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.
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.