Mr. McCain, we must remember that a root of our housing crisis is twofold. First, some people cannot make their mortgage payments. Second, banks no longer receiving those payments must cover those losses with money that cannot be loaned to other borrowers. These two facts have revealed a sick and broken relationship between borrowers and lenders by causing a spiral of declining home values and a credit contraction (an inability to get loans) that is affecting the average person’s sense of security for family, retirement, and working life.
It is true that some people’s dreams were certainly larger than the reality of their pocket books. It is true that some banks made risky loans beyond many borrowers ability to repay. It is true that our present crisis is revealing that enticements such as no money down, no fees, no income verification, and high debt to equity ratios were evidence of a system breaking down. These borrower/lender problems, masked by years of quickly rising housing prices, could be ignored only as long as the house could be sold at ever increasing prices. The real cause of the crisis is the acceptance of ‘poor equity and high risk’ by both sides of the borrower/lender relationship. Equity is the tangible evidence of the borrower’s real interest in the present property. Put simply, equity is what the borrower really puts into the property. Poor equity reveals that, at present, there is little or no real interest in the property and that any real interest in the present property is only imagined as equity projected into the future as something the owner might have later.
What is revealing itself right now is that the financial crisis has infected more than just the housing markets: it is probably in all sectors of the economy to varying degrees. It is signaling that the world wide system of money circulation is damaged. While we in the United States have overextended ourselves as borrowers by importing vast amounts of the world’s goods it could not have happened so easily without others financing our debt by loaning us the money to buy their exports. Money, at home and around the world, is no longer flowing so freely from one place, or person, to another because lenders are simply afraid that they have a smaller chance of being paid back tomorrow on money they could loan today. No matter a person’s, or a country’s, credit score or down payment, it is getting harder to find money to borrow to get a car, a student loan, or a house. The credit score needed, the collateral needed and/or the interest cost of borrowing money may need to go very high during the process of reestablishing a healthy relationship between lenders and borrowers.
We must remember that the real cause of the financial crisis is the acceptance of ‘poor equity and high risk’ by both sides of the borrower/lender relationship. Before spreading, this crisis first showed its ugly head in the housing markets here at home. To begin solving our problems we must first work at restoring a healthy borrower/lender relationship that begins with housing. This is not an easy thing when it is hard to judge the real value of a house in an unstable real estate market. The problem is in finding a way to stabilize declining house values. During the time that takes, more people could lose their homes through foreclosure. Vacant homes depress prices further as they continue adding to the supply of available homes on the market. Rising interest rates would also depress home prices as the cost of borrowing increases. Additionally, there is a growing percentage of borrowers that have a great negative equity in their home; and, if or when it becomes evident that the home will not regain its former value it will make financial sense for many of these borrowers to abandon their property by leaving it to the lenders.
The revolting aspect of just buying these bad loans to take them off the balance sheets of banks is that it does nothing for the troubled borrower or for any other person experiencing their housing value decline. Interest only loans in the hope that housing prices will again increase makes no sense except as a crap shoot. A person owning a house that they cannot afford to live in because of a high debt to equity ratio makes no sense. Continuing mortgage payments on a house that was grossly overvalued makes little sense in the long run. A borrower who has no ability to increase equity in the property has no reason to keep it up. Keeping people in a home in which they have an established and growing equity is the only way to begin to reestablish the healthy relationship between lender and borrower. It must be in the interest, as well as the ability, of the borrower to keep making payments that grow equity; and, it must be in the interest of the lender that the borrower be interested in growing property equity so that the lender has the long term ability to recycle the money loaned.
One way (and it is vital that we come up with other ways) for lenders to encourage troubled borrowers to stay in homes declining in value is to set up a five year program where the lender offers a ‘rent to own’ alternative. Market rents for any neighborhood are still relatively stable and easy to determine. Instead of conventional mortgage payments, offer payments of market rent plus ten percent; of which, that ten percent is to be held in an ‘equity down payment’ escrow account for the borrower. This ‘equity down payment’ account will begin working on the borrowers equity side of the problem and by encouraging people to stay in their homes the lenders assets begin performing again. At any time after participating in the program for at least one year, and prior to the ending of the program in five years, the borrower may repurchase the home at a new fair market price by adding to the ‘equity down payment’ escrow an amount of money at least equal to ten percent of that new market price. During this program, if the borrower wishes to move then the ‘equity down payment’ money moves with them and can be used for the purchase of any other home. With both borrower and lender participation in this program we can: first, begin using rental income as a basis for stabilizing housing values for lenders by keeping their assets performing; second, begin growing equity as a real foundation supporting housing values for borrowers; and third, in conjunction with one and two, the real problem of cultivating healthy relationships between borrowers and lenders is begun. The program is simply encouraging the development of a qualified borrower for a serviceable loan from a lender. Is this simply too good to be true? Not at all! In fact it is the only sane way to do it. Right now, we are coping with the aftermath of our insane lending and borrowing practices. Until we begin to change our poor habits, which are grounded in our unhealthy expectations, money will not flow properly or efficiently; thus, we will continue insanely repeating the same mistakes over and over again.
