Stemming the Rising Tide of Foreclosures Plaguing the Middle-Class With a Guaranteed Mortgage Assistance Program (GMAP)

The following is a sequel post to "The Rise and Fall of Artificial Wealth"

A slogan on the White House website states "A Strong Middle-Class = A Strong America."

Vice President Joe Biden, recently gave a speech at the Brookings Institution on the status of the economic stimulus plan and shared several examples of how the American Reinvestment and Recovery Act is starting to benefit the economy, including middle-class Americans.

We applaud the positive points he addressed. However, the truth remains that millions of middle-class Americans are still on a collision course towards losing their homes. The objectives of this paper are three-fold: 1) to put this problem into perspective, 2) to address why the existing program is not working effectively and 3) to propose a bottom-up solution that could be readily implemented for the benefit of not only middle-class America but also the nation as a whole.

The Scope of the Problem:

Recently many articles have expressed optimism that the recession is ending. While we all want this, foreclosures are still an enormous problem with many adverse secondary repercussions. Unless proactive measures are taken quickly, this problem will escalate. The flood of foreclosure filings continues to rise according to the latest data from RealtyTrac. Les Christie of CNN Money recently reported that between June and July of this year, the number of foreclosure filings rose by 179,599 or 9% in one month alone. This foreclosure rate is up 93% above the rate recorded in July of 2006. Right now there are at least 15 million Americans who are out of work. This number is expected to rise and by the end of the year1.3 million Americans will lose their unemployment benefits and tens of thousands of these are destined to lose their homes unless a more effective program is implemented quickly. Twelve percent of mortgages are now delinquent. RealtyTrac's® July 2009 U.S. Foreclosure Market Report™, indicated that in July 360,149 U.S. properties were in default and received foreclosure filings, default notices, or were scheduled for auction and bank repossession.

This represents an increase of 32 percent from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July. "July marks the third time in the last five months where we've seen a new record set for foreclosure activity," noted James J. Saccacio, chief executive officer of RealtyTrac. The problem is acute and, as Biden's speech revealed, is not getting proper attention from the Obama administration. For example, the payroll tax cuts which Biden referenced do very little to prevent unemployed homeowners from losing their homes as they only benefit those who have jobs. The program we propose benefits unemployed homeowners who are striving to become positive contributors to the nation's GDP.

Through June of this year, aggregate wages and salaries are down 4.7%. This problem is compounded because 25% of all homes in the U.S. are now worth less than the mortgages against them. Thus there is often little incentive for homeowners to keep their homes when they are struggling just to make their mortgage payments. Coupling this "upside down" status of homes with the employment situation, it is no wonder that over 844,000 homes were foreclosed on by May 2009. Even though the economy may be starting to show signs of a weak recovery the glut of upside-down properties will put a major drag on this recovery. In quantitative terms, the Conference Board Consumer Confidence Index has been rising: From a low of 23.5 in February 2009 to 47.4 in July and now 54.1 in August. So, although the trend looks like it is moving in the right direction, the reality is that it takes a reading of 90 to indicate that economy is on solid footing. A reading of 100 or more means that the economy is growing. This is prima facie evidence that the U.S. economy is not on solid footing and has a long way to go before returning too normal. So, if we are going to end the recession now, we need to do something different.

Deficiencies with the Existing Housing Recovery Act

The Housing Act does not directly address those who have lost their jobs. For example, a job loss may put the homeowner in even more jeopardy of not qualifying for assistance! The applicant must comply with several conditions. Even then, there is no guarantee the applicant will receive assistance since the program is voluntary and lenders are not required to participate in it. The program's scope is also too narrow. Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers who are in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. This number is by no means acceptable. In California alone, foreclosures scheduled for sale in July rose to 124,874, a 10.4 percent increase from June, and a 93.3 percent increase year-over-year from July 2008. Although the American taxpayers bailed out banks, these banks have not reciprocated in a commensurate manner and have been rejecting too many applications for loan modifications. For example there have been incidents where Aurora Loan Services has rejected requests for home loan modifications from clients who are in need of help due to losing their job, but, have tenaciously continued to make all their payments on time. With the proposal we introduce in this paper, such clients would be guaranteed assistance in making their mortgage payments.

