5 Step Recovery Plan for America
The views expressed in this commentary are solely those of Richard S. Berg.
Step #1: Restore confidence in housing market.
Solution: Offer price protection for 5 years to any new purchase of a home for owner occupied purchasers.
Rationale: People who are interested in purchasing a home are still aware that the market has not bottomed, and they may become upside down. If the U.S. Government offers “price insurance” of 95% of the purchase price for 5 years in exchange for a monthly insurance premium added to the mortgage, that risk has been eliminated for the homebuyer. The government is currently insuring virtually every mortgage loan written today to the lender; why not to the borrower? Hyundai has established a similar program for new car sales, and it has been extremely successful. This would be revenue positive for the U.S. Government.
Step # 2: Increase spendable cash flow for every homeowner by almost $3,000 per year
Solution: The US Government should offer a 4.50% fixed rate 30 year refinance to every mortgage borrower regardless of loan size and appraised value.
Rationale: Assuming an outstanding mortgage amount of $250,000 at a 6.5% interest rate, the annual savings by refinancing that loan into a 4.5% rate would be $3,768 per year. That extra cash would certainly work its way into the economy! The only criteria is that you have to be current on your payments for the past 12 months in your previous mortgage. This would be revenue neutral to positive for the US Government because they can currently borrow for 30 years below 4%. Freddie and Fannie Mae can sell these refinanced loans as government guaranteed mortgaged back securities. Freddie and Fannie Mae already have most of this exposure; let’s use their mandate to help current homeowners.
Step #3: Eliminate 50% of the “toxic” assets, increase the valuation of the remaining ones and recapitalize the banking system
Solution: See #1 & 2
Rationale: Since the majority of the “toxic” assets are mortgage related, and because the majority of mortgages have been securitized, solutions like the TARP and mortgage remediation have fallen short. What you may not know is that a minority of “bad loans” inside a security can cause the entire security to be viewed as “toxic”. Refinancing the good loans will significantly reduce the amount of outstanding “toxic” securities, and also allow banks to “write up” many of their previous “write downs”. Hundreds of billions of capital and market value would be restored to the financial system without direct government intervention.
Step #4: Heal the banks and restore lending in America
Solution: Pass a 3 year reduction in capital requirements in banks, reduce rather than increase the regulatory scrutiny, and redefine “Fair Value” for OTTI to the “expected loss incurred.”
Rationale: Banks are not lending because they are preoccupied with self-preservation. Banks must keep a minimum level of capital or they will be deemed insolvent and closed. Write downs of “anticipated” losses in advance of the realized losses can be very tricky, especially in this market. Many of today’s write downs will not ultimately result in anywhere as severe as realized loss. Regulation and accounting both contribute to this downward spiral of capital (as well as falling asset values, which #1 will certainly positively impact). Regulators are under intense pressure to “regulate” better, which has an adverse reaction, banks refuse to lend out of regulatory and accounting fears. If we enact numbers 1, 2, and 3, banks will actually become much healthier over a reasonably short time frame period because many of their “write downs” will be certainly not be realized.
Step #5: Stop draining capital from the system that requires more bailouts
Solution: Enact a “mark to market” holiday for 3 years.
Rationale: Did AIG really lose $60 billion dollars? For reported earnings and capital levels the answer is yes, although much of that write down and others’ write downs reflect very long term commitments that may actually turn out to produce vastly different cash flow results. Unfortunately, in a regulated business such as banking and insurance, once your reported capital levels are below minimum, you are effectively out of business unless “bailed out.” MTM caused wildly inflated asset prices on the way up during the boom. Can we at least agree that the current MTM accounting rules are causing wildly negative unintended consequences, and if not halted may ultimately put every financial institution and insurance company out of business? There is a better solution and let’s take 3 years to study what it should be before we cause additional damage.
Interestingly, the implementation of this 5 step program would likely not cost the US taxpayer a dime, but we believe the impact to the US and world markets and economy would be profound.
Copyright 2009. Richard S. Berg. All rights reserved.
