The root cause of this financial crisis is adjustable rate and interest only mortgages that were available to consumers for zero money down. These mortgages have a fixed rate for the first few years and then the rate is adjustable. The assumption was that house prices would continue to rise and when the adjustable rate kicked in the homeowner would simply refinance their house. With falling house prices it has become impossible to refinance because the value of the house is now less than the amount owed to the mortgage provider. Banks will only loan issue a new mortgage for the current assessed value of the home, so home owners are stuck paying as much as 15% interest rates on their existing loans because they cannot refinance.The solution is to put the banks in a position where they are willing to refinance existing mortgages. My proposal is that the bank servicing the current loan be required to offer the any homeowner with a adjustable rate mortgage the option of converting that mortgage into a 30 year fixed rate mortgage at the current rate offered to new customers (i.e. 6.5% vs 15%). This conversion must be offered without any preconditions (such as credit score or home valuation) and at no cost to the customer. Also no additional money can be added to the new mortgage, it is a straight conversion of the existing loan. In exchange the government would guarantee the new loan for 20% of the loan amount. If the homeowner subsequently defaults on the new mortgage, then the bank will receive the value of the property plus the loan guarantee, but only up to the point where the loan is paid off. Neither the bank nor the homeowner can profit from this government money.With a loan guarantee, banks will be willing to refinance existing mortgages and the adjustable rate mortgages that have a high risk of default will be flushed from the financial system. Homeowners will not be forced into defaulting on their current mortgage because they have no way to refinance. As adjustable rate mortgages are replaced by fixed rate 30-year mortgages, the derivatives based on these mortgages will acquire a lower risk (become less “toxic”) and they will also become easier to value. The return on these derivatives will also fall, but those returns were unrealistic anyway, because they were based on the premise that homeowners would be willing to pay 15% on their mortgage for a home that was falling in value. The current bailout plan has taxpayers buying the high-risk derivatives directly from the banks to improve their bottom line, but it does nothing to improve the chances that the underlying mortgages will be paid or reduce the rates of mortgage defaults. It provides no incentive to the banks to hold the loans or to stop their predatory lending practices in the future. The bailout is much more expensive than addressing the root cause of the problem and unlikely to succeed.My plan is not a bailout for anybody! Homeowners pay off their existing loans and stay in their houses. The return on mortgage derivatives falls, but so does the risk, so the value will be more predictable and the market will be more willing to buy and sell these financial instruments again.
Alan Jenks
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