Our Proposed Solution to Stemming the Rising Tide of Foreclosures

In a Financial Times article, Paul Krugman, the most recent Nobel Prize laureate in economics, candidly stated "Damned if I know," in response to an inquiry per what the most promising short-term investments would be for promoting the recovery. We have an answer to this question, which addresses a major subset of the overall macroeconomic problems. Specifically, in this paper we present a solution to the problem of middle-class Americans losing their homes. The primary objectives of this program are to prevent homeowners from losing their primary residence while simultaneously enabling these homeowners to focus their energies on obtaining new jobs and being productive members of society. If not these homeowners will waste productive energy on the hardships of relocation associated with foreclosure. Further, this program will provide homeowners positive incentives and help shore up the balance sheets of the banks and other financial institutions that are holding the mortgages.

We term this program "The Guaranteed Mortgage Assistance Program" (GMAP). The basic concept for this initiative involves guaranteed loans for making mortgage payments in the form of mortgage vouchers. Here we: 1) articulate the framework for the rapid mass implementation of this initiative, 2) provide an example of how this program could benefit a typical middle-class homeowner, 3) estimate in aggregate how much this program would benefit America as a whole, and 4) propose the recommended next steps towards implementing this program.

To date, most of the Federal government's initiatives have been of the "top down" variety, which resulted in billions of dollars being pumped into banks, and insurance companies with the hope there would be trickle-down benefits to the middle-class. But hope is not a strategy! These rather startling initiatives included the unprecedented funding of foreign banks, the relaxing of accounting rules and even the funding of private corporations. However, it was the Cash for Clunkers program which worked the best. In magnitude it was miniscule in comparison to the TARP bailout. Specifically, the $3 billion allocated to the Cash for Clunkers program is only 0.381% of the $787 billion TARP bailout. But Cash for Clunkers put approximately 17,000 people back to work on automotive assembly lines. This program worked because it was bottom-up; that is the investment was focused directly on those who were the beneficiaries. It had the triple-benefit of:

* Saving Americans up to $4,500 per vehicle purchased

* Putting thousands of Americans back to work

* Decreasing Greenhouse gas emissions

Americans have witnessed that bottom-up programs are a much more effective use of capital than top-down programs. In a manner corollary to Cash for Clunkers, our proposed guaranteed mortgage loan voucher program is a triple-benefit "bottom up" approach which would get right to the core of solving the housing crisis while simultaneously helping the banks and stimulating the economy; but at no long-term cost to the government. We now discuss the program in detail.

The Mortgage Payment Voucher Program

We propose a fresh new and innovative solution that hasn't yet been tried. This initiative is aimed at benefiting middle-class taxpayers; who for the purpose of this initiative we define as individuals with personal or family incomes of no more than $250,000 with this number selected based on President Obama's definition of the middle-class during his campaign. These loans will be limited to a) primary residences and b) to a maximum of 10% of the mortgage amount of the home. The bottom-line objective of this program is to enable homeowners to be able to make their mortgage payments without losing their homes. This program would have the secondary benefit of enabling the homeowner to focus on finding another job without the stress and dilution of focus caused by the pending loss of one's home. This program would have the immediate benefit of putting a stop to the majority of primary residence foreclosures.

The basic structure of this program is that the government grants 10-year loans to homeowners to help pay their mortgages in the form of a Guaranteed Mortgage Assistance Program (GMAP). These GMAP loans will be fully repaid because they can be secured in the same fashion as a tax lien, so the program is deficit neutral, and hence at no cost to the government.

In terms of specifics, there are three primary time-staged phases to this program, which would work as follows:

Phase 1: After successful completion of an application, the government provides a voucher to the homeowner who in turn transfers the voucher to the bank. The homeowner uses this voucher as an equivalent to dollars, which, together with their payment, makes up the total monthly mortgage payment .

Phase 2: The government reimburses the bank for the amount of the vouchers over an extended period of time.

Phase 3: The homeowner reimburses the government for the loan at the end of 10 years as a balloon payment that could be funded either by the homeowner's accrued savings or by taking out a second mortgage against the property or selling the home.

