The reason why a government-led effort is urgently necessary is due to the disconnect of the credit risk holders and the original mortgage lenders/servicers as a result of the mortgage securitization process. With the excuse of maximizing their shareholders’ value, lending banks could be well justified to have no urgency to do anything to fix the problems and are literally fire watching while Americans are losing their homes, workers are losing their jobs and investors are filing bankruptcy. Fed jawboning may not have any effect to solve this unprecedented problem in our financial history.
SwapRent (SM) is basically the economically synthetic version of the traditional “sales and lease back” transaction. It only transfers the economic interests while the homeowners continue to own 100% of the legal title of their homes. It allows the homeowners to switch between owning and renting only economically during the contract period while maintaining the entire legal ownership.
From a technical stand point, SwapRent (SM) is a quantifiable instrument which extracts out the property value risk component of these mortgage loans and allow the lending banks to pass these extracted property value risks on to other investors. The remaining mortgage loans will have no property value risks left. These could all be done simply within the new HELM and FVCM which the defaulting borrowers could convert to with their existing lenders.
The homeowners could economically give up partially upside appreciation potential of their homes for only a short period of time, which may or may not even be realized in the future for them to economically receive a monthly income. They can use that income to pay for the higher reset mortgage payments and therefore get to avoid foreclosures. Again the homeowners maintain 100% legal ownership through out the contract period. To solve the current mortgage default / foreclosure problems we will need to tackle the problem at its root, a long term economically sensible and fair way to let more low income Americans afford homes. Property value itself provides the new dimension to do so where interest rate has already ran its course. Using subsidy to the low income people at the expense of the average tax payers will not be a sustainable long term solution under our capitalism system.
The key to the success is to let the financial institutions offer these new opportunities to the homeowners in a very careful, open, conservative and controlled way. Both the providers and the homeowners will benefit from it and hence our economy will remain safe and sound.
The FHA or the GSEs can utilize this new solution in a variety of ways. One of the simplest way is to set up a “homeowners rescue fund” to establish a long term real estate recovery investment position by receiving SwapRent (SM) from the homeowners and paying them monthly subsidies (3% annually in a 5-year SwapRent (SM), as in the example in the presentation slides) so that they would not have to default. Better still, FHA could team up with investment firms in private sectors to set up these funds.
In this way, FHA and the GSEs can simply offer guarantees to those existing lending banks and let them to allow the defaulting borrowers to convert to HELM or FVCM. These guarantee will have very little cost to FHA and the GSEs since it will only happens when the real estate indeed recovers many years later after the underlying SwapRent (SM) contract expires. It would also save FHA and the GSEs a lot of admin hurdles and save the homeowners from the added cost of going through a refinancing.