My classmate in my dance class, Laura Emerson, who is on the staff of the Las Vegas Review Journal, recently wrote a piece on the historically low mortgage rates. The low mortgage rates are out there, beckoning homeowners in Las Vegas and elsewhere, she wrote. Nearly everyone who owns a house probably would refinance these days because of the bargain-basement interest rates. Except that most cannot take advantage of the low mortgage refinance rates.
Most homeowners in Las Vegas are not qualified for refinancing. Many have homes that are under water, i.e., with market values lower than their mortgage balances. No mortgage banker or broker would refinance such properties. Homeowners whose houses are not under water are also shut out of the refinance market because their houses are barely above water and their home equities are much less than the 20% that banks require. Banks would refinance houses that have less than 20% equity provided that the homeowner purchases mortgage insurance. The cost of the mortgage insurance effectively shuts most people out of the refinance market.
I was reflecting on Laura's front-page business section article the other day and may have stumbled on a solution to this conundrum.
Assume that a house owned by a Las Vegas couple - let's call them James and Eleanor Alfonso - has a mortgage balance of $300,000. Their house now has a market value of $270,000. That house is clearly under water, with a negative value of minus $30,000. The bank that holds the mortgage on the house is probably watching this loan with eagle eyes for any sign that the Alfonsos may be thinking of defaulting and skipping town, or buying a second house - a very cheap foreclosure - prior to defaulting on their $270,000 house.
It is the way of a lot of houses in Las Vegas. People are just walking away from their houses. The "responsible" debtors are the ones who buy a second home - a cheap foreclosure - move into that second house and then default on their first house.
It's a sad, sad tale of mortgage waywardness in Las Vegas and elsewhere in America.
But what if there is a way to make both the bank and the homeowner whole?
Obviously, the biggest housing crisis since the Great Depression calls for the most creative solutions.
What if the bank that holds the $300,000 mortgage is willing to set aside the $30,000 negative equity on the Alfonso house and freeze it? The $30,000 will not be forgiven, just set aside and frozen. What that would do is that the mortgage will suddenly be equal to the market value of the house. The equity on the house will be zero, but at least it will no longer be under water.
Not long ago, people could buy houses with no money down. There were loans to first-time home buyers, to military people and others that the government was trying its best to put into houses. The mortgage industry can revive such programs, except that now the only people who would qualify for such programs are those who already are living in their own homes and have zero equity in them. The goal will not be to qualify as many Americans as possible for home ownership. Instead the goal will be to keep Americans in their current homes after years of proving that they can afford the mortgage payments.
The government will back the refinancing of mortgages that mortgage companies now hold on under-water houses. There could be a requirement that the homeowners who qualify for these zero-down, zero-equity mortgages have lived in their houses for two or more years. There could be an additional requirement that the homeowners have had a good payment record, that is, no more than one month in arrears in their mortgage payments.
With today's mortgage interest rates at about 4.5%, the Alfonsos' house, refinanced at a net loan amount of $270,000, will mean a monthly payment of $1368.05. Assume that the original mortgage amount on the Alfonso house was $350,000, with a mortgage interest rate of 7.5%. This means that the Alfonsos' monthly mortgage payment is currently $2497.25.
This means that the Alfonsos will see their mortgage payment (principal plus interest, not including real property tax and insurance) reduced by $1129.20. What this does for the Alfonsos is that they will do everything in their power to stay in their home and to continue making mortgage payments. Most Americans in a similar plight as the Alfonsos will welcome the decrease in their mortgage payments because a lot of them are hurting due to the Great Recession. A lot of them used to be double-income families but are now struggling with only one of the spouses working while the other spouse is receiving unemployment insurance compensation or not receiving anything at all.
The special refinancing arrangement, of course, would not be available to those who bought houses in 2006 and 2007 in Las Vegas. By 2006, home values had nearly tripled in the Las Vegas valley from a base year of 2002. Houses bought in early 2007, 2006 and some in 2005 had appreciated so much that when home values plummeted to 2002 levels those houses had lost up to 60% of their market values. At some point, the banks and the Obama administration will have to figure out what to do with those houses. The great majority of houses in Las Vegas and across the U.S., however, would qualify for the special refinancing arrangement.
Because of the help that can be provided to the Alfonsos in Las Vegas and millions of American families, the number of foreclosures and abandoned houses will slow to a trickle and the housing market will stabilize. At some point, the value of houses will start to climb and people who once owned homes that were under water, will see increases in their home equities. (In some parts of the country, the housing market has indeed stabilized and home values are starting to rise - even without much government intervention.)
This may even result in a mini-boom in the real estate market, as more people are encouraged to buy houses because of the expectation of increasing home values. The resultant mini-boom will encourage contractors to build again, causing a mini-boom in the construction industry.
Remember the $30,000 that the mortgage company set aside when the Alfonso house was under water by exactly that amount? Because the market value of the Alfonso house at some point will have increased to more than $300,000, the Alfonsos can refinance their house a second time, adding the $30,000 to their mortgage debt. This refinancing will divert $30,000 to the Alfonsos' original mortgage company, wiping out the amount that was set aside and frozen by that mortgage company.