For example, if 10 percent of the homeowners elect to participate In this program (roughly correlates with the unemployment rate) at the program limit of 10% of the outstanding mortgage balance, the program will have an upper limit of $100 billion. This number was computed based on the $10 trillion total outstanding residential mortgages. If the government elects to reimburse the banks at the 5% rate then the upper-limit cost to the government is $50 billion over the course of 10 years, which would be fully collateralized and fully repaid by the homeowners. We envision that this program would immediately begin to increase housing equity for the following reasons: When the government announces this program Americans will see that the end of the housing crisis is in sight. With government now backstopping the fall in prices, a large number of potential buyers on the sideline will jump in, driving up demand and leading to further rising prices.

Benefits of the GMAP Program

The banks benefit by converting non-performing loans into performing loans, thus shoring up their books. This will significantly contribute to a further thawing of the credit markets by enabling the banks holding GMAP loans to loan against them (like a Treasury asset) at a reasonable multiple of value, thereby further stimulating the economy with new loans. The banks redeem GMAP funds back to the government at a rate of 5 or 10 percent of the principal value per year. Under the 5 percent per year plan, the government would be required to pay the bank a balloon payment of 50% in the tenth year. This is at the same time the homeowner is paying the government the entire loan amount, at the end of the term. The 100% repayment by the homeowner may require taking out a second mortgage. However, after ten years the equity in the home is likely to increase. Thus we have proposed a solution to stem the rising tide of foreclosures at virtually no cost, which would also significantly contribute to stabilizing the banks.

Other bottom-up programs should also be considered by the Obama administration. These include small business loans and an initiative for funding pre-school education. For example, University of Chicago Professor of Economics and 2000 Nobel Prize winner Dr. James Heckman states in his prescient paper The Productivity Argument for Investing in Young Children "Enriched pre-kindergarten programs available to disadvantaged children on a voluntary basis, coupled with home visitation programs, have a strong track record of promoting achievement for disadvantaged children, improving their labor market outcomes and reducing involvement with crime." [http://jenni.uchicago.edu/Invest/FILES/dugger_2004-12-02_dvm.pdf]

The details associated with implementing these two other programs are beyond the scope of this paper. However, the authors intend to expand on the details of these programs in future papers.

Conclusion:

This continuing economic disaster can be dramatically mitigated with the GMAP program that serves as a triple catalyst for increased equity in housing, stronger bank balance sheets, and no increase in government debt. This program is based on providing a little short-term reprieve to struggling homeowners while counting on them to have full accountability by fully reimbursing the government.

As we see it, it is now time to adopt the GMAP initiative and other such bottom-up economic solutions to address the recession so as to avoid an economic relapse or a prolonged recession like the "lost Decade" in Japan in the 1990's.

Michael D. Intriligator is Professor of Economics, Political Science, and Public Policy at UCLA; Jud Ireland an investor; and R. Kyle Martin Is an accredited investor and a consultant to institutional investors with a focus on companies in the technology sector.

 

Comments

[Onesime]

Your proposal has its benefits and drawbacks, as previous readers have noted. Since I am in this very boat, I'd like to note that there is the new Making Home Affordable program that has a component for people like me (laid off but not yet late on any payments, long steady work history). However, the banks and servicers are balking at the "unemployment insurance income" feature for one-income folks like me. (For two-incomers, with one on unemployment, they are not including the unemp in totat household income.) The program requires verification of the mortgagee's income for 9 months going forward, which is difficult to square with unemployment insurance (short term extensions that are typically automatic but not "for sure" till you get there). If Making Home Affordable denies you, then you cannot reapply, so single unemployed people like me are waiting in the weeds, hanging on for dear life until this issue is sorted out. Making Home Affordable is potentially a great program and it obviates the problem of the balloon payment that this proposal has. It also provides an eventual out of the loan I am stuck in now and helps bridge the short term $600/month gap between my unemployment benefits and all my essential financial obligations, including COBRA (would have been impossible without the emergency help offered via ARRA!!). Since I've exhausted savings and am now cannibalizing a coupla extra retirement vehicles I had, I am now driving on the rims, so to speak.

