Note: These suggestions, sent to Treasury & FRB in Oct 2008, after the Treasury announced the original TARP plan to buy distressed assets, proposed a plan similar to the TALF and PPIP programs, months before Treasury and others came around to the idea. They were mentioned in the NY Times Executive Suite column by Joe Nocera and the complete document is available at nytimes.com here. The new Treasury plan was first announced by Treasury Secretary Tim Geithner on Feb 10, 2009. My writeup also included the Turbo concept of limiting interest payments and using excess interest to pay down loan principal, which was included in the later TALF announcement on Legacy CMBS on May 19, 2009. Another suggestion was to use tax incentives to increase housing demand.
By Malay Bansal
After TARP plan came out, I made some suggestions for improving it to the Treasury & Federal Reserve for their consideration.
My Suggestions included the following points:
- Treasury should provide financing to private buyers rather than buying distressed assets itself. Financing will help private buyers reach their target returns, and get them started on buying distressed assets clogging the system. Also, by providing financing to highest bidder on distressed assets, treasury will create a mechanism for pricing these assets based on competition from private buyers. Treasury can protect public funds by getting paid first and ensuring the private buyers get no more than 4 or 5% coupon (to cover expenses) on their invested money before the treasury gets its money back. Also, by requiring recipients to agree to certain steps to help homeowners, the plan can help homeowners who may be facing difficulty.
- Treasury will get the biggest bang for the buck by helping those on the cusp of defaulting, or those who may be considering buying a new home. Increasing home buying demand is as important as steps to decrease supply by reducing foreclosures. One step that will help more than a one-shot stimulus payment, will be to make the mortgage principal payments tax-deductible for next 5 to 10 or more years.
- One of the easiest steps to lower monthly mortgage payments will be to extend the mortgage term by 5 or 10 years for those facing potential problems. This should be least controversial of the modifications being discussed, and will not encourage those who do not need it to ask for it.
Suggestions for Additional Steps for Tackling the Credit Crisis
By Malay Bansal
Oct 19, 2008
Several steps have been taken by the Treasury and Federal Reserve to address the current economic crisis. These are important and useful first steps, but as everyone knows, the problems are complex and will require additional action, including steps to tackle the root cause of the problem – declining house prices.
Obviously, any step to stabilize house prices will need to focus on decreasing supply by preventing foreclosures as much as possible, and increasing demand by providing incentives to new home buyers. Making mortgage payments more affordable is key to both. Most efficient will be approaches that help people on the margin – people on the verge of defaulting on their mortgage, or those considering buying a house.
Below are outlines of three suggestions I have for consideration along with other steps being contemplated:
1. Make mortgage principal payments tax-deductible for next 5 to 10 years.
- Mortgage interest is already tax-deductible. Making principal also deductible will make it easier for those who want to but are barely able to make their mortgage payments, and those who are considering buying a house.
- As an example, someone with a $350,000 mortgage and 28% marginal tax rate will save $6,250 over 5 years or $1,250/yr. Over 10 years, savings will be $14,900.
- Better than a single-shot stimulus payment, since (i) it will provide relief over a longer period of time, (ii) it attacks the root cause of the problem by targeting housing, and (iii) it will benefit local governments by preventing loss of property taxes that will otherwise result from foreclosure.
- The deduction may be limited to maximum 15 to 20% of total mortgage payment to focus the benefit more towards newer mortgages (after ten years, principal payment is likely to be more than 20% of total mortgage payment), &/or to mortgages issued in certain years to control total cost.
- The deduction can be phased out above a certain level of AGI to focus the benefit towards those who need it more.
2. Better use of part of TARP Funds targeted to buy mortgage assets: Treasury can partner with private buyers instead of buying assets itself.
- Will increase efficiency by tapping private funds. There is a lot of capital waiting to be invested in distressed assets, but has not been invested yet as prices need to be lower to achieve targeted returns without leverage.
- Treasury can lend to or partner with private buyers of distressed mortgage assets with terms like the following:
- Treasury will put up 50% and the private buyer will put up 50%, with Treasury’s interest being the senior interest.
- Funds will be used to buy distressed mortgages and securities at a discount from various large and small banks and financial institutions.
- Mortgage payments from purchased assets will be used in sequential order to (i) pay 5% interest to Treasury, (ii) 5% interest to the Private buyer, (iii) principal to Treasury, (iv) principal to the Private buyer, and finally (v) all residual to the private buyer as its return for the risk. This ensures that Treasury gets its money back first.
- The 5% interest for Treasury will apply for 5 years. After that, it will increase by 0.5% every year till it reaches 9%. Interest for private buyer will stay at 5%.
- Those taking the loan from treasury will need to agree to change mortgage terms to help homeowners including giving borrowers the option to (i) increase loan term by 5 to 10 years, and (ii) prepay loans at any time without penalty (any existing prepay penalties will be waived). Other terms to help homeowners may be included.
- Treasury will offer mortgage assets from banks for bids. The private buyer with the highest bid will get funds from Treasury. Banks will have option of accepting the highest bid or keeping the assets themselves.
- This type of plan will allow participation by numerous large and not-so-large investors. Since there will be multiple buyers competing to buy assets, with their own capital at risk, the plan would help in determination of fair market prices for distressed assets (instead of a situation in which TARP manager is the only buyer).
- This program can run in parallel with direct purchases of assets by treasury, or can be used to sell off assets purchased by Treasury at a future date.
3. Encourage mortgage modifications to lower monthly payments by extending the mortgage term by 5 to 10 years.
- Modify mortgages by increasing the term by 5 to 10 years to lower monthly payment. As an example, monthly payment on a 30 year mortgage with 6.5% rate will decrease by 4.4% (or $1,172/year on a $350,000 mortgage) if term is increased by 5 years. An increase of term by 10 years would reduce monthly payment by 7.4% (or $1,960/year on a $350,000 mortgage).
- Lowering payment without lowering interest rate may be more palatable from fairness perspective, and should be attractive to lenders if it avoids default. Removing any prepayment penalties should also be part of the modification as much as possible.