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Mortgage Crisis Undone at the Speed of Light

November 10, 2008

Mortgage Crisis Undone at the Speed of Light

Depression to be sold in foreclosure sale. All bad mortgages must go.

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Is it possible to dramatically reverse the course of the financial crisis? Plan Orange suggests the solution may be simple. It’s a one-sentence plan.

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Plan Orange for Mortgages

“Any owner of a residential property may modify their mortgage debt to a current first lien 30-year fixed rate of 6% with all borrower debt forgiven which is greater than 80% of the present appraised value.”

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How does it work?

Home owners who want the new loan terms request a modification at a United States Treasury web site. The Treasury immediately provides its appraised value (based on statistical analysis). If the borrower accepts Treasury’s appraisal value, the terms are re-disclosed (6% 30-year fixed rate) and accepted. Borrower prints out a confirmation of the new loan terms with a Treasury account number.

If a borrower has equity greater than 20% of the new appraised value, they simply send in the signed confirmation to their bank. The bank changes the terms. The loan is made current if necessary. Any past due balance is added to the principal balance. No money is exchanged.

If a borrower does not have 20% equity, debt forgiveness is triggered, and the borrower will immediately schedule a close with a registered title company. The title company orders payoff letters. At the closing the government will forward funds to the title company which are required to reduce the total mortgage debt to 80% of today’s appraised value.

If the property, for example, is now worth $100,000, and the 1st and 2nd mortgage debt total $110,000, then Treasury forwards $30,000 to the close. The bank receives a $30,000 payment, reducing the mortgage debt of $110,000 to $80,000.

The title company mails the new mortgage documents and principal-reduction check to the original lender. The original lender cashes the check and changes the loan terms in their system.

The deal is done. The circle is squared.

We have assaulted the financial crisis with a massive counter-assault.

Markets would reasonably react with a boom.

graphic plan orange mortgages jpeg B version 6 09 publish date

SUPERIOR CHARACTERISTICS OF THIS PLAN:

  • If time is money, then this is by far the cheapest plan. It employs massive simplicity to achieve maximum speed.
  • It instantly assaults the confidence killers with a smart powerful weapon: falling home values, negative equity, non-performing loans and insolvent banks.
  • Ends foreclosure and eviction for anyone who wants to keep their home. Returns evicted owners to their home when possible.
  • Instantly rewrites the terms of all unfair loans.
  • Provides a fair and judicious distribution of bailout funds to both homeowners and banks. We have not previously had any reliable way of cutting homeowners in.
  • Eliminates guess work in distributing capital to banks. Banks receive funds as needed based upon live data about their individual loans.
  • Minimizes government investment by keeping the preponderance of bad mortgage debt with the original lender. At the same time, it makes the bad asset a good asset. Bad mortgages are cut with a scalpel not a machete. Treasury pays for the surgery, but counts the billions out by hand.
  • Minimizes administration costs and deletes bureaucratic delay. The servicing bank does not change. Ownership of the mortgage does not change. The mortgage-backed security holding the mortgage does not change. Banks, servicers and investors are bypassed entirely. They have no authority or say in the matter. If they want partial payoffs of low-equity loans envisioned by the plan, then they agree to better the terms of high-equity loans – a grand bargain which should not be difficult to impose.
  • Troubled borrowers with bad terms are guaranteed good new mortgage terms. The borrower is the decision maker about how to handle their present mortgage.

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TECHNICAL SPECIFICATIONS:

  • A single universal mortgage document, promissory note, and disclosure document will be used and acceptance mandated in all states and by all mortgage regulators. Close costs? Probably have Treasury pay a fee of perhaps $500 to the title company for closing, recording, admin, etc. This $500 fee should probably be added to borrower debt.
  • Borrowers must own the home they are refinancing with one exception (see note below on owners who have been foreclosed). Borrowers will qualify regardless of income or credit or savings and there is no need to even ask for this information. It is not relevant. Keep it out. This eliminates all decision making regarding qualification. If you eliminate decision making, then the plan can move very quickly.
  • The only wild card is the appraised value. And if the borrower disagrees with a statistically-generated value, then they may pay for an appraisal ordered by Treasury.
  • Everything else is decided ahead of time. The whole thing can be done very fast once we start it up. When the system is rolling, a new loan could be in place after A FEW DAYS or hours.
  • How long do you have to own the property? If you have owned the property for 50 years but now have negative equity, why would you be excluded? I don’t see a reason. Participation may be limited to homeowners as of the date of the announcement (or perhaps as late as 120 days after the date of the announcement if you wanted to boom the market a little).
  • If somebody just wrote themselves a big check on their credit line in the last month or two, it is hard to justify their participation. It’s also hard to justify giving banks free money, which they are getting in very large packages. The cutoff date needs study as does the use of credit lines prior to the modification. Probably better to keep the plan radically simple and ignore the borrowers who jump the turnstile to get on the train. Start the train and get it up to speed.
  • Some maximum contribution from Treasury would have to be established for each individual mortgage. If the borrower made a $1 million purchase on a house that is now worth $600,000 and the owners started with $800,000 of debt, should Treasury write a check for $320,000? Maybe. At some point the amount will be too high. If in this example the debt equaled $1 million, the Treasury check would be $520,000. Is that too much?