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Five causes of the credit crisis and how to fix it
First cause. An absolute lack of accounting rules for derivatives. Nobody knows *exactly*, in dollar terms, how many “toxic assets” are “out there.” How is it possible that trillions of dollars in assets are simply unaccounted for, to the point that nobody knows who owns them and nobody knows the answer to “how much?” question?
Second cause. Predatory Lending. Predatory lending must be either eliminated as a practice or tightly controlled in the mortgage market. Increasing the interest rate during the life of the mortgage increases the likelihood of the mortgage default. We cannot have a system that makes mortgages more likely to fail as time passes, simply because of a contract clause. If an clause is “a must”, then mortgage should not be granted, period. Bring more cash, then re-apply.
Third cause. An absolute lack of accountability and responsibility for the success of financial operations. CxO-level executives must be 100% accountable for the performance of their business. Their paycheck must depend on it.
Fourth cause. Broad lack of understanding of key risk concepts. How many crisis do we need to prove this point? Starting with LTCM, then moving to Enron and now the global crisis. It is safer to assume that current risk models should be completely revamped than to assume that they will work again, eventually.
Fifth cause. Broad lack of education about how financial markets work. If market participants, including home owners and other investors, would spend some time to learn how markets work, markets would be more self-controlling. Instead, we have this casino-like system which seems to work as long as someone is supplying the coins.
Sixth (bonus) cause. Whining about the market. Stop whining. If you cannot afford your mortgage, find someone to live in your basement and help you pay for it. Take responsibility.
Rich,
Guaranteeing house prices?! I want folks more worried about the price they pay for their house not less. I don’t want folks to look for the government to toss them yet another binky if things go (further) south. I want more, not less private capital in homes that do sell too -why put more than 5% down if daddy government is taking the downside risk? Talk about open-ended liability and fraud potential.
While most would agree houses were overvalued, there is no proof one way or the other that homes today are undervalued, fairly valued or overvalued. If we knew (and we can’t) that houses were undervalued today, this recommendation would be a freebie to the government. Any other situation, its a boondoggle. Maybe I do this for Detroit, where the median home price is under $20,000.
The refi America at 4.50% creates a lot of unintended consequences that hurts far more banks (the liitle guys) than you think. Think of all the S&L-like institutions, with 50-60-70% of their assets in residential mortgages -in performing, very refi-able mortgages, refi-ing down to 4.50%, extending durations back out to maybe 6-8-10+ years for the portfolio lenders. Think of the holders of (nonprivate-label) MBSs seeing their high yield securities come back at par.
Unless the plan includes Fannie/Freddie selling back to the banks mortgages securities at substantial discounts to replace lost loan yields you risk killing off the little guys to help the big guys. Now all you’ve done is shift credit risk from the largely healthy banking sector to the Feds.
This would certainly help holders of private-labels however -in particular downgraded senior tranche holders. In some cases, rapid prepays get me entirely out of some cashflows before credit losses overtake the subs. Even in cases it does not, it reduces the balance in my tranche leaving me with a smaller-balance downgraded tranche. This in effect liberates the AAA portion of these tranches quickly.
I would not suspend capital requirements. The requirements aren’t the problem, its the flawed accounting rule requiring P&L charges that grossly exaggerate economic reality, thereby triggering its own rolling series of economic consequences.
I hear some of the MTM mavens, including Buffett (who I greatly admire) saying not to suspend or eliminate MTM because it gives Management to much discretion on asset valuation -yet, bankers have this discretion on its loan portfolio and no one is saying this is broke? Banks typically hold twice as many loans as investments yet we can’t trust management to apply the same discretion in determining loan losses to fixed-income cash flows collateralized by loans?
Also, forget the MTM holiday -it sounds like a gimmick. It just looks cheap. The issue needs to be addressed head on. The current crisis has identified a huge flaw in current fair value accounting practices and the FASB, if it wants to retain its current role, needs to open its eyes and fix it.
If behavioral finance is a academic field of study, so should behavioral accounting. The FASB does not get the fact that not all readers and users of financial statements have to time, talent and aptitude to make qualitative judgements about the various components of various financial statements. They’d be far better off going with historical/amortized cost on the financials and footnoting fair values (with discretion to also include intrinsic/economic values) than the current mishmash approach we now have.