Many analysts believe that President Obama's Housing Rescue Plan, although well conceived, may not go far enough. There is also an understandable concern about moral hazard implications of any rescue program.
Some critics question the plan's focus on marginally "under water" and soon-to-default mortgages rather than the millions of homeowners who "have been doing the right thing" but are suffering the consequences of housing market de-valuation.
Could a more systemic solution be necessary, perhaps requiring a paradigm shift in the way people finance home ownership in America? This may be the time for truly "outside the box" approaches to be considered, at least to provoke more original thinking on the subject.
One radical approach that could have broad impact is the creation of a simultaneous hybrid "mortgage/lease" form of financing. Under this concept, homeowners could theoretically own as little as 51% of their home and finance that partial equity with a mortgage, while simultaneously leasing the remaining position in the property from their bank.
Homeowners would be responsible for real estate taxes, but would pay a low monthly rent for the bank's portion of their home.
Upon future sale of the home, the bank would receive higher-than-proportionate benefits of the appreciation of the property. Although higher minimum equity shares for homeowners could be mandated to avoid concerns that this program would "over-stimulate" certain housing markets (and to ensure that banks receive a fair return for the equity they retain), a minimum homeowner share of 51% is necessary to ensure that homeowners -- not banks -- control all decisions to buy, improve or sell their homes.
Because a government subsidy would probably be required to give the bank a fair return in cases as extreme as 51% homeowner equity, it is more probable that a mortgage/lease, leaving the homeowner with 60% to 65%, would be the lowest feasible example in unsubsidized cases.
Each bank's partial equity interest could either be held by the bank or sold in the secondary market. Unlike the derivatives and other financial instruments, whose lack of connection with actual real estate fueled much of the current crisis, these partial equity interests could be sold or traded without losing their direct connection to the underlying real estate.
In fact, private sector REITs could be established to hold these partial property interests. Government-guaranteed bonds could be issued to the public to provide initial seed money for the REITs.
The viability of these REITs would, in part, rely on the prospect of eventual home appreciation, but would be significantly improved if their portfolio contained a broad mix of homes. Therefore, use of the partial equity mortgage concept by as broad an audience of homeowners as possible, not just by those in duress, would be desirable from a private investment perspective.
A less radical variation of this idea would use a silent second mortgage held by the bank instead of a true equity share. In this approach, the homeowner would retain title to 100% of his home, and the bank would hold a second mortgage with very low-debt service (equivalent to the low-rent payment in the shared equity scheme) and a principal equal to, say, 40% of the home's price, which would be payable (with a share of profits) upon sale of the home or at the end of the mortgage term.
Second mortgages could be sold in the secondary market and held in REITs, just like the partial equity shares. However, unless 100% guaranteed by the federal government, instruments collateralized by these second mortgages might not have the same value as partial equity shares in the actual real estate.
From the homeowner's perspective, these approaches could be used to:
1) gain freedom from "under water" situations;
2) allow families facing foreclosure, due to income reduction, remain in their homes by reducing the equity in their homes; or
3) offer affordable financing options to all potential home buyers.
Theoretically, provisions could even be created through which homeowners could "buy back" equity in their properties at some future date when their economic circumstances allow. Additional equity shares could be purchased for cash or, after passing rigorous re-financing tests, by increasing mortgage principal.
As a practical example, a family buying a $400,000 home would put down $80,000 (or 20%) in cash, but might choose to finance only an additional 50% (or $160,000) through a mortgage, bringing their equity interest in their home to 60%. The remaining 40% (or $160,000) would be owned (or silently financed) by the bank, and the homeowner would pay monthly rent for this remaining portion of the equity in their home.
Since the homeowner would be paying 100% of property taxes, it is conceivable that the monthly rent portion of their payment to the lender could be relatively small (say about $400), conceptually like a triple net lease on that portion of the property's equity.
In this example, the lender might be guaranteed 10% more of any appreciation realized upon sale of the home. Additional provisions could enable the homeowner to lower monthly rent or increase equity in the home by selling the lender additional disproportionate shares of appreciation.
Theoretically, it is even conceivable that this "equity buy-back" provision could be used during wage-earning years and then reversed to provide the benefits of a reverse mortgage at an appropriate point in the life of the homeowner.
Giving the homeowner an option to buy more equity later in the mortgage term would be preferable to the potentially destructive use of teaser rates in early years.
Just as President Obama's plan would require all banks taking TARP money to participate in its programs, banks could similarly be required to utilize hybrid mortgage/leases as a certain percentage of their mortgage portfolio.
To guard against abuse of this type of mortgage, however, the maximum percentage of these mortgages in any bank's portfolios could be limited as well. Moral hazard implications of this program would be addressed by the fact that homeowners would be sacrificing equity in their own homes, as well as significant upside potential upon sale of the property.
Although these concepts would represent a paradigm shift in home ownership in America, it is conceivable that they could effectively achieve the "increased home ownership" goals to which many in government have aspired in the past, without any loosening of credit and income requirements.
In fact, these mortgages could actually have higher "gross income to monthly payment" requirements than conventional mortgages. These provisions would ensure that the program not serve as a way for unqualified homeowners to live in "twice the house they can afford."
The result would be a new category of home owners whose partial equity would enable many to have "a taste" of ownership without potentially jeopardizing their financial stability or the prevailing price of homes in the marketplace.
Interestingly, if this form of hybrid mortgage became widely popular, it could spread home ownership while reducing the average family's reliance on home equity as their primary investment.
Admittedly, a hybrid mortgage/lease program would entail additional government and financial sector involvement in the nation's housing market. The federal government and the nation's banks could, at least temporarily, have an equity stake in millions of homes throughout the country.
As the market recovers and these partial equity interests demonstrate value in the secondary markets, the minimum required percentage of mortgage/leases in bank's portfolios could also be reduced by regulation. The result would be a public/private partnership to achieve stability through short-term infusion of public funds but capable of becoming self-sustaining in the long-term.
Dramatic approaches like hybrid mortgage/leases and the creation of a new category of home ownership may be part of the price needed to ensure a floor in house prices and to achieve reduced volatility in the housing market as a whole.
Many aspects of the program require study and refinement, including:
1) provisions for simultaneous rent payments;
2) mechanisms for periodic equity share re-valuation;
3) ownership implications of home improvement paid for by homeowners;
4) mortgage payment implications of increased or decreased owner's equity during the mortgage term;
5) alternative forms of partial equity shares held by REITs (e.g., separation into 10% equity tranches to facilitate buy-out) and, of course
6) alternative forms of "remaining equity" financing and/or mortgage reversal at the completion of the initial mortgage term.
Treatment of all equity positions under foreclosure scenarios would require extensive study, possibly requiring that equity positions held by banks or REITs be something less than fee simple ownership.
Because of the potential applicability of this hybrid mortgage/lease concept to a broad range of buyers and markets not currently in duress, it is difficult to estimate the eventual size and scope of the program without modeling a wide range of partial equity/eligibility combinations under different market conditions.
In generic terms, hybrid mortgage/leases are just one form of equity and price adjustment that should be considered (e.g., silent second mortgages can achieve many of the same market impacts, as long as they are combined with government guarantee of a percentage of mortgage principal).
In contrast to the Obama Administration's plan, privately financed hybrid mortgage/leases could serve an ameliorative purpose in the short term, while eventually becoming a permanent self-sustaining aspect of housing finance in America.
Charles Shapiro is a real estate advisor and urban planner with more than 30 years experience in private and public sector development, facilities and portfolio analysis.