Proposal for Ending Housing Crisis

In 2008, the housing bubble burst leading to a financial crisis that sent the economy into a tailspin, drying up liquidity. Home values have dropped precipitously and continue to drop in many major housing markets. The housing bubble was caused by government policy to keep mortgage interest rates low and to encourage sub prime lending practices that increased home "ownership" across America. If the government didn't directly cause the housing bubble, its policies certainly encouraged the inflation in housing prices and development of a market in mortgage-backed securities that turned the inevitable correction into a financial crisis. The deep recession led to unemployment, which increased home loan defaults and mortgage foreclosures, causing home prices to drop further, to the point where existing homes now sell for substantially less than its costs to build homes.

The government stimulus passed by the President and the democrat-controlled House of Representatives and Senate did nothing to address the precipitous decline in the assessed value of homes, which caused the financial meltdown.

Michael Lissack, a famous (or infamous to some on Wall Street) whistleblower who once worked for Smith Barney, has proposed a solution to the underlying problem that is holding back America's economy. He proposes a mechanism that will establish a new floor for home valuations for the majority of homes that are now underwater (assessed value of home is less than the amount of the home loan). He proposes the following:

1. Refinance 80% of current assessed value of homes in a conventional conforming loan / first mortgage.
2. Provide a second mortgage (Lissack proposes a zero-interest loan) for the difference between the second mortgage and 100% of the current assessed value of the home.
3. In exchange for the write-down to the current assessed value, allow for banks to hold an equity interest in the up-side of the home, when sold, if any. Lissack proposes a standardized, stand-alone contract (and presumably a lien that must be satisfied at closing) for 50% of appreciation above the current assessed value of the home.

Presumably, all home owners would be allowed to participate in this program, and the mortgage companies and banks would be either encouraged or required to participate. As a result, all homes would no longer “underwater” immediately. Monthly mortgage interest and principle payments would be reduced, and the freed up cash would be available to stimulate the economy. The second mortgage and equity sharing contract would be a future cost to the home owner, but this cost would only be incurred upon selling of the home for a price above the current assessed value. This would put a floor on home values at current prices, encouraging a return to a stable housing market.

Lenders could look forward to the equity-sharing return on investment to partially offset the loss caused by writing-down home loans to current market prices, instead of taking losses in foreclosure sales that continue to drive down home values.

It would be an interesting exercise to compare the costs of Lissack's proposal to financial institutions compared to the continued uncertainty and costs of foreclosures. The primary and secondary mortgages and equity-sharing arrangements could be pooled and sold into the capital markets, particularly as housing prices start to rebound.

Possibly, the economic result for the lender would be far better than the costs of foreclosing on homes, which Lissack estimates incur 30%-40% reductions in current values.