Proposed Mortgage and Financial Industry Solution Model for restoring sustainable housing and economic value to distressed homeowners and communities in Nationally
Even though the Nation’s overall economic indicators have improved, too many citizens are still struggling to restore their personal economic standing to pre-mortgage meltdown status. In 2013, I proposed a plan for addressing the continuing mortgage and financial industry challenges that threaten economic growth and stability. The premise considered that the continual instability of consumer confidence in the housing market and toxic assets/mortgage defaults is a direct and immediate impact on any efforts to create business and resident growth in communities like Detroit, Flint, Cleveland, Lansing and other economically distressed communities. My thought process was that it is important to look at all aspects of the problems facing homeowners and the ability to create value in real estate, which has dragged the financial industry into a sustained decline for the past 4 years, so we could have a proper outline to recommend solutions. I’m republishing my solution, because as we seek to find ways to increase the earning and purchasing power of American citizens, this plan is a direct tangible comprehensive strategy to achieve the following objectives:
1. Accept the reality of the fiscal crisis that exists today.
2. Create a floor for valuation of property to allow homeowners to identify value in their property and opportunity to reinvest in their home and community.
3. Reduce the level of toxic bank products and mortgage defaults and increase the portfolio of positive performing mortgage products in distressed and non distressed communities.
4. Restore a common sense model for property valuation in distressed communities and allow for market principled growth in taxable revenue.
5. Create a model for increasing consumer confidence, financial industry confidence and stimulate consumer and small business spending without an inducement of federal or state financial investment or stimulus.
I used Detroit as a model for analyzing the problem and potential benefits from this approach, circa 2012. The Fair Market Assessment and Valuation Act (FMAVA) portion of the solution would have to be tweaked to address changes in the marketplace since 2012.
Synopsis of situation (Detroit family of four as model):
A home in a Detroit neighborhood was valued at $70,000 in 1994. As values increased in the surrounding neighborhood (comps for sold homes in neighborhood average $150,000), the homeowner sells to our family at a price of $140,000 with a 30 year mortgage and 8% interest rate in 2000. The family’s monthly mortgage payment is $1,183.52.
By 2005, values in the neighborhood continue to rise (comps for sold homes and refinanced homes in neighborhood average $250,000). The family decides to refinance at a price of $235,000 with an ARM interest rate of 3.5% to cash in the equity in the home and reduce their interest rate. The new monthly payment for the family is $1,940.39 over 15 years. The family has reduced the long term interest debt on the mortgage from $222,117.35 over 30 years to $64,164.06 for 15 years.
By 2008, the mortgage industry crashes and home foreclosures rise in the surrounding neighborhood. The dual effect drops values of homes declining to $70,000 by 2009.
As strategic defaults increase in the neighborhood and abandon homes rise within the neighborhood, housing values now have declined to $35,000 by 2012.
The ARM interest rate has risen to 7% and the family is paying $2,372.66 and has a principal balance of $234,999.98 and interest balance of $67,395.31 for a home valued at $35,000. The family is also behind on their taxes.
The family has experienced some economic hardship and is considering walking away from their mortgage and leaving the neighborhood, partially because they are tied to a mortgage balance of 276,704.31 for a home valued at $35,000.
Family Payments on both mortgages since 2000
Reduction in family’s economic impact in Detroit
The family’s mortgage and tax bill have increased from 20% of their monthly budget in 2005 to 45% of their monthly budget in 2012. Our family has scaled back disposable purchases since 2009 by $650 monthly, which translates into $7,800 annually taking out of the local economy. The family has also eliminated their annual family trip ($4,500 annually), home improvements and making new car purchases for the mother and father, eliminating another $50,000 in capital purchases.
The reduced local economic impact of this family is $135,209 over a three year period (2009 to 2012). They are upside down in value by a negative ($267,395.29) in loan to home value ratio after paying $132,654.99 in mortgage payments over the past 12 years.