[mrscofla]

Great article. However, to offer a loan modification plan. One must understand the implications. The current plan is voluntary. Mandatory loan modification plans initiates the following. First, loan modifications imply that lenders made a mistake. A mistake that the Government has been aware of since 2001 but failed to address. Second, this mistake could fall under one or two violations. Subjecting Brokers and Lenders to lossing their opportunity operate in States in addition to prosecution. 1st is a FTC unfair practice, 2nd is a Bank fraud issue. Now periodically, these issues go undiscovered. However, in this day and age. The FTC will change the CRA for Banks which is not good. Additionally, the FBI will investigate, indict and prosecute violators. Loan modifications open up past fraudulent loans subjecting them to any statue of limitations laws and potential exposure to Government. Rapid loss of employment, distrust of lending institutions, loss of revenue and taxes just to name a few affects are the results. This is why the Government did'nt get involve earlier and only created a voluntary plan. Government and other agencies would have their hands full! Also, this is why paying Borrowers are having trouble loan modifications. It make it appear that Financial institutions have their hands full. And can't stand any additional work load or investigations!

[mjtaylor22]

I like the idea that soemone has a plan and not a complaint as i so ofter see in these comments.
but the whole no job help you keep your home thing.
not gonna work in selfish america.
too many argue against helping period, even if one was swindled by their banker or mortgage broker.
so an all out program to keep a jobless family in their home, ha, the bumper sticker slogans agaisnt that willb e as nutty as the ones agaisnt health insurance reform

[kbee819]

How about this idea, modify primary residential home loans by lowering the principal balance more in line with market value and drop the monthly payments to affordable levels. The Federal Reserve has more than adequately padded lenders balance sheets to absorb the loss. Or, lower the principal and/or interest rate of the loan, add additional years to the back end of the loan with the option for homeowners to amp up payments if equity returns or the "jobless recovery" a term only an economist can love, becomes a real life recovery. So, a 30 year mortgage becomes a 40 year mortgage, but with the option to revert back to a 30 year term if circumstances for the homeowner make that possible. The bonus is a slightly higher interest rate for the extended mortgage period thereby giving incentive to reverting back to the 30 year plan when and if the housing market improves. Also, add language that if the homeowner sells within the first five (5) years of modification, any equity first must go toward the principal write off amount.

The GMAP is a nice boon for banks, no reduction in upside mortgage amounts, a 5-10% interest on top of the interest built into the original mortgage and no guarantee that equity in most of the hugely inflated home values will bear enough equity in ten years to enable a home owner to take out a second. I'm skeptical.

[usna73]

I bought a home to live in. I did not speculate. I pay substantial taxes because I believe in my community. What do I get?

Sorry, but bad decisions are not to be rewarded.

Sell me the home at "lower" market value and I'll rent it to you. Seems fair, doesn't it. It rewards the good actor, who saved and inevsted prudently.

BTW: Do I get a cash rebate from Lowe's and Home Depot from the sale they made for all those granite countertops and stainless steel appliances?

[portlandpete]

I have two issues with your plan. The first being that you "Envision the program..." and the second with your statement, "equity in the home is likely to increase". What if your crystal ball isn't as clear as you hope it to be? What if home prices don't increase? What does the homeowner do then? Wouldn't they be saddled with a debt to both the government AND the bank? What if the banks choose to trade the vouchers and create another flavor of the evil derivative?

Your plan needs to address what all the parties involved are going to do if the unforeseen derails the homeowner's ability to pay at the end of the term of the voucher.

[goodytwoshoes]

Ballon payments in ten years? Don't you remember the late 80's/early 90's when home financing was done with balloon payments instead of ARM's and everybody lost them due to not being able to pay the balloon pymt!! What are you people thinking??!!!
Please pay close attention to the following suggestion:

Interest rates on *All MORTGAGES* regardless of size should be reduced to *4.5% fixed immediately*: *no modifications, no refinances, no requalifying, just change the rates on the lenders computers *-- plain and simple!!! Just do it! Everyone will have more cash to buy food, clothing, cars etc. on an ongoing basis!! Stimulate the economy by giving everyone a break! Not just Wall street!

[Dwight5]

Sounds good to me.

[portlandpete]

At least it's something reasonable. I have two issues with this, 1. you state, "We envision that this program would immediately..." and 2., you wrote, "However, after ten years the equity in the home is likely to increase" My problems are what if you are wrong? What if your vision doesn't come to pass? What then? What if prices stall or some major "too big to fail" institution drags us back into this abyss? What then? The homeowner is then in a far deeper position, faced with a debt now in the hands of both the government AND the bank.

What would your contingencies be if your crystal ball isn't as clear as you hope it to be?