Having the down payment to establish home equity will not in itself reestablish the healthy lender/borrower relationship. The lender/borrower needs a realistic debt to equity ratio for the relationship to succeed. Unfortunately this debt/equity ratio reveals a problem we have barely begun to talk about; which is, that the overall debt of many consumers is too high to be serviced. Evidence of this growing problem can be seen by comparing the flood of credit card offers mailed in our recent past to the present mailing of credit card offers which is now approaching zero. The serviceability problems of auto loans and student loans is also growing and indicating the severity of the problem posed by high debt/equity ratios. Servicing this total debt/equity is a great problem facing us today. Mortgage payments are just the largest part of the debt side of the equation for most homeowners and future home buyers. Actual declining house values are a symptom of this greater problem. The solution to the real economic problem can only be achieved by establishing a workable, sustainable, debt/equity balance: that is the only thing that can create a tangible confidence in the markets and the restoration of a healthy relationship between lenders and borrowers. Right now we have a great debt to equity imbalance and we do not know what the proper balance should be.
Since the bailout bill passed, authorizing 700 billion dollars worth of taxpayer backed funds, my team has come up with one principle step to productively use that money. We are proposing that, on a conditional basis, we immediately freeze home foreclosures and end evictions for the next five years. The borrowers conditions are; first, that the borrower be living in the home; and, second that the borrower agrees to provide equity for a future loan. The lenders condition is that the lender work with the borrower on an appropriate debt/equity ratio that includes realistic mortgage payments, credit card payments, car payments, school loan payments, and any other payments such as medical, utilities, phone, etc. which should have been considered within the terms of the original loan. The meeting of both lender and borrower conditions has the potential to properly restructure a future loan that may be adjusted to future market rates of both principal and interest within the five year period. We understand that people who are in over their heads will be unable to qualify for the new loans as things stand. That is why it will be important for the lender to take guidance of the whole debt/equity reality that the borrower is in and that is why the ‘rent to own with a down payment escrow account’ is the other half of this proposal. It is certainly probable that loans beside the mortgages will have to be renegotiated too. To have the mortgage lender be the only responsible party to the resolution of this debt to equity imbalance is ridiculous, especially when the credit card and student loan companies extended seemingly unlimited amounts of completely unsecured debt to borrowers often only in pursuit of short term corporate profits.
The science of economics was in its infancy during the great depression of the 1930’s. We are probably experiencing the wild and frantic teenage years of capitalism today. Today’s science of economics has matured between the great depression and now and what economics now knows must be taken into account. The current bailout proposal, as it is being talked about, seems to take considerable care of Wall Street lenders and it seems to give only lip service to caring for the borrowers. Based on certain conditions as already discussed the freeze on foreclosures and the possibility of converting the property to ‘rent to own’, is the only proposal now up for consideration that will help create a supporting floor under the housing market based on the rental income of that housing capital. It will also help give us at least one year of time needed for economic scientists to experiment with ways to address the proper balancing of debt to equity.
The economic realities which we are experiencing today will force us to reeducate ourselves regarding the economic values of money, work and property. Our economic institutions as they stood yesterday, the regulations or the lack of regulations set up by congress, and poor or greedy personal habits have all combined with other external events such as war and volatile energy prices to create what seems to be the perfect financial storm. New thinking that will address both sides of the debt/equity balance is demanded in these times. The old thinking will take care of the institutions because it does not know any way to include the borrowing people: the people it makes money from and the people it uses to make that money.
