I'm sure I'm just naive here, but why is solving this sub-prime issue so difficult?
- Given an ever-growing market, lenders figured they could take a hit up-front on a mortgage (the sub-prime & minimal downpayment part), bait/switch the homeowner (who never read the contract anyway) with a substantially higher interest rate (super-prime) in subsequent years.
- They were comfortable knowing that if there was a default in future years, there was now positive equity in the home, and they'd be able to recover their mortgage + fees. But with a slowing/stopped/retreating economy, home values dropped; buyers dried up; bad things happened.
- When the debt was sold, and resold and mixed with other assets and then resold yet again. The assumption was that these sub-prime mortgages would be mixed in with a bunch of well-secured debt, making the asset as a whole seem pretty reliable.
- BUT - when enough of the sub-prime debt began to be written off (due to foreclosures), the asset as a whole became untenable and the financial institution with enough of these assets began to lose their ability to raise funds, and then momentum grew, and bad news followed.
The US Government forms a for-profit business called The 70-40as a wholly-owned subsidiary of the IRS (yes, the IRS). Simply, this company would offer every homeowner in America that was dumb enough (because after all, society's role is to protect its weakest members) to buy a sub-prime mortgage the following:
- If you are in foreclosure (ex. missed two payments in a row),
- The 70-40 will buy your debt from your lender @ 70 cents on the dollar (this is a great deal for the lender, who often will sell this debt for 40 or 50 cents on the dollar, if not lower).
- The 70-40 will then sell you their one and only product, a 40-year fixed rate (@ say prime+2), interest+principle mortgage on your home, which is now worth 70% of the original price.
- The 70-40 will only buy new debt for a fixed period of time (say one year).
Impact on the financial institutions:
- Ability to convert all debt once potentially toxic into reasonable losses (absorbable within the margin).
- Take comfort in knowing that the US government will similarly convert any future bad debt.
- Know that they will survive, stay afloat, and while the earnings will be severely lowered, it won't be to the point of bankruptcy.
- Be severely fined at the executive level; these fines (say 50% of total compensation for two years (current + 1, and + 1 more if compensation grew dramatically in year 3) before tax for top 50 executives); these fines would be part of financing The 70-40.
Impact on the stupid homeowners:
- They get their home back, albeit a home that is now worth 70% of the original purchase price - but at least it's a roof over their heads.
- Their payments are now fixed, and lower because of the 70% reduction in the principle and the 40-year amortization (vs. the typical 30 years).
Impact on the taxpayers of America:
- A much lower price to pay (both up-front and in the long term) to alleviate the crisis.
- An opportunity (if taken) to learn more about fiscal responsibility and better decision-making.