Sunday, February 22, 2009

Shared Appreciation Mortgages

Realistically, some lenders will see it in their best interest to reduce the principal of outstanding mortgages. The transaction costs of foreclosing on a home and the value lost is a huge. However, reducing the principal and interest of some outstanding mortgages is an incomplete solution. It is only fair that if lenders write down principal that they participate in the upside when the house is ultimately sold. There is already a way to do this very thing, but some tax regulation stands in the way.
This keeps the loan alive, the family in their home and the property occupied and maintained. Unfortunately, the IRS can’t make up its mind whether such a transaction is an equity investment or a debt instrument, so it has created a vast body of rules before such a mortgage can be created, making the transaction costs so high that a SAM is feasible only for large commercial transactions.
-- Seeking Alpha, "Regulatory Reform: Change We Can Believe In," 2/20/09
New rules and regulations that are likely to come will try to regulate for the last crisis. It will do nothing to prevent a future crisis, and they may reduce the flexibility to avert a crisis or innovate. The greatest supporters of change seem unwilling to allow prices to change too much on certain assets, permit ownership of real estate to shift to other investors, or make individuals to accept the consequences of their over investment in real estate.

Keeping People in Their Homes

I am skeptical of plans to "keep people in their homes" by government action. First, I take issue that they were in any meaningful sense, theirs at all. In many cases, real estate was bought with little or no down payment. Sometimes interest only or negative amortization(the loan balance grows in the first years of the loan) and no equity was created for the "owner." Even when a more traditional payment structure was used, the first years of the loan accumulate very little equity in any case. The lender in many cases was always the full equity owner of the property, the "homeowner" was merely renting anyway.

Over the last year and a half, home prices have fallen nationwide and particular in California, parts of the Southwest, and South Florida. In Phoenix, the median home price is $150,000, while in recent years the median in Phoenix was $262,000. With these numbers, there is a huge percentage that have no equity in their home at all. Their option to walk away from the mortgage is valuable at this point. Due to a rising unemployment rate and many people already overextended on their mortgages people are unable or unwilling to make the payments and they are being foreclosed upon.

Inefficiencies and problems of foreclosure
  1. Damage to property or poor maintenance due to an imminent forclosure (similar to an agency problem)
  2. Transaction costs for selling a distressed property
  3. Quickly changing neighborhoods and school systems.

Efficiencies of Foreclosure
  1. By letting homes be foreclosed and prices fall, lets prices be set closer to where it makes economic sense, arguably
  2. The homes won't go unused for too long. As long as prices are flexible, they will keep falling until someone buys the inventory. There are two sides to this. Someone is losing their home, but somebody else gains a home at a price compared to their income that is reasonable or an investor buys a property to rent to a "working American."
In many areas of the country, the multiple of home price to income was at astronomical levels. Even with prices down, in many places housing is still expensive relative to median incomes.

"After soaring during this decade's housing bubble, home prices recently fell back in line with what people earn -- and then kept falling." -- LA Times

Some people will benefit from this fall in prices and buy more housing.

Politicians and the media lament about falling home prices or rising gas prices. There is always a temptation to say that this price is too high or that price is too long. The response by some is "there ought to be a law." Surely, it does cause disruptions to some people, but for others they get much more affordable housing. Propping up the housing market prevents everyone from knowing what real estate is actually worth, blocking the signaling mechanism of a capitalist society.

Saturday, February 21, 2009

What Happened to Lending

In the popular press and in everyday conversation we hear that banks that received TARP money are not lending. As usual, there is a grain of truth to this statement. According to Bloomberg,


"Fifty-one lenders who got TARP money reduced total loans by $92.9 billion, or 2.5 percent, in the fourth quarter from the prior quarter...Their smaller peers who didn’t apply for capital or declined cash infusions curtailed lending by $1.87 billion, or 1.3 percent. "



Some people have the impression that these banks are doing no lending or that they have sharply curtailed lending. Of course, lending is down. There is a lack of demand from credit worthy applicants and standards have undoubtedly risen. A Sandler O’Neill & Partners analyst, Kevin Fitzsimmons, recently said, “I think everyone’s standards have increased, so you’re looking tighter at a loan application and probably rejecting more than you used to.” I suppose we could go back to lending to anyone and everyone in absurd amounts, but that would just be going back to the cause of the crisis in the first place. We cannot look at 2005 and 2006 as the standard of normalcy in lending. Even throughout the 1990s there was a huge increase in credit. Who is to say what is normal?


Many will have anecdotal evidence that banks have sharply curtailed lending, but it does not stand up to reality. The Treasury department recently stated, "In sum, loan activity was resilient in the face of the worst economic downturn in decades."

Friday, February 13, 2009

"An international mathematics research team announced today that they had discovered a new integer that surpasses any previously known value "by a totally mindblowing shitload." Project director Yujin Xiao of Stanford University said the theoretical number, dubbed a "stimulus," could lead to breakthroughs in fields as diverse as astrophysics, quantum mechanics, and Chicago asphalt contracting."
http://iowahawk.typepad.com/iowahawk/2009/02/numbers-in-the-news.html

Maybe we do really need funds to research bear DNA. Certainly, some bridges to nowhere will help. I think we can all agree on that. This bill is so big that it is really is incomprehensible.

"There are 1011 stars in the galaxy. That used to be a huge number. But it's only a hundred billion. It's less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers." - Richard Feynman, US educator & physicist (1918 -
1988)

I have serious doubts that borrowing hundreds of billions of dollars to spend is a good idea. I really don't think the Congress or Senate has any idea what investments have a positive net present value. Even if they do know, there is a temptation to get as much as possible for your district whether or not it makes sense economically. This stimulus bill was sold as a way to modernize infrastructure while putting people to work. This is a dubious reason at best, jobs are a cost. Labor is like a machine or raw material in the production process. Using that input takes it out of the economy and from another productive use. Opportunity cost, opportunity cost, opportunity cost. Parts of this bill are entitlements, which probably have no realistic end in sight. So, much of this stimulus may not be reigned in when it outlives its usefulness.

"Government programs, once launched, never disappear. Actually, a government bureau is the nearest thing to eternal life we'll ever see on this earth! " -- Ronald Reagan

Take some time to watch this speech or read the text of it.