Comprehensive solution for restoring sustainable housing and economic value post-mortgage and financial industry crisis
This solution for the mortgage crisis rest in the following principles:
· Market based property valuation reset
· Creating a valuation floor for toxic loan assets
· Addressing the real challenge facing borrowers, renegotiation of principle loan amount to realistic property values
· Creating new property valuations to recalibrate property tax income for distressed urban communities
· Reduce the opportunity for speculators and negligent property owners from using the foreclosure process as a personal governmental bail out and negatively impact property value restoration efforts.
The belief is that the following steps will allow for a stimulus type of effect on the local, state and national economies in three ways:
1. Consumer spending will increase due to the stability in their largest personal asset
2. Businesses will spend money to invest in communities that hold and retain a sensible return in property value and can allow for spin off development
3. Banks will see a reduction in toxic loan assets and defaults, improving their loan portfolios and investment ratings, which will introduce liquidity into the market and open up business and residential loan markets
1. Fair Market Assessment and Valuation Act (FMAVA) — This act would restore the value of taxable residential and commercial land in distressed communities and individual properties in non distressed communities to a fiscally sound value floor based on traditional economic principles. The act would function as follows:
a. Market assessments by current appraisal models would be suspended. Valuation of distressed communities and individual properties in non distressed communities would be rolled back to 1994 valuation data.
b. The re-assessed property value would then adjusted to 2012 value by calculating the 1994 value of residential and commercial property annually times the rate of inflation for each year (1995–2011) and consumer price index. This would become the new property valuation floor.
c. Market assessment and appraisal models would be indexed to inflation and CPI models for a five year period to allow for continual stabilization of the real estate market.
d. Distressed communities would be defined as municipalities or significant geographical sections within a municipality (15% of the residential and/or commercial real property) with high rates of bank or tax foreclosures, toxic loan portfolios and underwater mortgages on residential and commercial property.
The model eliminates the artificial cycle of comps, positive and negative consumer speculation and panic and replaces it with valuations based on reasonable logic and monetary policy. This will create stabilization in the housing and financial markets and finally define the floor for the toxic loan products in the US market.
2. Mortgage Patriot Act (MPA) — This act would compel existing mortgage holding banks through the CRA renegotiate the principal of a distressed mortgage or toxic mortgage to newly re-assessed valuation model for the distressed community or individual property in the non-distressed community or allow a new lender to finance a renegotiated loan indexed to the new principal amount. The act would function as follows:
a. The bank servicing or owning the mortgage loan with the borrower would recalculate the principal amount of the loan to the new assessed property value and then apply the existing interest rate to the balance of the loan term (allowing the bank to retain the interest rate income opportunity).
b. The bank would credit all mortgage payments made to date by the borrower to the value of the new loan product at a 60% principal & 40% interest ratio.
c. The bank and the borrower would sign the new mortgage loan certificate and the borrower would be extended a reduced balance on any current and outstanding late fees or penalties (10% of fee and penalty balance).
d. The new loan would be a non-recourse loan for the commercial and residential borrower.
The rationale behind this act is twofold. The first aspect of this law would be to allow the borrower to refinance their loan product at a rate and value that will value their existing activity to stay compliant with the terms, encourage retention of the loan and the home and provide real and substantial monthly payment relief to the borrower and family. This allows the borrower to see the value maintaining their loan and payment history with a loan that is structured to a realistic value for the home. The monthly payment relief will also create a monthly family stimulus effect, freeing monthly cash for the family to spend in other loan products, consumer spending and investments. The second aspect with of the MPA is that it creates a vehicle for the mortgage holder to improve their good loan portfolio while maintaining a primary profit driver, the existing interest rate. It would be applied to the new loan vehicle.
