There were many causes of the housing crisis that hi the US in 2007 and set off the depression that began in 2008. Many of the problems remain but the biggest question is what do we do now?
When the housing market began to decline many problems were created. Banks that held hundreds of billions in Mortgage backed securities found that what they had thought were low risk securities discovered they were taking huge losses. Home owners could not afford their mortgages anymore and the down real estate market put them “underwater”, that is, they owed more than their homes were worth. Many individuals chose to walk away from their debt to start anew while many others were foreclosed on by the banks. Banks hate foreclosures because they must recognize the loss, begin what can be expensive procedures to remove the occupant, and are stuck with property they don’t have the means to maintain and run a high risk they will be either occupied by squatters or gutted by criminals seeking a quick buck. Clearly, kicking homeowners out is undesirable for both parties. Banks then must sell the home in a declining real estate market bringing down the comps for the remaining neighbors, creating a “death spiral” that put the remaining neighbors under water.
Up to this point, banks have chosen to let many foreclosed homeowners stay in their homes paying nothing. This is known ad foreclosure stuffing. As stated above, this allows banks to put off the recognition of the loss and allows them to put off selling the home in a declining market. Whether banks foreclose or not they face a decline in revenues and accounting losses. A home owner who moves out loses their home and their families lives are put in upheaval. But for a new healthy real estate market to emerge, prices must correct and be allowed to fall to their real value. Only then will new buyers step in at the lower prices because one, homes are more affordable to young people who begin household formations and two, because people still view a home as their biggest investment and want to think the odds are in their favor their investment will increase in value rather than become a “money pit”.
Up to this point the Federal government has tried to help by easing requirements for homeowners to refinance. But this does little for people who are underwater by over one hundred thousand or more. Accounting standards were also suspended to allow banks to “mark to model” rather than “mark to market” making a joke of our accounting system which is a cornerstone of a free market since analysts rely on reasonable accounting to value companies. Meanwhile, the Federal Reserve has in both QE1 and the current QE3 bought mortgage securities to provide liquidity to banks. Certainly this is helpful to banks who get the bad debt off their balance sheet but is does little for the homeowners and worse it socializes the losses from the banks to the US taxpayer who see the value of their dollar reduced by the money printed by the Fed to buy the bank’s mortgage securities. So neither of these programs helps reset the market, rather they both stretch out the time it will take for the real estate market to find its new, lower equilibrium. Neither of these solves the documentation problem where documents on mortgages were incomplete, fraudulently signed or where documents are completely missing. This has clogged our courts with cases of homeowners suing their bank or fighting eviction and no clear indication as to who the real owners is legally.
The solution is REITS
REITS are real estate investment trusts. They trade like a stock but have special tax privileges. REITS are made up of a portfolio of income producing real estate. They can hold anything from commercial offices to shopping malls to storage companies. As long as 90% of their revenues are passed along to shareholders they avoid the double taxation that corporations and investors face when the corporation must pay taxes on its revenues then pay a dividend that the shareholder must pay income taxes on. In this way, REITS are attractive investments to investors seeking reasonable income and possible appreciation from rising real estates and /or revenues.
The banks could collectively form an entity (Trust) that they would put their foreclosed homes into. They would receive shares for the property they contribute to the Trust. If the home is still occupied by the homeowner, they could agree to give up their home and pay a market based rent. In return for them giving up the home and any claim associated with bad deeds or record keeping they would be offered a market rate rental which is typically far below their mortgage payment, especially in hard hit areas like Stockton, CA. This way the occupants, who have in some states been in their home up to two years without any payment, would be paying some reasonable amount to the bank. This would allow them to stay in the home for the immediate future but give them the flexibility to move for a new job. For homes that have been foreclosed on and the owner has left, they could hire a management company to maintain and rent the home to create revenues.
Each Trust could be securitized and sold to investors seeking current income (seniors) at a much higher rate than savings accounts, money markets or Treasuries. Each Trust could have a maturity rate where part of the Trust holdings are sold off in the market at specifies periods, say 3, 5 & 7 years. The Banks could decide for themselves whether to sell their shares to investors or hold the shares to maturity when they might get better prices for real estate. The homeowners who stay in their home and rent during the length of the REIT would have first right of refusal when the home is resold at maturity. Conceivably, a homeowner with a family who defaults on their mortgage could still stay in their home, pay rent and possibly even buy back their home at a reduced price five years later!
In this plan we would solve several problems for banks, investors and homeowners. The banks would not be forced to sell homes into a declining real estate market. They would have liquidity if they sold their Trust shares ore income if they held their shares. The taxpayer would not be on the hook for bailing out the banks as Fed purchases would no longer be necessary. The homeowner, as stated above, could stay in their home if that is what is best for them, relieving the stress and anxiety of relocating their family. At the same time they would no longer be bound to the home and could move if a new job in another city became available. Investors, often older Americans who are taking the brunt of the Feds zero interest rate policies (ZIRP) by not being able to get more than 1% on their cash or 2-3% on Treasuries would have another, higher paying investment option. The added benefit is that homeowners, in giving up their right to the home and receiving incentives, would free up the courts that are bogged down in fights over documentation between banks and homeowners as a result of poor documentation that was widespread during the real estate boom.