This email is aimed at somebody in your campaign that is looking at the economic crisis that is currently facing the USA & the rest of the world. It is being sent to your campaign first & to nobody else (the Republicans or news channels etc) so that if you like all or any part of it you would be the first to make use of the ideas. In other words it might assist you in providing part of the solution to the crisis.
My name is Michael Bouwer. I live in South Africa but have also spend quite lot of time in Ireland during the last few years. In Ireland specifically I have watched property prices decline. I have followed with great interest the unfolding credit crisis and specifically USA & UK government planned intervention. What I have seen is both governments printing money, it seems without limit, highly inflationary. Paulson’s plan to buy toxic debt, & Darling’s plan to give money to banks in return for equity which Paulson also seems to now favour. The amount given to banks appears to be on the basis of “what do you need?” to prevent you immediately going toes up. I suppose desperate measures for desperate times. But I do not see any plan made for home owners that individually are in a desperate plight. Nor have I seen any attempt to quantify this “toxic debt” from the banks perspective or “negative equity” that many home owners are facing.
So the following is sent in an attempt to make a logical framework along the lines of which these problems can be resolved.
It is specifically aimed at the relationship between banks & home owners. Solutions are offered for both, using taxpayers money, buying equity in banks against toxic debt while simultaneously temporarily freezing negative equity portions of home owners bonds. The taxpayers money would be recoverable from both sources.
I am aware that the banks are in far more trouble than that caused by offering bonds against properties where there is now negative equity. However, all current government intervention is aimed at saving the banks, which obviously is the priority.
However, what about the man on the street? I have not seen any proposed solution for his problems regarding negative equity. This has always been one of your campaign objectives. There is also a suggestion to allow partial ownership of property. It is better to have this than leave houses empty. The concept of a co-owner is introduced. This would be using private funds aiming at making profit & might interest an investor like Warren Buffet whom I know is a campaign supporter of yours.
I thought about calling my proposal “Plan B.” Government solutions are their Plan A’s. B is also the initial of my surname.
I would like response from yourselves regarding whether you are interested at all. If you are not or I have not heard from you by say Wed 15 October 2008 I will forward the proposal to the news networks etc, but still not the Republicans.
I am available to answer any queries you may have which I will do ASAP. My details are below.
Thank You
Michael Bouwer
Email 0781513426@mtnloaded.co.za
Tel +27 31 563 2436
Cell +27 78 151 3426
The following is my proposal.
The current financial crisis stems from:
This might have started in the States but is prevalent in many other countries.
The above factors have caused home owners to become unable and/or unwilling to repay their mortgages, throwing the property market into disarray and adversely affecting the balance sheets of banks.
There are certain factors that have been raised that are important to maintain with any solution. These include minimising the cost to the taxpayer and assisting home owners stay in their houses. Also important is that rash actions by both home owners and banks are not rewarded. It is also getting banks back to basics – holding deposits safely and lending money to customers.
Solutions proposed by government so far seem to be massively inflationary. They are perceived to be the unlimited printing of money which is injected into the banking system while not making a direct solution available for the home owner.
There are three factors that have to be considered to correct these problems:
Solutions suggested are kept as simple as possible as any solution must be readily understood by Joe Public.
We will first consider the situation where the home owner is still in their house, and later consider remedies for those that are empty, unfinished etc.
Interest
It seems to me, specifically in the States, that there have been two distinct ranges of interest rates that have been charged to home owners against their bonds. These are:
The suggestion is that interest charged on bonds must be uniform. If it is currently less than that paid on a fixed rate mortgage by a home owner who has no problems, it should be passed on as a reward. It should be based on the Fed rate in the States. This is currently 1.5%. The banks are then entitled to a percentage range that they can add on to cover their administration costs and discount the credit rating of the home owner and achieve a reasonable profit, say 2 to 4 %.