3. Property Assessor Valuation Act — this act would reset the SEV for a distressed community or an individual distressed property in a non-distressed community based on the FMAVA effect on the community or property in question. This act would be an emergency provision only and would not be used except in defined financial stress or property devaluation stress situations. The mill rate for the community in question would be assessed against the new SEV value. For communities that see a net increase in taxable income, the income must be dedicated through statue to a minimum of one of the following three functions:
a. Debt Reduction — paying above minimum on bond, pension and health care benefits.
b. Funding quality of life agencies (Parks, recreation, police, fire, EMS, library, etc.)
c. Funding business development, attraction and interaction agencies to improve business retention efforts.
We project that a significant number of residential and commercial tax payers will see a tax decrease because their homes are valued based on the artificially high market prices during the housing bubble. Municipalities should realize a net tax receipt increase because the number of artificially low value properties will rise in value and the foreclosure rates should decrease due to stabilizing the value of underwater mortgages.
Application of this solution
1. FMAVA Act — In 1994, the value of homes in the neighborhood were $70,000. The housing bubble and lack of market restraint led to an artificial inflation of housing values for the home in question and surrounding neighborhood, spiking at $260,000 in 2006 and now deflating to an artificial low value of $40,000 by 2012. Both of the values are not consistent with the steady housing value growth experienced from 1950 to 1994.
Applying the FMAVA act to the 1994 value and indexing it for 17 years to CPI and rate of inflation, the non speculation housing value is reset at $135,000. The value increase is $100,000 for this home in question, from the $35,000 speculation driven appraised value.
2. MPA Act — The current mortgage for our family of $235,000 is recalculated to $135,000, which eliminates $58,086.97 from their mortgage principal. The interest rate (7%) and balance would stay the same at $67,395.31 for a total outstanding base balance of $202,395.33. The bank would next credit all payments made to date from the refinanced loan amount, which equals $82,318.00. The credit would be applied at a 60% principal/40% interest ratio. The family would receive $49,391 credit towards the new loan principal and $32,927 credit towards the new loan interest. The new principal amount would equal $85,609.02 and the interest amount would equal $49,827.27 for a total remaining loan balance of $135,506.29 for the remaining 10 years of the new loan. Our family would see a reduction in their monthly mortgage payment from $2,372.66 under the former loan to $1,213.59 under the FMAVA & MPA Acts, providing the family an extra 1,159.07 a month in year one. By year 10, the family would have an extra $1,344.29 monthly from their former loan product.
Our family would see a reduction in their monthly mortgage payment from $2,372.66 under the former loan to $1,213.59 under the FMAVA & MPA Acts, providing the family an extra 1,159.07 a month in year one. By year 10, the family would have an extra $1,344.29 monthly from their former loan product.
Our family now gets back on a regular payment schedule with their loan and catches up in their property tax payments, which they had fallen behind by two years, contributing back to the City of Detroit. The bank now has a positive loan performing product due to the family paying timely on their mortgage. While the Bank has taken an accounting lost on the loan of roughly $131,000, the loan moved from toxic and in danger of becoming a non-performing asset due to a strategic foreclosure to a positive performing product. The family’s increased disposable amounts to a family stimulus of $13,908.84 in the first year. The family is will spend the majority of the freed up capital into their local community and in the consumer market. The family will also potentially invest in more bank debt and savings products, which creates additional revenue streams for the bank owning the mortgage from an existing customer. The inverse supply side economic effect will be a trickle up of consumer spending and confidence based in a recapitalization of their most important asset, their home.