[TJCole]

Let's bare this in mind when a bank or mortgage holder forecloses on a property, it can't sell that property for anything more than the Current Market Value..!

Not the price of the original mortgage...so we rest these homes to their current market value..which is all the banks can now sell them for after a long wait for what they now deem a qualified buyer which could take a long long time as they are only giving very strict loans to those who can put a really sizable amount down as well...

Then give these folks a fair reasonable Fixed Rate not the usurious predatory corrupt rates they are being gouged for now from 11-14%..

What you gentlemen are proposing is designed to preserve the unrealistic obscene profits anticipated by these poisoned corrupt banks at the tax payer and Treasuries expense...with your vouchers..

This is not to help the people but the sleazy corrupt banks and even criminal mortgage companies..as there are another 8 million of these foreclosures on the near horizon..if not more the greatest displacement of Americans in our nations history..all due to our casino economic system so it's heads we lose, tails you win...nice try..!

Also these foreclosures are collapsing the local tax revenues and so a real emergency that will be picked up by even those who say well I can pay my mortgage, if they can't, that's their problem, not exactly..!

[mcmchugh99]

Why can't we have a national housing bank, tied to the Federal Reserve, that would aid homeowners directly?

[NeverUndecided]

This is yet another attempt to ignore the real problems & kick the consequences of faiure to address them down the road.

The plan, undressed, looks like this:

Channel more Federal money to the banks for an extended period, the "collateral" for that money which must be borrowed taking the form of 2 assumptions that were proved false in the current crisis - that home prices wil again start to "only appreciate" and that the millions who lost their jobs will find new employment that pays as well or better.

Completely ignored is that the huge building boom of too-big-by-half homes, the 2-3 cars in the driveway, and every other component of the insane, accelerating consumption boom of the last 25 years has been entirely fuelled by "cheap money" and debt taken on by the bulk of Americans whose incomes have stalled or fallen in the same time frame.

The result was the most spectacular mis-allocation of capital in history. To perpetuate this madness through myriad, myopic short-term "infusions" by government acting as debt-based guarantor of further discretionary consumer demand of goods already vastly oversupplied is very close to the very definition of stupidity.

There aare indeed real solutions. This ain't one of 'em.

[Kevin M]

I agree with this posting. As he stated, it assumes that housing will appreciate and the owners will find new jobs, if this assumption does not materialize then we will see a large percentage of foreclosures in 10 years. Furthermore, when sold the home would need to appreciate by a greater percentage in order to cover this new lein that would be added to the principle. At this time, I believe the best path would be to let these homes proceed into foreclosure and be bought by buyers that must conform to more stringent loan practices. Some of those being 20% down and possess good credit. Sure we would take a hit in the short term, but it frees us for long term growth. I do understand the plight of the people that will lose their home, however, I believe that under this plan we are only suspending that plight rather than ending it while having the tax payer fund the entire process.

[usna73]

You ( and the market) are correct. May I add the propsect that this will only insure inflation, should it even work out partially.

We cannot resort to rewarding or subsidizing bad beahvior, be it banks or individuals.

The GMAP punishes savers and dmaages the currency. Very bad through any lens.

Let the zombie banks fail, the inventory clear at market prices and perhaps we should insure the debt of those willing to step in at a community level who borrow from the community banks and rehab and offer the property to renters at market prices. Risk and reward back in balance.

The virtue of home ownership is a fantasy.

The subsidized housing ( rent control, etc.) of the 1950's and 60's were far better programs. Tenancy wasn't a bad word and communities were not fractured to the benefit of the unscrupulous developers and bankstas who have taken the money and long since run away.

[mtwashingtonmike]

Agreed:

And those of us that lived within or beneath our means and paid off our mortgages on time or early. Drove our cars until they fell apart, and took on no credit card debt. We "Ants" are punished by subsidizing the "Grasshoppers" of this world.

The problem is the solution. Let these overextended people fail. They will learn an important lesson, I hope. this will drive housing prices down to where they are more affordable, especially for young people just starting out.

[corkonian]

We're talking about people who are losing their homes due mainly to unemployment, not 'Grasshoppers' - most of them did nothing wrong, played by the rules and this is what has happened through no fault of their own.

[drkazmd65]

A logical, well thought out, revenue neutral (at least in the long term) plan,...

So of course,... it won't be done.

Yes,.. I am a cynic.