming the rate of foreclosures. This is why California needs The MAP Fund!!!

Go here to see the report issued by Senator Boxer:

http://boxer.senate.gov/features/mortgage/Senator%20Boxer’s%20Foreclosure%20Crisis%20Report.pdf

Go here to see the report issued by the National Coalition for the Homeless: http://www.nationalhomeless.org/housing/foreclosure_report.pdf

The economic figures are grim to say the least, but let’s consider some of the social consequences that are occurring. As a result of the foreclosures the rate of homelessness is rapidly rising. According to a report by the National Coalition for the Homeless (link provided below), nearly 61% of local and state homeless coalitions say they have experienced significant increases in homelessness since the foreclosure crisis began in 2007. In many locations the homeless shelters are full beyond capacity. Cities such as Fresno & San Diego, CA (this is also occurring in other states as well) are reporting a phenomenon of “tent cities” springing up as a result. The city of Santa Barbara, CA has gone so far as to open up a large parking lot for people forced to sleep in their cars.

How much of your money do you want paid to a millionaire?

Understandably, many people feel that the government should not bail out homeowners. To their credit, most people of this opinion also are opposed to the government bailing out banks as well, so it is more of an opposition to the principle of bailouts then a lack of concern for people going through hard times. Since I am at heart a free market capitalist, in theory I completely agree that the market should have been allowed to correct itself and the government should never have gotten involved. However, sticking to these ideological principles right now is a moot point. The bailout legislation was passed by congress and the treasury department was allocated $700 billion. They are going to use that money whether you like it or not, the only question left is “how will they spend it?”

The Wall Street Journal recently reported that at the end of 2007, the financial institutions who are about to receive injections of taxpayer dollars from the government bailout “owed their executives more than $40 billion for past years’ pay and pensions.” That is more than 5% of the total $700 billion in funds set aside to combat this crisis. These companies have indicated that they intend to honor the obligations out of fear that if the executives will otherwise leave. This is completely outrageous! They are taking our taxpayer dollars and giving it to huge companies who are going to turn around and pay it out to millionaire corporate executives. So I pose these following questions to you: Does it really help the economy to give money to companies if they are paying so much of it to these executives instead of lending it out? Would you prefer your money be used to pay these executives or to help a family with children that are about to be evicted from their home? Is it really better for your money to go to these banks, or to be invested in a portfolio of real estate?

If you are as appalled by this as I am, I encourage you to do one simple thing. Spread the word to everyone you know and tell them what is happening. Send them a link to this blog and let them know there are better ways to use that money. If Barack Obama being elected last night has taught us anything, it should be that if enough people care passionately about something then their voices will be heard. You should care how your money is spent.

Here is a link to the WSJ article   http://online.wsj.com/article/SB122542331644887249.html

 

 

The Partnerships

The best way to explain how the partnerships between the individual homeowners and The MAP Fund should be structured is by giving a comprehensive example.  To make things easy, interest will not be considered in this example.  However, keep in mind that the interest & principle portions of each payment will follow the same logic.

KEY ASSUMPTIONS:

1.  Two years ago, J acquired a home with a value of $500,000. To complete the purchase, J made a down-payment of $50,000 and assumed a mortgage of $450,000.
2.  To date, J has made $50,000 in mortgage payments, leaving a mortgage balance of $400,000. However, J has violated the terms of the mortgage agreement by failing to pay the required monthly balances. As a result, J is now facing possible foreclosure of his home.
3.  In response to J’s possible home foreclosure, J signs an agreement with MAP, with the following terms and conditions:

a.  The length of the partnership agreement shall not exceed ten years
b.  The remaining balance of the mortgage is $400,000
c.  J’s current investment basis is $100,000, which is the sum of J’s down-payment and mortgage payments to date. 

4.  At the end of the ten year partnership agreement period, the following holds true: 

a.  J made additional payments of $100,000 and MAP made total payments of $50,000. As a result, the total investment in the property is $250,000, which is broken out as follows: 

i)  J’s total investment is $200,000; eighty-percent (80%) basis.  
ii) MAP’s total investment is $50,000; twenty-percent (20%) basis.  

b.  The remaining mortgage balance after the ten year period is $250,000, which is the original mortgage balance of $450,000, minus the $150,000 in payments made by J and the $50,000 in payments made by MAP.

