Seth Wu

Radical Solution to Housing Mess

The last few weeks I have written letters to editors, Federal Reserve and over 80 US Senators suggesting the same. A full writedown to current discounted values will help with future purchases and resales.

Self-Recapitalizing Bad Bank Plan Enables Mortgage Fix With No Permanent or Substantially Reduced Taxpayer Cost

Dear [Rescue Plan Policy Maker / Senator],

Almost all of the prior mortgage solutions have had multiple problems:

1. Ownership of the debt was dispersed and legal rights were difficult to consolidate for a fix.

2. All suggested fixes result in huge "permanent" subsidies either to debt holders or whoever, at huge permanent cost to taxpayers.

The Big Bad Bank ("BBB") Plan enables a two step solution (the second step is my idea which I have not voiced, but which I hope rescue leaders might think of and consider).

A. It consolidates ownership of debt, allowing for application of the "fix" in B.

B. "Qualifying underwater home borrowers" would get a principle write down based on current discounted market value of home at current long term low interest rates. However part of the deal is an added provision that will "run with the land," and require any future gain on resales (and subsequent resales) be split (say 50% - 50%) between the home owner and the BBB (which of course is pretty much owned by the federal government and the taxpayers), until the principle writedown, including interest) has been paid back to the BBB. The future gain to be recaptured might simply be required to be withheld by the seller (through the sales escrow), and remitted to BBB (or to IRS for administrative convenience). Through this mechanism the taxpayers and the government is merely out the initial costs for a temporary period (the $4 to $5 trillion needed by the BBB), and will eventually recoup most if not all of the costs. We would have to limit this program to those who truly need it, and deserve it. So it is reasonable to place definitional limits on "qualifying underwater home borrowers." Qualifying borrowers might be defined to include, for example inter alia, those whose earning power cash flow are shown to be unable to cover their original mortgages, but are able to cover a current fair value adjusted mortgage, and whose original mortgage did not involve any element of misrepresentation or fraud.

The average American home owner is said to change residences every 3 to 7 years. If true, this would provide a churn element promoting recognition of recapturable gains, restoring funds to the BBB and taxpayers.

In the event of a death of home owners, the realty would have to be excepted from the normal step up basis rules, and death beneficiaries and their successors would remain subject to the BBB refinanced mortgage terms and have to assume such mortgage.

Because purchasers of such realty are subject to the (say 50% - 50%) gain recapture rule (which will run with the land until the BBB recaptures its fair share of costs from the gains), the resale value of the realty is reduced. To enhance such realty's attractiveness to purchasers, the BBB might extend preferred interest rate mortgage terms to qualifying purchasers if the recapturable residual exceeds certain minimum thresholds. For example, if the recapturable residual exceeds say, at least $30,000 then a qualifying purchaser can get a preferred interest rate first or senior mortgage for a value of say 2X such recapturable residual, provided that the then current fair market value exceeds the new BBB mortgage amount by say 1.5X.

Of course I am tossing out somewhat arbitrary numbers, subject to discussion and fine tuning for various considerations and factors.

Various elements support an eventual "long term U.S. general home pricing bounceback" perspective, including among other factors:


1. It has been historically true on an overall basis.

2. The US remains for the long term foreseeable future the world leader in general overall economic growth because of various factors, especially because of the magnetic human and business environment supported by the rule of law, respect of property rights, respect of contract rights, ease of business development, capital funds development system, natural resources, education, technological innovation, equality of opportunity, et cetera.

3. Long term inflationary pressures generally increase the value of property and other non-renewable resources and devalue the value of currency.


The BBB's gain sharing rights would "run with the land," which is to say it is a perpetual right as long as the taxpayers' subsidy remains outstanding. What percentage of home realty (esp. the underlying land value) has not appreciated in value over 30 years; over 100 years; over 200 years?

Thus, if qualifying homeowners were refinanced into 30 to 50 year loans, at a reasonably low interest rate (currently under 5%, so arguably the Federal Reserve's BBB could finance at 3% rate or lower [knocking out the profits and overhead of the middlemen banks], or perhaps at a 1% or 0.5% variable interest rate above the cost of living index changes), then the underlying realty may more than appreciate sufficiently over a 40 year term to "prices" above, say 2006 values. Usually long term retail mortgage interest rates average about 2% to 4% above the inflation rate (so that banks, et al, can cover their costs and make some money). Yes buildings depreciate, and condominiums depreciate, and home structures generally depreciate, but the underlying land values usually do not depreciate (throwing out the Love Canal scenario, sure one can think of slums and failed public housing projects, among other exceptions ... but usually all of which can be redeveloped into higher value realty).

Factor #3 above of course suggest that the price recovery after 40 years results in a return to the taxpayer of a value that may be less or substantially less than the inflation adjusted return of the 2009 dollar. Arguably then, not only is there an running long term interest-principle payment factor based on the value of the 2009 adjusted market value of the realty, but there should also be a variable multiple to be applied to the built in gain recapture that is to innure to the BBB and taxpayers, which is to run with the realty to successive owners. Historically, say over a 40 year period, realty values have appreciated greater than the inflation factor [this however is a statement of opinion, based on generally observed lay impressions; and probably should be verified by economists.].

Imposing a built in gain recapture rule that runs with the land and binds successive owners, of course will affect the resale value of the realty involved, but this is part of the cost of such a plan. Instead of the simplicity and speeded recovery based on a 50%-50% gain sharing scheme, arguably, the gain recapture could be based on a ratio of the dual equities involved, but that may increase the monitoring and compliance complexities.

One conceptual difficulty may be with condominiums. For example, say the underwater realty is a fourth floor condominium; here, the property right is a primarily a right in the fourth floor unit's space. If the condominium structure at some later time is condemned and razed, and later the underlying land is redeveloped into a two floor building, the BBB's gain recapture rights might be lost unless there is a mechanism to persuade condominium or land owners in the aggregate to be subject the the BBB terms. Realty specialists and Congress will have to work that issue out.

Very best regards,


Seth Wu