[cnn-photo-caption image=http://i2.cdn.turner.com/cnn/2008/images/09/24/art.howard.sosin.jpg caption="Howard Sosin, co-founder and former CEO of AIG Financial Products."]Editor's note: Here is a "Mortgage Rescue Plan" from the founder of a company that later created many of today's complex financial products. We'd like to hear your ideas, too. Thank you for sending us your comments.
Co-Founder and former CEO of AIG Financial Products
THE PROBLEM: The American economy is on the brink of a financial melt down that has been caused by a failure of the housing market. Our country needs a comprehensive solution to this problem that addresses the issues of both Main Street and Wall Street.
From Main Street’s perspective the problem is that housing prices, which were only supposed to go up, have fallen dramatically and continue to fall. Falling prices have exposed weaknesses in mortgage lending – an industry that has relied on price increases to hide poor lending practices. Extremely low down payments and complex interest rate structures that allowed buyers to acquire houses beyond their means have led to defaults and foreclosures. Main Street is hurting.
From Wall Street’s perspective the underlying problem is that mortgage backed securities have gone down in value, and even at dramatically reduced prices investors are unwilling to step forward to purchase securities. Furthermore, financing for mortgage backed securities is increasingly difficult to obtain, which forces sales, which exacerbates the problem. Wall Street is hurting.
THE SOLUTION: The Mortgage Rescue Plan outlined below encourages mortgage investors to voluntarily lower the outstanding principal amount as well as the stated interest rate on homeowner’s existing mortgages in exchange for a government guaranty of the modified mortgage. In exchange for these more advantageous mortgage terms, a homeowner would agree to share any future appreciation of his home (realized upon subsequent sale) with the mortgage investor and the government, in accordance with some equitable sharing rule.
This solution is simple, comprehensive and can be implemented quickly and inexpensively. It immediately lowers principal and interest payment on mortgages to allow homeowners to avoid defaults and foreclosures and to give them peace of mind that homeownership is a viable and valuable American dream. Simultaneously, it immediately liquefies mortgage-related securities allowing them once again to trade actively and be easily financed. Finally the solution is voluntary on the part of mortgage investors and homeowners and involves minimal government intervention.
THE PLAN: The government would announce that it is prepared to guarantee the repayment of principal and interest by homeowners if mortgage investors are willing to modify the terms of outstanding mortgages by reducing the principal amounts as well as the stated interest rates, and if homeowners are willing to share some of the future appreciation in value of their homes (realized upon sale). Here is how it would work:
After discussions with the government to set the terms (in particular the loan amount), the mortgage investor, if he so chooses, would send a term sheet to the homeowner describing the proposed modified mortgage. Upon receipt of the term sheet, it would be up to the homeowner to accept or reject the proposal.
New Loan Amount: A reduced loan amount would be proposed by the mortgage investor and approved by the government. The allowed reduction in loan amount should be based on published data telling how much housing prices have fallen in various regions of the country since a particular mortgage was written. It would be the government’s role to work with the mortgage lenders to see that reductions were sufficient to have the desired economic impact and appropriately sized to avoided moral hazard issues. All principal repayments on the new mortgages would be guaranteed by the government.
New Interest Rate: The rate could be either fixed or floating plus a spread. This spread would be divided between the government (as an insurance premium), the servicer (as a servicing fee), and the mortgage investor (as spread income). All interest payments on the new mortgages would be guaranteed by the government.
Loan Maturity and Repayment Schedule: Traditional maturities would apply and standard principal repayment schedules would be implemented.
Distribution of Funds upon Resale: Funds would go first to the government (to pay off the principal of the new mortgage), second to the homeowner (to reimburse him for his down payment in his original loan and improvements made to the house, if any) and to the mortgage investor (to make up the lost loan balance), and third to the homeowner and the government (to share residual profit). There are many possible equitable sharing rules for parts two and three.
QUESTIONS AND ANSWERS ABOUT THIS MORTGAGE RESCUE PLAN
1. What does this Mortgage Rescue Plan do that the Administration’s plan does not do?
This Mortgage Rescue Plan does something immediate and concrete for homeowners – it decreases mortgage loan amounts and interest rates, which decreases principal and interest payments thereby increasing the probability that homeowners can stay in their homes and neighborhoods.
The Administration’s Plan, provides no direct benefit to homeowners. Somehow the benefit of “fixing the financial markets” is supposed to trickle down to homeowners.
This Mortgage Rescue Plan does something immediate and concrete for mortgage investors – it provides government guarantees for vast quantities of mortgage backed securities thereby stabilizing prices and adding tremendous amounts of liquidity to the financial system.
The Administration’s Plan takes some illiquid securities off the market temporarily in the hopes that this action will “un-seize” the rest of the market.
2. How much will the Mortgage Rescue Plan Cost?
Besides administrative costs, there would be no initial outlay of funds by the government under this plan. A fund would be established to cover costs associated with defaults and foreclosures. It would have its own capitalization (see question #5 below) and would receive as additional funding the portion of the interest rate spread allocated to the government and the government’s right to receive amounts upon sale. The final cost to the government is not determinable, but if this Mortgage Rescue Plan is successful it should stabilize housing prices which would minimize future government outlays.
3. How will administration under the Mortgage Rescue Plan work?
The initial role of the government under the Mortgage Rescue Plan would be to encourage mortgage investors and homeowners to participate and to approve principal reductions that encourage economic growth. Over time there will be defaults and foreclosures, and procedure (much like those used by FNMA and Freddy Mac) will need to be developed to deal with them.
4. How long would it take to make the Mortgage Rescue Plan operational?
Once approved by Congress the plan could be operational in 90 days – 60 days for mortgage investors to develop and send out term sheets to homeowners and 30 days for homeowners to accept. In the interim, the Government could continue to lend funds to mortgage investors to support their illiquid securities.
5. How could the Government implement the Mortgage Rescue Plan?
One way to implement the MRP would be to establish an entity, which for working purposes we will call the “Mortgage Refinance Entity” (the “MRFE”). It could be housed in the Treasury Department, much like the Federal Financing Bank, or possibly as a division of the Federal Financing Bank.
The MRFE would have an initial capitalization agreed to by the Congress and the Administration. It would be the entity that would offer to the Investor the new mortgage security in exchange for an existing one. Having these securities issued by the MRFE would be an added benefit (particularly if the legislation makes the MRFE paper good collateral for the Fed discount window and TT&L accounts, which commercial banks establish for Treasury deposits.)
Howard Sosin was co-founder and former CEO and president of AIG Financial Products. He created AIG Financial Products with former AIG CEO Hank Greenberg as a joint venture. During Sosin's tenure, AIG Financial Products was one of the most successful creators of "boutique" financial products in the world, with all financial products hedged. There were large profits, no material losses, and NO credit default swaps or other credit derivatives (the primary source of AIG's recent failing). Sosin left AIG in 1993. The most recent CEO was Joe Cassano, whom Sosin hired and who built the credit derivatives business there in the late 1990's and early 2000's to a $500 billion insurance business (housed within a financial products company).