A simplistic overview of a semi-complicated solution
IN FOUR COMMONSENSE STEPS
(And one VERY tacky fifth one)
1. RAISE CAPITAL: Issue $700 billion in 30-year treasury bonds at, for this example, 4.00%, as usual (i.e., backed by nothing but the full faith and credit of the United States) to fund the TARP. (This is like setting up a Sovereign Wealth Fund.)
2. INVEST CAPITAL IN DISTRESSED ASSETS: Offer to buy the illiquid "toxic" mortgage-backed securities via a reverse auction or in tranches (for example, 50 cents on the dollar of principal loan amount for the first $100 billion tendered, first come first served, 40 cents on the next $200 billion, 33-1/3 cents on the next $200 billion and 25 cents on the last $200B). Perhaps the reverse auction procedure would give similar results.
Considering that Merrill Lynch sold a bunch of these at 22 cents on the dollar, whoever is stuck holding them should be relieved to get more than that. Require the holder to analyze and list each underlying mortgage and the multiple factors that go into its value (e.g., the principal, payment, interest rate, FICO score of the borrower, previous payments, equity held by the borrower, how long in default, etc., etc.), so the amount we (the TARP) pay will be adjusted to the actual underlying value of each mortgage, taking all those factors into account. (Here is another way of perhaps valuing mortgages. And here is another take on just comprehending what the securities actually ARE.)
Here's what we (the govt)
wind up owning, using the example above:
So we've just gotten 2.1 trillion for 700 billion, triple our investment. Of course, this is mostly defaulted or near-to-default loans that need some workout efforts. But we got a great deal, dollar-wise, paying a third of face value, on average, and our cash payments restored SOME liquidity to the folks who got caught with these (banks, investment houses, pension funds, individuals, etc).
One danger here is that the holders play "chicken" and don't participate at those prices; thus, the folks on Main Street will be held hostage to a standoff ... again.
3. INCREASE VALUE OF DISTRESSED ASSETS: UNbundle the underlying mortgages and offer the borrowers/homeowners a new mortgage, with minimal or zero closing costs, at a reduced principal amount and a reduced interest rate (perhaps even extending the term of the mortgage to 40 or 50 years, although the math makes that less appealing, so I'm not including that in this example).
An example, using this LOAN AMORTIZATION CALCULATOR, for a homeowner who got caught in an adjustable rate mortgage that reset to a much higher fixed rate, and I'll just use 100K for the principal amount; multiply by five for a 500K mortgage, etc.
Original ARM terms: 4.3% rate on a 30-year amortization schedule, monthly payment of $483.25.
Reset to, for example, 9.6%, 30-year amortization, new monthly payment of $848.16, nearly doubling the payment and pushing the homeowner toward default and then foreclosure.
We offer to refinance
with an ASSUMABLE mortgage with, for example, a reduction in the loan amount
to 80K (remember, it only cost us 33.34K) at 5.75% interest, and keep it
at 30 years. With those terms, the loan payment turns out to be $466.86,
actually less than the original payment under the original ARM, the homeowner
gets to stay in his/her/their home and that takes one house off the market,
reducing supply. Here's a table to summarize:
Where do WE wind up? 80K to be paid back over 30 years, with a net interest margin of 1.75% (5.75 less the 4% we pay on the bonds we issued); based on the 33.34K we paid for the mortgage, that's a 240% increase in principal value on our investment. If we run a current value calculation on that amount (and I'm just ballparking this figure), perhaps that 80K works out to 60K or so in present value (keep that in mind for Step 4).
Making the new mortgage assumable ties the mortgage to the house, not the borrower.
Do this for as many of the mortgages as we can (sets an example for the private market, too). Note that this example ignores closing costs, mortgage filing fees, etc., which, since we're the government, we could MANDATE be near zero; local governments should understand that's a least-worst choice. (Hey, we ARE the feds, after all; we can do whatever we want.)
(A similar plan might be applied to any foreclosed houses that might come with or result from mortgages we bought, perhaps lowering the principal amount to 70 cents on the dollar, which might also help to set a floor on house prices. That might tempt new buyers in and take those houses out of foreclosure.)
4. CREATE A MARKET FOR THESE INCREASED-VALUE ASSETS: REbundle a FEW like-termed mortgages into fungible tranches, set up a transparent market exchange and offer them to private sector investors. (Use this as a pilot program and allow other holders of the "toxic" mortgage securities who didn't participate in our 700 billion buy to participate, if they also have raised the values of their holdings to at least compete with ours; be sure to control for fraud, etc.) Once the market has developed some liquidity, we can sell as many more of our holdings as seems sensible.
5. (TACKY DRACONIAN SELF-SERVING TACTIC, semi-tongue-in-cheek): After the market has gotten a lot of these new bundles off our hands and back in private ones, have the Federal Reserve RAISE interest rates, driving down the value of the 4% bonds we issued, and buy them back for a lower price than we got when we sold them (another profit!) ... and then lower rates once that's done.
I suppose I ought to copyright