Monday, March 23, 2009

Episode 46: The American Loan Forgiveness Act

032309.0328

I had an idea on how to solve the financial crisis. It probably won’t work, but I figured I’d throw my plan out to the Blogosphere to get chewed up and torn apart!

As we all know, the large part of the financial problem stems from toxic sub-prime loans, an over-inflated housing market, and a home foreclosure epidemic. The plan that I propose will not cost the government a dime, and will allow the government to allocate the stimulus money for more infrastructure, education, green tech and healthcare projects. I call this bill the American Loan Forgiveness Act of 2009.

In this plan, we would have to put together an investigative committee to ascertain the average debt to income ratio for all loans that have been tainted in the risky sub-prime business, and determine the actual value of all homes in America. The latter can be done mathematically. First a sampling if home values in different neighborhoods of various socio-economic statuses can be surveyed. Say the current listed home value is $400,000 when it is determined to be worth $200,000, the appreciation would be valued at 100%. If we take an average of the inflated value of the houses in all 50 states, (let’s say the average rate of inflation is 75% in the whole country) then we can develop a formula that will be applied *across the board* to all homes in America. After calculating the aforementioned three factors, if the amount of inflation was rated at say 45% (housing may be over-inflated, but smaller debt to income ratios would close the gap for example) the value of ALL mortgages is forgiven by 45%. It would be as if the debt was completely erased off the books. Now this doesn’t erase the entire debt; if a person had $300,000 left on a mortgage, he’d now have $125,000.

The immediate reaction is this forgiveness comes at a steep loss to the banks. I don’t see it that way. In the current state of the economy, no one has money to pay the bills and mortgage payments, and as a result, homes go into foreclosure anyway. This plan effectively puts money into the pockets of Americans, because the bad debt is gone. Those who still cannot pay the monthly payment can renegotiate a longer term at higher interest. My plan effectively is a reset button for the market. However, it doesn’t carry the stigma of bankruptcy, which allows Americans to maintain or improve their credit score. With all the bad assets erased off the books, banks have no reason to keep credit lines frozen. Significantly reduced home prices will inspire Americans to shop and travel and get money moving again as they feel the weight of crushing mortgages lifted off their shoulders. I know the plan originally doesn’t call for any stimulus money, but as an incentive to banks, they can receive tax credits in exchange for participation in this program. With all the bad loans simply erased, investors will be anxious to invest in promising companies because they won’t be hampered with the day to day worries of layoffs and business closings.

There you have it. I bet there are a million reasons why this won’t work, and I’d love to hear what they are! And if it has a shot, I will PERSONALLY hand my plan to Obama and Geitner… they can use all the help they can get!
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7 comments: on "Episode 46: The American Loan Forgiveness Act"

conservative generation said...

tL,

I need to chew on this a little bit. However, I am so-so on your plan. Obviously, the fairness issue you pointed out is a potential problem. However, I would rather see a nonbailout issue.

Would you mandate that banks write down the principle? Or solely based on tax breaks as incentive? Also, are you talking only alternative mortgages or traditional mortgages as well?

I wanted to give you a little food for thought. Citimortgage (3rd largest mortgage company) has a total of ruffly 3.5 million mortgages. As I understand it, the average home price is $200,000. If those homes are devalued as much as .1%, then the loss would be $700 billion. Citigroup had a profit of 21.5 billion last year. Based on the loss and their most recent profit, it would take 32 years of negative earnings to pull the entire company out of the whole. Taking that big of a loss would certainly put them out of business.

The Law said...

Hehe... I'm still digesting it myself =)

I definitely think banks would have to write down the principle. That method would see the most immediate results. I think tax breaks for participating banks is something that always seems like an attractive proposition for businesses. Personally I would rather not give tax breaks, but I'll have to compromise somewhere =)

I'm also talking about both traditional and alternative mortgages for fairness' sake. This plan will help out all Americans, not just the bamboozled and over-reaching ones.

The way I see it, and I'm probably incorrect in thinking so, but I feel the company wouldn't lose money in this deal - there would be no debt to pay because it would appear in the ledger as if that transaction never happened. What *would* happen is the company would lose a lot of its value causing its stock prices to plummet most likely. However, the stock prices for these companies is already pitifully low, but they would have a better time building up from a clean slate.

I think this plan's success lies in its ability to erase debt, unfreeze credit, encourage spending, instill confidence, cost no money from the stimulus (save possible tax breaks for participating banks) and provide a fresh start. The only con (and it would be the deal breaker) is this plan would significantly devalue the institution for a while until they start making good loans again. BUT I think that is fair -- they made tax payers pay the ultimate price, so they should too!

The true beauty of this plan is it would not affect the value of the dollar - it may actually strengthen it some, since a person's dollar bill carry them a lot farther than it would in the current economic climate.

conservative generation said...

tL,

I'm still still digesting, but I realized an error in my math and it would be 4 years to recoup a 10% decrease (so every 10% in devaluation would mean 4 years to recoup).

Unfortunately, it would have to cost companies on the simple fact they need to move these assets off their financial balance sheets. To do so, they would need to do a write down of the asset which would be an expense against income. So what would happen is that they would realize a large loss for one year. Then those losses go against the companies earnings.

I'll flesh out my Citi example to see if it's actually rosier than my initial numbers. 4 years of negative earnings is not wonderful, but not impossible to bounce back from.

I'll have more for you to come.

conservative generation said...

tL,

I must admit, I do like your idea. If you don't mind, I'd like to refine it. You could create an accounting rule that would reduce the balance sheet assets by the percentage you mentioned and enact a law that the book value would need to be reflected in law on homeowner's mortgages.

This would force companies to right off the assets against their profits and earnings. Now I had used Citigroup earlier, but I checked up on them and they actually have enough earnings to decrease everyone of their mortgages by 10%. No incentive needed. The right off would create a loss, which can be carried forward so that they would not need to pay taxes in future years.

This is actually something most companies would do when having a bad year. If people defaulting on payments once again had equity in their homes, they would certainly be more likely to start paying their mortgages again. This is actually a practise that many companies would do if they were having a bad year.

The only downside I can see is that there are two issues with banks that other companies generally do not have as much of a problem with. A bank must keep more than just their promises as assets (aka future mortgage payments) to stay in business, they must have a lot of cash in order to lend to people. In writing down these large amounts, I'm fairly sure that this might hurt their cash flow and causing a potential run on the bank (this is a maybe circumstance). Also, I'm basing my thoughts on what I've look at from Citibank. I used to work with them so I'm somewhat familiar. I don't know if other banks are in as good a shape as them and could shoulder the burden. However, I do feel as though this would be a very viable option for Citibank.

Del Patterson said...

Hey, I like the plan. The Prez says he is open to new ideas. Send it on, but damn it, try to get some credit.

The Law said...

Thanks for the endorsement del =) I'll send my outline to Obama right away! If Jim Boehner can get away with submitting a 19 paged budget plan with no actual numbers in it, I suppose I can get this in the door as well ;-)

conservative generation said...

tL,

Why provide numbers? This congress doesn't read the bills before they vote. We should just trust the representatives in congress.

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