Negative Equity and Toxic Debt
Negative equity results in a home owner having to decide whether it is really worthwhile spending the next twenty years paying off a bond on their house that is significantly greater in value than the current worth of their house.
There can also be no reward to a home owner by simply coming to his rescue. Two neighbours, identical houses, both purchased two years ago for $100 000, one paid cash, the other used a 100% bond, but both now worth $80 000. The cash purchaser has to suffer the loss, the other with the bond is considering walking. We cannot simply save the bond holder and ignore the cash purchaser.
A deal could be made to help the bond holder if he so wishes. We will term the $20 000 ($100 000 - $80 000) as the Negative Equity (NE) amount.
The “Bail Out Fund” (BOF) is used to pay this $20 000 into the bank holding the bond against what in effect is “Toxic Debt.” The bond is reduced and the BOF or Fed holds a $20 000 equity share in the bank, say Preference Shares. This is straight taxpayers’ money and has a reasonable chance of being fully or at least partially redeemable. The shares could be converted to Ordinary or sold as is at some future time to the public. It is not rewarding the shareholders of the bank as it is diluting their equity. It is also a very specific amount of money. It is not sucked out of the air. The total of the Feds equity would equal the total of the NE incurred by that bank.
To assist the banks in the interim, a provisional amount could immediately be paid by the Fed to the bank for equity to support the banks’ balance sheet until the exact amount is determined, say within six months.
This has handled the banks side of the equation. Their balance sheet is propped up and the home owner is happy and can pay his bond repayments on $80 000.
However, as it stands, the home owner has received an unfair advantage. The $20 000 NE cannot simply be ignored.
My suggestion is that the $20 000 NE is written against the homeowners title deeds as a second mortgage, payable to the Fed. However it is interest free for a period of say 5 years and can simply be ignored by the home owner until then if he so chooses. But it must be repaid at some stage and a system is suggested along the following lines:
We will use the 4% interest rate that was suggested earlier for illustrative purposes as staying constant for the time period of the example to maintain simplicity, yet bearing in mind that in reality the interest rate could change, and interest is payable no later than the end of each year
As an incentive to make the homeowner repay the NE as fast as possible, he could be offered a discount calculated on when this repayment is made in the five year cycle. So the discounts would be as follows:
During year 1, 5 yrs * 4% = 20%
During year 2, 4 yrs * 4% = 16% etc.
The discount is being reduced as time passes.
This could be financed by the home owner by increasing the mortgage bond based on an improved value of the property which has resulted from a market recovery, improved job situation etc.
If the NE is not repaid after five years, it would be simply handled as a normal bond, being a second bond, at an interest of 4%, over a fixed time period, max 15 years, payable to the Fed. Disadvantages of holding it as such would be restrictions on the first bond regarding things like access to further finance and if the property were sold, the NE would be second in line after the normal bond for the proceeds of the sale.
The net effect for the taxpayer is that the repayment of this NE is an additional recovery of taxpayers’ money. The homeowner and the bank have both benefited without gaining unfairly.
How would the NE % on a specific property be calculated that could be claimed that would make it relatively easy for the system to be implemented? In other words, you don’t want an inspection of each property followed by months of wrangling.
Negative Equity Zones could be formed that describe losses, as a percentage of the purchase price, incurred in similar parts of the country by property purchased in each of the last five years. The number of zones would be minimised, say five, A to E, and they would encompass no more than a state but no less than a suburb of a town or city. This would be legislated so that a home owner has no doubt which NE Zone his property falls into. Even though different parts of the country will have been affected in a similar fashion, and neighbouring suburbs might have been affected totally differently, multiple suburbs, towns, cities or states would be described by each zone. They are the areas that have been affected the same as a percentage. Each home owner would know which zone his property falls under. There is no argument. So zone C might be as follows:
NE ZONE C
2004 0%
2005 10%
2006 20%
2007 10%
2008 5%.
The above %s are listing what can be claimed against the purchase price as NE corresponding to the year the property was purchased.