It is important for mortgage rates to remain low, or even go lower, for this plan to work. The Alfonsos, after adding back the $30,000 to their mortgage balance, must not see a substantial increase in their monthly mortgage bill for this to work. If the government keeps mortgage interest rates low, or drives rates even lower, the Alfonsos and millions of refinancing homeowners will not be discouraged or inconvenienced.
If the $30,000 is added back to the Alfonsos' loan and the Alfonsos refinance a second time, assuming that the mortgage rate stays at 4.5%, their monthly mortgage payment will rise to $1520.06, still considerably less than what they are paying now.
The Obama administration is wracking its brains trying to figure out how to end the mortgage crisis in America. We may have stumbled on the way out of the conundrum.
If nothing is done, the economy will continue to be dragged down by a real estate market that is not just under water but is in the midst of a great flood. Banks will continue to suffer as more Americans walk away from their homes after defaulting on their loans. Banks and mortgage companies have every reason to embrace my plan, which will stop the bleeding from the foreclosures.
A second government initiative that must be pursued and announced in dramatic fashion immediately is the creation of millions of jobs. This is priority one for this administration.
This is my recommendation to the Obama administration:
1. We will offer every recipient of unemployment insurance payments, starting with the 99-ers, those who have been unemployed for 99 weeks or more, a chance to work and at the same time keep receiving unemployment insurance checks for another six months. The mechanism for doing this is the private sector, as explained in 2) below.
2. We will start with small businesses and gradually add larger businesses to the program. Small businesses with five or less employees typically are unwilling to hire additional employees even when work volumes increase because of possible harm to the bottom line. The government program will make it possible for a small business to add an employee it needs but cannot afford to hire. Assume that a small business needs an additional employee at a position that typically pays $15 an hour, $120 a day or $600 a week. An unemployed person who gets $450 a week from the government would probably want to take that job, which would pay her an extra $150 a week and put her in the ranks of the employed, rescuing her from her desperate straits.
What is the incentive for a small business owner to hire this additional person? The small business owner will only have to pay his additional employee $150 a week because his new employee will still get her $450 from the government.
This arrangement will put money in the pockets of unemployed Americans, resulting in increases in business activity. The resultant increases in business activity will mean more revenues for small businesses and eventually large companies, as small businesses start to increase orders of office supplies, equipment, plant, raw materials, machinery, etc. Restaurants will have a mini recovery as more people decide to eat out instead of eating at home. The increased business activity will ripple and echo into the larger economy.
With more people being employed again, tax collections will increase and local, state and - to a much more limited extent - federal government coffers will begin to fill up.
The federal government cannot afford to finance this program indefinitely for obvious reasons. The program may, however, over a six-month period be enough to jump-start the economy and get all its pistons humming again.
Many of the unemployed Americans who are hired by small businesses will probably stay on after the crash federal make-work program ends. An even larger number will find work in other companies, as the economy expands, causing the creation of millions of jobs in the private sector.
The third leg in this three-legged dance to the gods and goddesses of employment is the single-minded focus on the manufacturing sector. Small businesses in manufacturing industries would have the priority over other kinds of businesses in the creation of jobs that are partly paid for with unemployment insurance. The start-up businesses in the alternative energy sector would have high priority.
The contractors engaged in the erection of solar panels on rooftops. The sub-contractors engaged in the building of plants that will manufacture solar panels. The sub-contractors engaged in the erection of wind turbines. The manufacturers of futuristic cars - cars that can be driven in water and sprout wings, electric sports cars.
Small businesses that supply GM, Ford, Chrysler and the foreign manufacturers with plants in America will automatically qualify for this program that puts unemployed Americans in jobs while still receiving unemployment insurance.
Sub-contractors that install electric recharging stations all across America to power the electric cars that are now entering the American market.
Apparel manufacturers, electronics manufacturers who wish to add employees because Americans are becoming conscious again of the need for patronizing American-produced consumer items. The Made in America campaign of the Obama administration, if pursued with imagination and presidential resolve, will drive home the point that if Americans want jobs they must be willing to buy goods manufactured in America even if the goods cost more than the cheap imports.
In the past, our financial wizards and Federal Monetary Board poobahs fought inflation in a knee-jerk fashion. Recent experience tells us that some inflation is good because manufacturers are not afraid that they are producing goods at today's prices but may be selling these goods at tomorrow's lower, bargain-basement prices, killing their profits. Increasing prices mean that goods produced at today's low prices will be sold at tomorrow's higher prices, thereby assuring bonus profitability.
In other words, we want more inflation, not less. But not too much. Too much inflation will erode the value of our money too fast and the result will be an inflation spiral that could go out of control.
If I were Obama I would go before the American people and announce a plan that will dramatically reduce monthly mortgage payments for many Americans through a boom in refinancing. I would also announce a plan to put unemployed people back to work in small businesses, financed partly by a continuation of unemployment insurance payments to such people who find employment through such a program. Thirdly, I would announce that the first small businesses that will be helped by the make-work program are those engaged in manufacturing.
I would do it the day after Labor Day.