The old thinking cannot measure the pain of the people as individuals or as a community, but it can measure its own pain symbolized by going out of business. That pain of dying as an institution is unacceptable to those in positions of power and they do not like feeling pain. To some extent, the dying of the institutions is unacceptable; but, their painful experience is absolutely necessary and death must be a real possibility. Our institutions are our means of organizing our productive resources. Without them in some form, which may be a new form that is not yet evident, nothing will get accomplished on the scale that will be needed. We have seen in Iraq that wiping out existing institutions and creating new ones from the ground up, with no historical traditions to provide a base from which to do work, simply does not work. Saving evolving institutions is necessary to some degree but not to the exclusion of the people they are here to serve. It is these new economic realities that are forcing a great institutional change in how business will be done in the future across the world. It is the new thinking that is brought into the world by the inheriting generation that must solve these problems. The younger generations must respectfully take responsibility for the living it will be creating for itself from what the older generations are leaving.
Jim Cramer, on his show Mad Money, Friday night, suggested a meeting between Paulson, the Fed, and the major surviving banks in which it would be agreed between parties that all problem loans would be taken care of and that each bank would be given 100 billion dollars to loan out on an immediate basis. In principal that is a fine idea but it only addresses half the problem. If there is no equitable reason to give out the loans then we will just compound the problem by just wishing that equity will be created. Do I suppose that we should just trust the bankers to do what is right for all of us? Not on our life! Never again! We need to stop and take a breath even if only for a day.
Mr. Cramer also addressed the need to go after the powerful people that should be taking greater responsibility for this mess. And that is very, very, necessary; but, recognize that it is a second concern to the overall restoration of the economy. He also spoke about greed and the hundreds of millions of dollars stolen with careless disregard for the consequences. With regard to that greed, I was reminded of Khruschev’s assertion that ‘capitalism is based on greed’. I believe that is completely untrue. Capitalism, as well as any other form of economic system, cannot possibly survive based on greed. Any system that survives survives only as a sustainable system of working relationships based on honesty, openness, equality, and transparency: greed as well as dishonesty, close-mindedness, inequality and opacity ultimately destroy all relationships. Honesty, openness, equality, and transparency foster all relationships including capitalistic ones.
Even though these ideas are very simple and fraught with unanswered questions regarding monetary losses for borrowers, lenders, and society as a whole they will provide a measured step in stopping the bleeding so we can begin the process of recovery. Wasting time playing the blame game just increases the costs and the severity of the injury. Restoring the healthy relationship between borrowers and lenders must start from where we are today accepting that vast sums of money disappeared. So far, all I have heard pundits talk about is restoring the ability for institutions to borrow and lend to each other hoping that some form of healthy borrowing/lending will trickle down to the average consumer once the ability to lend money is restored. We must remember that it is just as important to restore the personal interest for acquiring the property in the first place: that takes equity – for equity is the present measure of economic value personal interest places in the property itself.
Now I would like to see what kind of new thinking would come about with regard to the credit card and student loan industries if they were to be reregulated. They might even be encouraged to come up with some realistic proposals on their own if we consider easing bankruptcy restrictions. Imagine if the right to first payment on various held credit cards was actually based on which card has been held the longest and/or on which card has the lowest interest rate. Imagine that the longest held credit card had a credit rating based on the first ten percent of after tax income and the second longest held card had a rating based on the second ten percent of after tax income. Let us just see which banks want to be third or fourth in line to extend the credit that will be treated as though it were a third or fourth mortgage.
With regard to student loans it might be a good idea if lenders tied loan amounts to a figure based on average pay over five years for someone graduating with a particular major: say a $40,000.00 salary per year. That would require both lenders and students to consider the potential return on the education for that major. The money borrowed ($40,000.00) could also be amortized over ten years insuring that payment would be roughly ten percent of yearly pay ($4,000.00). This would encourage students to carefully consider the relationship between education, work, and wage. This would also begin to reorient colleges toward more productive educations. It would also take away a fixed upper limit loan amount that it can get from students no matter how well or for what employment they are taught. I would bet that if the government guaranteed that any student could get $100,000.00 in student loans for any four year degree every college would quickly find a way to increase costs to around that $100,000.00 limit. Might this actually lower college tuition costs? It might!
By just suggesting regulations such as these, I think we can spur new thoughts as to how to do things differently in Washington in a way which will make a real difference for the average person’s sense of security regarding their family, their retirement and their whole working life.
Thank you,
From the imagine of
Mauruy
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