These NE Zones must then be allocated to at least whole States but no more detailed than specific suburbs of towns or cities. Each home owner and bank can easily identify what NE Zone a particular property falls into, and hence a negative equity claim that could be made.
It probably would be politically prudent to offer the NE facility to home owners who paid cash to assist their liquidity if desired. The facility would still be subject to the conditions above. The cash would simply be put in the home owners’ pocket.
For the banks it would be relatively easy to quickly assess the total NE claim that they could have against their mortgages by simply breaking each property purchase (the bond they hold) up into the applicable NE Zone and year of purchase. An immediate claim can be made against the Fed as a provisional claim while the six month time frame is used to get the actual.
The fact that the home owner may have paid a deposit has not yet been accounted for. The simplest solution is to work with the ratio of the deposit to the bond when making the purchase. Only that ratio expressed as a percentage could be claimed by the bank and used to reduce the bond amount as described above. Let’s say a $100 000 purchase price, $30 000 deposit and $70 000 bond. Only 70% of the NE could be claimed by the bank and reduce the bond. The balance, 30%, could be claimed as for the 100% cash buyer. Both amounts would together create the second bond.
Now the above has discussed the situation where the home owner is in the position to save the situation – in other words retain full ownership.
What happens when the home owner is simply in over his head?
Partial Ownership and Toxic Debt
The States currently seem to have an over supply of residential property. Or actually what it means is that there are not enough people who can afford to buy these properties. So properties are empty, largely because the home owner could not afford the bond repayments and the property has been repossessed, or they are new and have never been sold, or they are still being constructed and that might have been halted because of the economic situation. In other words, the developers’ bond facility has been stopped.
Let’s consider the situation where the home owner is still in his property but in the short term is only realistically able to pay a portion of the bond. We are assuming that there are not people queuing up to buy out this unfortunate individual. We are also assuming that it is politically desirable to assist the home owner as much as is reasonably possible to stay in the property and indeed convert him to full ownership if possible.
Home owners could categorise themselves into 10%, 20%, 30% etc to 90% partial ownership. Realistically this might only be practical in a more limited range, say 50, 60, or 70%
The first point is that the higher the equity the owner can hold, the longer the time period available for him to gain full ownership – so 50% would give him 5 years, 60% 6 years etc. The home owner has certain rights and protection during this period. Let’s call it the “protected period.” Thereafter, normal market rules come into play.
Next we will introduce a co-owner. This person – it could be an individual like the mother-in-law or a private fund created specifically for this purpose – would purchase the balance of the equity of the property that the owner cannot afford. However, the co-owner will not live in the property or be able to charge rent. So the co-owner must be able to purchase his share at a discount. The co-owner could pay cash or raise his own bond against the property.
In simple terms, multiple funds that are using private, not taxpayers money, could be created to purchase these equity balances. Simple rules could be made to control them, fixing charges like administrative costs. The fund is private and is solely formed to make profit. The tax situation would have to be considered. The fund might insist on a 20% deposit, the balance of the purchase price being raised by co-owners bonds on the properties. Further, during the protected time period mentioned above (the number of years determined by the owners’ share of equity) certain rules will be in place. An investor in one of these funds might be required by law to pay a 20% deposit against their total investment, the 80% being financed by bond. Thereafter, he only has to be able to meet the bond repayments due. There is no huge outlay. It is a relatively safe investment.
The owner has precedence during the protected period. He could sell his share at any time at market price. He could buy at any time during the protected period the co-owner’s share at a regulated price, as well as always having first option to match any offer made by a third party to the co-owner.
The co-owner is second to the owner but would always have the option to match any third party offer to the owner. He is bound by a restricted selling price of his share to the owner during the relevant time period. Thereafter normal market practices apply. He does not earn any rent during the protected period nor is he responsible for any expenses (like property taxes.)
