FAQ #16: What about those shared appreciation mortgages, aren’t they options, or derivatives too? If so, aren’t Fed Governors and Presidents recommending the use of these derivative products for homeowners to solve the current housing crisis?
Yes indeed you could call them derivatives. This could well be a case in point of how derivatives can provide good economic value to consumers. Technically speaking shared appreciation is in fact a call option on the property value of your home that you will share in part with someone else for a certain period of time. For example, a typical shared equity or shared appreciation mortgage would be to share xx% of the legal interests in your home. In return, they will get 2 or more times the xx% in upside appreciation of you home in the future. Because it is similar to a "covered call option" concept which means that the homeowners will give up partially only something that they may or may not gain in the future, it will not create economic hardship when that indeed happens. Meanwhile they could enjoy all current benefits received now from giving up this "potential", irrespective whether this future potential financial gain happens or not.
The big questions are a.) how do they put a fair value of such an option without a transparent traded market place to be able to both buy and sell? (no price discovery mechanism) and b.) once the provider financial institution does the transaction with you what could they do with it, in terms of handling risk management for themselves (risk transference and financial institution regulatory issue), realizing a profit on the transaction and generating liquidity by passing the exposure to someone else to scale up the scope and do more deals (scale issue). These are, among many other issues, the unsolved economic problems that have hindered the wide use and acceptance of these conventional shared appreciation mortgages (SAM) in the past in many other countries.
On top of all that, what do you, the homeowner, do after you have shared part of upside appreciation potential with some one else, will you still love your home the same way as before (moral hazard issue) and will you still go to Home Depot or Lowe’s to make home improvement projects on weekends (various home improvement issues), … etc. all need to be properly addressed before they could receive wide acceptance. SwapRent (SM) and its embedded mortgage, HELM were since day one, created to deal with these issues and therefore have properly solved all these problems.
The recommendation of the use of shared appreciation by the Fed officials is a defensive reaction from the sudden crisis created by the mortgage default blow-up. As mentioned before, there weren’t any wide use of these more conventional ways of offering housing affordability in the US as it has happened in other countries and therefore unscrupulous mortgage professionals resorted to providing fictitious housing affordability by simply playing tricks with interest rates alone (e.g. teaser rates). That has, in a major part, contributed to the current massive mortgage default crisis.
Now with the crisis the politicians are perceived to have to come up with something that could solve the problems. For example, many mentioned the use of a 2nd mortgage to do the shared appreciation in order to buy out the negative under the water (or called upside down) part of the mortgage value, but how? What is a fair way to value them? What percentage of appreciation, for how long? How to create a secondary market for it? … etc., etc. Without a systematic, quantifiable way to create a transparent marketplace and the ability to extract out the risk elements these answers could only be drawn arbitrarily from thin air. As they do more research in this direction, they will eventually come to those worked out ideas and methodologies which were already incorporated into SwapRent (SM) and HELM. Through the past year, we have provided many of them the details of our solutions. I sincerely hope by then they will appreciate and respect the time and efforts that we have already devoted to the development of these intellectual properties.
Should the Administration officials propose to go back to use these old arcane conventional recycled British shared appreciation mortgage products and concepts that were developed long time ago and have been practiced for more than 30 years already or should they go for a better improved version of them in the new era? We all know that the last greatest inventions we got from the respectable British people are the steam engines and locomotives. If you want to build a new high speed train now do you want to use the latest French TGV, Japanese bullet train maglev technology or do you still want to rely on those old locomotive technology? (No offense intended. Apology if offensive to anyone who reads English.) These conventional shared appreciation mortgage products and concepts in their current forms will not be able to help solve our current mortgage default crisis anyway.
Derivatives concepts exist everywhere you look in our daily lives. Every conditional sentence you speak in your daily conversation has an option component in it. You could consider them derivatives but they provide little economic value. Similarly, the derivatives practiced in the financial markets, like those in daily life, will offer little economic value if there is no systematic way to create a liquid secondary market to provide price discovery and the risk transference functions.
Again, SwapRent (SM) and its associated consumer finance products were specifically created with these issues in mind and therefore have already solved these problems perfectly.