Veto The Housing Bill!

Bush is saying the right thing when he stated that he would veto the Housing Bill being debated in the House of Representatives. The proposed Housing Bill, at best, would delay for a few months the inevitable housing market correction that it is currently undergoing and, at worse, would send a strong message that the government will bail out speculators and builders who made poor business decisions.

What The Housing Bill Proposes To Do:
1. Give local government $15 billion in grants to buy and guard vacant houses from vandalism
2. Offer $7,500 tax credits to first-time homebuyers
3. Mandate FHA to guaranty up to $300 billion in mortgages on properties that are “underwater”
4. Allow states to issue up to $10 billion in tax-exempt bonds to refinance troubled mortgages

The housing bill will not help those families in danger of losing their house. Instead of bailing out the builders and speculators at a tune of approximately $23 billion, there are better alternatives (click here for the full report from the Joint Tax Committee).

Alternative Measure For The $15 Billion Grant
Why throw good money after bad? The municipalities are claiming that vacant houses attract criminals and are urban blight. True. However, rather than spend money protecting vacant houses that will deteriorate over time, provide grants to the cities to raze the vacant houses and turn them into local green spaces – either community gardens, local park, or public space.

Benefit: lower cost. It will cost about $20,000 per house to raze and cart away the debris opposed to approximately $2,000 to $5,000 per month (guesstimate cost of securing, monitoring, and maintaining) to protect a vacant house from vandals and criminals.

Benefit: Easier policing & lowers crime. It is always easier to police open space than series of houses. One officer can perform a sweep of an open space and easily identify potential problem. Moreover, a well-placed security camera can provide 24/7 surveillance.

Benefit: Better Upside. It is easier to sell a vacant land for development than a run-down house. No matter how well a house has been maintained, if it is not lived in, items requiring repair increases. In the end, the potential developer may decide to raze the house anyway.

Benefit: Clean Slate Design. By razing vacant homes, it is possible to rezone the land for different use in the future. It is also possible for the local government to re-plan their urban landscape with lower cost and less community opposition.

Alternative Measure For The $7,500 Tax Credit To First-Time Buyers
There really isn’t any way to force people to buy a house when (1) most potential buyers are still waiting for the price of houses to come down further; (2) it is more difficult for an average American to obtain financing due to the stricter credit review process; (3) It would delay the necessary housing correction as some sellers will use this to hold firm on their asking price. They can ask all they want but it will not sell.

Just drop this idea. It is a white elephant that our country cannot afford.

Alternative Measure For The $300 Billion In FHA Purchase Of Mortgages That Are Underwater
This is just a bad idea; dead from the get-go. Why do we want to reward banks that relaxed lending guidelines and either allowed or offered up to 100% financing (80% conventional and 20% “piggy-back”). The banks are in the business to take risks or fail. Since their risk management and corporate managers failed terribly, let them have their just dessert. To buy out the portion of the mortgage that is underwater only rewards poor judgment and lending practices and forces the taxpayers to shoulder the burden of their eventual default.

Alternative Measure For States To Issue $10 Billion In Tax-Exempt Bonds To Refinance Troubled Mortgages
One hare-brain scheme leads to another. The state and local governments are already getting squeezed from lower tax receipts and higher costs for services. Why would they now want to tack on an additional burden, especially one that has a high potential for losses?

We have a dysfunctional bond guaranty system with Ambac and other financial guaranty insurance companies having trouble meeting their existing obligations. By offering a tax-exempt bonds backed by payments from troubled mortgages, how much of a spread does the states have to give to induce investors to purchase this toxic security? Will there be any takers?

Perhaps the Congress could take a page from 1989 and do something similar to a Brady Bond.

My Thoughts, A Take On A Super-SIV:
1. Federal Government sponsors a creation of a private trust (super-SIV structure) into which any and all financial institutions may sell their unwanted mortgages and MBS at a discount to face value (‘haircut’) in accordance with established market practices. The Trust gives the Bank marketable securities in exchange, which will be treated as a non-taxable event by the IRC. Additionally, the Federal Government will earmark a reserve equal to 20% of the total value of the discounted value of the trust portfolio that will be there to pay in case there are losses (20% first loss subordination backstop).

2. The Federal Government will then treat the amount of the discount that the financial institution took in selling their mortgages into the trust as a tax credit that can be written off equally over a 10-year period, beginning with the year after the date of the sale.

3. The tax write-off would also be transferable to any business. In exchange for granting the tax credit, the Federal Government will hold the notional piece of the trust security. This way, if the trust is able to recover more than the discounted face amount of the mortgage pool, then the Federal Government will reap the benefit. As the trust sells the mortgage or re-packaged CDOs, each financial institution will receive payment equal to their contribution, pari parsu. After all the mortgages have been sold and Trust securities retired, excess interest or revenue will flow to the Federal Government.

Example: Trust “US” is established. Bank A sells $10 billion in mortgages to Trust “US” at a 25% discount, or $7.5 billion. Trust “US” gives Bank A securities equivalent to $7.5 billion. Federal Government gives Bank A $2.5 billion tax credit that must be written off equally in 10 years. Bank A, knowing that it probably won’t be able to maximize the use of the tax credit, sells the tax credit to Coal Burner Z, which is looking at $5 billion in tax liability over the next 10 years. Bank A sells the $2.5 billion in tax credit to Coal Burner Z for $1.54 billion, using a simple net present valuation at 10%.

In the end, Bank A was able to turn tier 2 or tier 3 asset into a tier 1 asset plus cash. The net loss to Bank A would be about $964 million, or 9.6% of the original face value of the $10 billion mortgage. While the Bank will still experience a loss, it is a manageable loss of less than 10% discount to face value. This is a better scenario for Bank A sine it (1) quantifies the maximum potential loss to a bank’s portfolio, (2) limits the downside to Bank A, and (3) Provides Bank A with more liquidity by replacing tier 2 / 3 assets with more liquid asset: cash and securities with implied government back-stop.

With this simple plan, the government will only be liable for the 20% of the discounted mortgage portfolio and not jeopardize its credit rating (as in the case of allowing FHLMC and FNMA to lower their reserve requirements and buy more mortgages). The shortfall in tax revenue is partially mitigates by the fact that the tax write-off occurs equally over a 10-year period and it will help to kick off a new market in tax credit trading. If the trust securities are well received, then the banks will be re-capitalized within months.

I’d like to hear readers’ thoughts on this idea.

Regards,
Ed Kim
Practical Risk Manager

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