The bottom line is that by the time the protected period expires, the owner is expected to attain full ownership. If that cannot be met, it is likely that he would have to get out, as thereafter he would be obliged to pay rent to the co-owner. If he wanted to buy out the co-owner at this time, he would have to pay market price. As we are aiming to help property prices recover, the deal would no longer be nearly as sweet. So in effect, the owner would be forced to sell but at what should be a reasonable price for his share.
One factor not mentioned is that the owner’s and co-owner’s share of negative equity if applicable would also be apportioned in terms of their equity ratio if the relief was applicable as discussed earlier.
Let’s look at an example:
Again we will use a purchase price of $100 000 financed by a 100% bond. To simplify the example, there is no negative equity, but it is easy to apply as mentioned. The owner can only pay off approx half the bond as his spouse was retrenched. The relevant time period during which the owner is protected is 5 years
We can’t simply go 50/50 as only the owner will use the property. So we have to formulate an equitable split to pay for the 50/50 ratio.
Something along the following lines is suggested: We will maintain the 4% interest charged against a bond for this illustration.
The owner pays 50% of $100 000 for his share plus 4% interest for 5 years that is halved (it is split with the co-owner as the price for his share will be reduced.) This equates to $50 000 + (4%X5yrs/2) of $50 000 which totals $55 000.
The co-owner has the same starting point of $50 000 but the interest is subtracted this time – so $45 000.
From the owners’ perspective, once there is a 10% or more recovery of the price of the property, he is breaking even or in profit making territory for his share. From word go, he is living on the cheap only carrying a $55 000 bond.
The co-owner is in for $45 000 paying interest of 4% a year which is $1 800 a year or $9 000 over the 5 years. The max he is in for during the protected period is $54 000.
What rules would apply to the co-owner if he wished to buy out the owner? It is simply the market price. He would have the right to match any third party offer as well, in other words he has a “first option.”
The situation regarding the owner is more complex as he is “protected” and we have to make it that the investment is worthwhile for the co-owner to make. The co-owner must be able to make a reasonable profit if he sells his share even during the restricted period.
If the owner were to buy out the co-owner, we would have to create a price structure for the protected period. Thereafter market price applies. The suggestion is something along the following lines. The owner pays what the co-owner paid, the $45 000 plus say double the interest payable on a 100% bond. This is $1 800 a year. So the structure would be along the following lines:
Year 1 - $45 000 plus $1 800 x 1 year x 2 which is $3 600 so total $48 600
Year 2 - $45 000 plus $1 800 x 2 years x 2 which is $7 200 so total $52 200
Etc till year 5 which would total $63 000. Thereafter price is determined by the market.
This is fair to the owner. If he had have paid $50 000 for the other 50% the interest after 5 years would have been $10 000, so he would have been in for $60 000 anyway.
How does the co-owner fare? Let’s ignore the fact that he might have had to pay a 20% deposit, $9 000 and work on a full $45 000 bond at 4%. His profit structure would be as follows:
Year 1 a selling price of $48 600 less the purchase price $45 000 plus $1 800 interest leaving a profit of $1 800 – in other words his profit equals interest paid or payable on a 100% bond.
Year 2 would be $3 600
Etc
Is this a reasonable return? Seeing that no money has been put down it is more than fair. Any deposit would increase profitability but it would also have an opportunity cost. In real terms, the only risk to the co-owner is a further devaluation in property prices.
Why would either party enter a scheme like this? There has to be the fundamental belief that property prices will recover.
This system would work on the same basis for any equity split. Say it was owner 70% and co-owner 30%. The protected period would be 7 years.
The owners’ purchase price is $70 000 plus 4%x7years/2 which is $84 000. The owner has 7 years free rent etc. His interest would be $3 360 on $84 000 a year instead of $4 000 on $100 000. Is it worthwhile? Yes, if it was the max that he could pay at that stage as it would only cost him $16 000 plus 2x4% interest which is 2x$640 or $17 280 to attain 100% ownership during year 1 if his financial situation improved.