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VALID OBJECTIONS:

It is expensive. Trillions probably. Is the drawback relevant? No. The money is already lost. We just haven’t recognized it yet. Since I don’t have a good estimate of cost, it is possible the cost will appear to be too high. We will be lying to ourselves if we believe this money isn’t already gone.

It is unfair. People who managed their financial life conservatively get nothing. This is true, but like the objection relating to cost, it is a non-objection because conservative homeowners who didn’t leverage up were never going to get bailout money. At least real estate values stabilize quickly. Better values do help the conservative homeowners. Since this plan anticipates wide participation, it can by those lights be considered the fairest. Since homeowners achieve great benefit, and not just banks, it is also much fairer.

Past is prologue. Moral Hazard. We are supposed to follow the rules. This plan will educate people into believing that they can benefit from breaking the rules. That’s true. Remember this also: How many of us would be here if we had not been allowed to try again to do what is right after failing to do what we were supposed to do? And this plan is a great weapon against severe recession or depression.

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UNANSWERED QUESTIONS:

Re-sale of Property After Government-paid Debt Reduction: What limitations should be placed on property owners after their debt is paid down to 80% of the property value?

Personal Liability: Should property owners guarantee their mortgage debt as part of the agreement to receive a government-paid reduction of their debt?

Empowering Old Bank Capital vs. Defending Taxpayer Expense: Who should be the winners and losers? Should Treasury opportunistically purchase mortgage investments to reduce the cost of Plan Orange, or should it simply pay down mortgage balances to make banks and other holders of mortgage investments strong?

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MAJOR POINTS TO REITERATE:

  • Treasury allocates capital with great efficiency. Capital is fairly divided between bank and borrower. Towering above all else is the magic speed of this plan. We could really fly based upon its principles.
  • From the day we decide to do this, we could eliminate in the space of 30 or 45 days almost all foreclosures, negative equity, delinquent loans, unfair loans. At the same time we will put a massive support under the price of real estate. Bank balance sheets are clarified and judiciously strengthened.

One would expect the plan to be greeted by an uproar because of its far-ranging implications and because it calls for a massive number of participants and has a price tag probably larger than any public project barring a few of our wars. After the initial shock, I believe many people will be convinced this is the right way to do it.

I hesitate to guess about the number of persons who would be eligible for this plan, but it is likely greater than 50% and possibly greater than 75% of all homeowners with mortgages. What previous plan have you reviewed which builds in the political support suggested by such participation? If 50% of homeowners benefit personally, and it puts back in the box most of Pandora’s friends, then shouldn’t we look at it seriously?

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One last note for the most difficult cases: We should also when possible provide a modified loan to families who have lost their home to foreclosure (and thus are no longer legally owners). If they still live in the property or even if the property is vacant, as long as the bank has not sold the property, the original borrower can stay or return if they chose too.

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This plan puts behind us that part of the crisis which is based upon bad mortgages and falling property values and impoverished banks. How much of the crisis is bad mortgages and falling property values and impoverished banks? Much, most or all. No ifs, ands or subprime about it: This plan clears away a ton of wreckage and helps a lot of people and all the banks. This is the right way to do it.

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Michael David White. November 10, 2008. Copyright 2008. “Financial Crisis Undone at the Speed of Light”.

Check out a summary of Plan Orange and links to four stories and three charts.

Note: This story was first published in November 2008 on a site which has been shut down. After publication I came to disagree with critical details of Plan Orange for Mortgages. The primary goal — ridding an economy of excess debt issued in a credit bubble — did not change and has not changed. The origin of this plan derives directly from Martin Feldstein’s proposal on mortgage replacement. My last serious work, in April 2009, on bubble-credit management was a review of 26 monthly newsletters from Bill Gross. In that story I hypothesized that the primary goal of credit-crisis management is bankruptcy and the write off of financial, government and mortgage debt. As of January 2012 our failure to recognize the failure of governments and banks and homeowners has grown far worse.

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