3. The PAV Act — This act would now allow a distressed municipality to reset the state equalized value of property in their borders. The immediate benefits will be the generation of additional income from undervalued properties inside of their borders. The medium term and long term benefit will be a net reduction of property taxes in middle class neighborhoods that were valued at artificially high housing and commercial property values and haven’t been readjusted because of Headlee amendment and the worry that adjustments to the artificially low values will rob communities of needed property tax income. The new valuation and impact of the MPA should lead to increased tax collections in distressed and non distressed communities as those families have more disposable income to catch up on past due bills, including their taxes. The PAV should have a similar stimulus based effect on local governments, especially economically distressed communities that have higher rates of property tax foreclosures and defaults. In the case of our family, when they refinanced their home at $235,000, their tax bill from Detroit raised to $7,990 annually. When property rates declined, they requested new assessments to lower their tax rate, but were unsuccessful. If they would have received an assessment at the $35,000 home value before the FMAVA & MPA, their tax bill would decrease to $1,190, but the revenue pool for the city, Wayne County, Library system and State of Michigan would decrease by $6,800. With adoption of the PAV, the newly assessed housing value would be $135,000. The family would now receive an annual tax bill of $4,590. The family would see a net tax cut of $3,500 annually, which allows them to get caught up on payments, with their reduced mortgage payment. While the revenue pool for the governmental agencies does decrease, it only decreases by $3,500, which still generates $3,300 more than an assessment on the home at $35,000. Government and the family both get a tax benefit from the PAV Act.
Benefits of program:
A. Stimulation of economic activity without federal or state stimulus programming — Stabilizing housing values will restore consumer certainty and confidence in their net worth. Understanding that there biggest asset has regained a significant portion of its value, consumers and businesses will now be free to spend in other purchasing sectors, especially consumer products. The circulatory effect of consumer spending and confidence will also extend to the banking community as people look for stable debt products for future modest investment in their home and family life (college loans, second car loans, etc.). We believe this model of inverse supply side economics will trickle up from consumers to producers and back down to consumers by focusing actions on making consumers the primary market contributor.
B. Financial industry stabilization — Since the mortgage meltdown was based on the following cycle:
a. Financial institutions give residential loans and refinancing loans without security, collateral and financial investment from non stable or traditional borrowers (toxic loans)
b. Financial institutions sell loans (Mortgage backed securities) on commodities market for huge profit due to confidence in housing market.
c. Financial institutions buy insurance from AIG and similar insurance brokerages to protect the principal amount of loan and MBS purchases again defaults.
d. Borrowers start massive defaults on residential loans, causing investor and consumer confidence to drop.
e. Massive defaults cause tremendous pressure on property values, sending them failing to record and continual declines.
f. Financial institutions start cashing in insurance claims to protect their investment (loan or MSB).
g. AIG nearly runs out of cash paying claims.
h. Industry in plagued for next few years with toxic mortgages, bad investment losses, growing residential loan walk-away and strategic defaults, booking continual accounting and real capital losses on balance sheets.
i. Continual defaults depress real residential and commercial property values, continuing to foster cycle of decline and uncertainty in markets.
The continuing instability in the financial and housing market is based on two key functional areas, value of assets and continual defaults of consumers. Both have clouded efforts to define the floor for the toxic loans and the property values associated with those toxic loans. Our model allows for a floor to be built into the toxic and distressed loan portfolio of banks around the US and world. The resulting floor allows for Banks to value the toxic loan products and determine which products may be rehabbed through other debt products and our other act. Our model also allows the banks to transform distressed loan portfolios into performing loan portfolios, which improves their balance sheets and gets positive ratings from investment firms. Banks will have to book new accounting losses for the first and possibly second quarter after implementation, but should be back to positive operating models by the third quarter after implementation.
C. Restored value equalization in communities such as Detroit, Pontiac, Gary Indiana, Baltimore, Flint, Ferndale, Warren, Hazel Park, Troy and other communities will have a short term to long term positive impact on the following:
a. Housing sales and new construction.
b. Growth in property values
c. Desire to invest in communities (residential investment and commercial investment).
d. Residential and business attraction.
e. Increased tax revenues for municipalities, school districts and counties to spend on core services and debt reduction.
D. Federal and State governments would be able to stimulate wide scale economic activity without the following actions:
a. Debt issuing.
b. Quantitative easing.
c. Increased regulation.
d. Unnecessary supply-side tax cuts.
e. Interest rate cuts from Federal Reserve.
f. Federal or state stimulus spending — unless necessary.
This solution model fixes a major economic flaw with short term emergency action and gives the market relief to course correct for long term stabilization. Use of these actions would be strictly limited by statue to defined emergency situations.