The co-owners purchase price is $30 000 less 4%x7years/2 which is $16 000. Again he could only sell to the owner for a profit of double the interest payable during the protected period.
It does not seem practical that the above system could work if the owners’ equity was much less than 50%. However it might be feasible if there are empty properties that do not have much hope of being filled in the short term to let a person in for say 30%. However, the risks are greater but the relevant period would only be 3 years. It certainly is better to put a family in an empty house on that basis, especially if they lost their property during this crisis and are now reduced to living in a tent in the richest country in the world.
Co-ownership could certainly also be used to finish projects that have been abandoned in mid-progress. Get in a 50% buyer, fund the balance with a co-owner and get the developers to finish their building. Reactivate the finance that dried up.
A few final issues:
The protected period has expired. No agreement can be reached between the owner and co-owner regarding selling equity to the other or a rental payable. The owner, who has eg a 50% share, is carrying on regardless. In other words the owner is now acting like a squatter from the co-owners’ perspective.
Legislation must be passed to resolve this. Both parties could have 3 months to market, if still no agreement regarding a sale is reached, then the property is put up for auction. The best has been done for the owner. It was never intended to give him a half price house.
One of the parties (the owner or co-owner) is in default against their bond. There is no hope that the situation can be redeemed. The other party has first option to take it over at current value. If that is not on, a third party could be introduced. It must only be as a last resort that the bank steps in. Again simple legislation is required to protect the interests of both parties.
Conclusions
Interest rates charged to home owners against their bonds must be based on the Fed rate. It is desperately unfair to punish a home owner because his rate is based on the Libor rate and the banks trust each other so little that this has increased exorbitantly to around 6% as compared to the Fed rate of 1.5%.
It has to be relatively simple to create say five Negative Equity Zones. These after all are very similar, the only difference being that NE Zone A is an area that has been the least affected by negative equity during the last five years and NE Zone E the worst if there were five. All that happens is that the percentages in Zone E are the biggest relating to what could be claimed against the purchase price as negative equity.
Every property in the States falls into one of these NE Zones. Which one is legislated according to the property address.
Knowing which, and the year the property was purchased, the home owner would be able to apply for Negative Equity relief as a specific percentage. This would remain as a temporarily “frozen” second bond held by the Fed deferring interest payments. A cash buyer would receive cash, a bond holder would have his first bond reduced by the amount. Both would ultimately repay this relief. Gaining relief would be optional. There is a cost. It is not for free. But it’s not a bad deal either.
Banks would have the same relief. The bonds they hold would be written down by this amount, as cash would be paid to them by the Fed. However, the Fed would then own equity in the bank for this amount. Banks could very quickly calculate the relief applicable in total, as for each bond they hold they would know the year the property was purchased and the zone the property falls into.
Co-ownership
We have also looked at joint ownership where private money can be used to invest in property. This system has at least two major benefits. It gives home owners that are currently financially embarrassed a sporting chance to hold on to their properties while giving investors a reasonable (in fact very good) return on their money. The duration of these agreements is limited. It is intended as a solution at the current time but might be useful generally in the future.
The use of taxpayers’ money
The use of taxpayers’ money is quantified, there is a good chance that it will be recovered in the case of negative equity more than once meaning profitability, and only private funds are used for joint ownership.
This has been an attempt to create a structured solution. Numbers and percentages and time frames have been used for illustrative purposes. No claim is being made that they are the correct values to solve the problems. The most important percentage is the interest charged against the bond. This can be adjusted when required. So can time frames. Extensions can be provided if required. The Fed after 5 years might only want half the negative equity to be repaid by the home owners. That promise might get the 2012 president elected. Everything can be adjusted. All that is important is having a structure. Although the States has been used, the same would apply to any country.
My contact details are as follows:
100 Edgeley Road
Durban North
4051
South Africa
Tel +27 31 563 2439
Thank you
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