Given these key assumptions, consider the following two examples:

EXAMPLE 1 – GAIN ON SALE OF PROPERTY
At the end of the ten year period, the property is sold for $600,000, resulting in a gain of $100,000 ($600,000 proceeds less $500,000 purchase price). Of the $600,000 in proceeds from the sale, $250,000 will be used to pay off the remaining mortgage balance. This leaves $350,000 of gain to be allocated to J and MAP. The allocation is as follows:
1.  J will receive 80% of the proceeds ($350,000), or $280,000, for a profit of $80,000; and,
2.  MAP will receive 20% of the proceeds, or $70,000, for a profit of $20,000

 

EXAMPLE 2: LOSS
At the end of the ten year period, the property is sold for $400,000 resulting in a loss of $100,000 ($400,000 proceeds less $500,000 purchase price). The loss will be allocated an 80/20 split, similar to the treatment of the gain. J will receive $120,000, representing his $200,000 investment minus his 80% allocation of the loss. The MAP Fund will be returned $30,000 representing its $50,000 investment minus 20% of the total loss. The bank will be repaid the remaining $250,000 balance on the mortgage.

The MAP Fund!

 For the past few years, many people have been acquiring mortgages to purchase homes that they realistically could not afford. Consequently, banks and homeowners are now facing a catastrophic number of home foreclosures. This has served as a catalyst for a series of related events, particularly the declining prices of mortgage backed securities, which have sent global markets into a tailspin. As a result of the homeowners defaulting on mortgage payments, banks are receiving less cash repayments than they originally forecasted, forcing them to recognize huge write-offs. Desperately needing more capital to meet regulatory requirements, banks have begun to restrict lending which has sent America into a liquidity crisis.

In an effort to alleviate the liquidity crisis, congress has passed a $700 billion mortgage rescue bill creating a fund known as TARP. As of now, TARP intends to use a portion of the $700 billion to purchase mortgage backed securities and preferred equity shares in various lending institutions. TARP is currently contemplating purchasing and renegotiating distressed mortgages as a strategy to help minimize the amount of home foreclosures. There is a better way to address this problem. A second Fund, tentatively called The Mortgage Assistance & Procurement Fund (“The MAP Fund” or simply “MAP”), should be adopted in conjunction with TARP. The primary role of the MAP Fund is to stabilize and reduce the number of foreclosures by serving as an investor alongside struggling homeowners.

The structure of The MAP Fund will be modeled after an investment vehicle that is currently very popular in the finance industry called a “Fund of Funds.” Simply stated, this is a Fund that invests in a series of partnerships. Under the provisions of MAP, partnership agreements with be set up between MAP and homeowners whose homes are currently at risk of being foreclosed. Under the terms of the partnership agreements, MAP will guarantee a portion of the homeowners’ mortgage payments in return for an equity stake in the home. The benefits are twofold: banks will not be forced to foreclose on properties and homeowners will avoid eviction and keep a certain portion of the investment in their home.

Partnerships between The MAP Fund and homeowners will last for a period of around ten years, depending on how long it is expected for the housing market to rebound in a particular area. Over this period, an agent of the fund will work with the bank and the homeowner to make sure the mortgage is repaid. On a quarterly basis, the agent will meet with the homeowner and a representative of the bank to determine the shortfall in payments for the previous period, for which the Fund assume the liability of the shortfall. At the end of the ten year period, the house will be sold on the open market. All gains or losses from the sale of the home will be allocated between the homeowners and MAP based on their respective ownership percentage. Alternatively, the homeowner may have the option to buy out MAP’s interest at any point if their financial situation improves.

The MAP Fund should initially be a special purpose entity chartered by the national government. This will allow MAP to act as a private company, seeking to minimize costs and maximize profits, thereby maximizing the value for its shareholders. As the true investors in MAP are the American taxpayers, MAP will strive to maximize a return on investment for taxpayers by strategically choosing its investment opportunities. Additionally, since MAP will be a private company, MAP can also be open to money from private investors, increasing the pool of money to be used to prevent additional home foreclosures. A “feeder fund” structure can be utilized to provide the flexibility to allow for an inflow of private capital. In all situations, however, management authority will remain with the managers of MAP so as to avoid a situation where government officials or private interests attempt to influence MAP’s investment decisions for personal interests.

I don’t want to bombard you with too much information too quickly. Now that I have briefly outlined my proposal, I will leave you think about the basic concept and I’ll be back soon to explain things in more detail. Until then, let me know your thoughts.