Today we have received the Obama housing rescue plan. Let us look back for a moment. The collapse in the housing market was caused by a number of issues such as supply constraints, the mortgage backed securities market, easy money for investors and sub-prime borrowers (to feed the mortgage backed securities market). In later postings, I will address these issues one-by-one. However, today, it is important to focus on the solutions.



Solutions should be addressed to specific problems. Over the last few months, the talking heads on TV, spokespersons for government, politicians and economists have consistently stated that the most important issue is the plunging value of real estate. With respect to President Obama's rescue plan, that real estate is focused on single family homes. The decline in real estate values is causing a dramatic erosion of capital in the banking industry, it has annihilated the value of all of the various fundamental and/or gimmicky mortgage backed securities (SIV's, CDO's, MBS's, Derivatives, etc.) sold by Wall Street, and it has stimulated the possibility of families opting to "mail the keys" back to their mortgage holder in lieu of paying on a mortgage that far exceeds the value of the home.



This specific problem was caused by the elimination of more than 50% of the demand for new and resale homes. The lost demand included: (1) The sub-prime borrower (depending on the market, this buyer represented 20% to 40% of the home buyers); (2) The investor buyer (depending on the market, this buyer represented 5% to 60% of the home buyers); (3) The qualified "Jumbo" buyer (as much as 15% of these buyers) and (4) The Conforming Conventional Buyer (as much as 25% of these buyers).



In tandem with the elimination of demand, we also encountered some rather severe supply problems. The first of these supply issues is the shortage of available housing that persisted from 1999 through 2005. It was this shortage problem that stimulated massive price increases (in selected markets). The price increases further stimulated demand, particularly from investors, and the investor activity further constrained supply. Hence, we entered a vicious cycle of shortage/price increase/demand increase/further shortage/further price increase.



Beginning in 2006, the housing industry production capacity reached a level that produced a sufficient number of new homes to meet the existing exaggerated demand. The resale market also added to its inventory (listings) as homeowners attempted to cash in on the exceedingly high values of their homes. These two conditions successfully increased the supply of new and resale homes to meet the identifiable demand in the market. By themselves, these two conditions were sufficient to bring home prices back in line with reality and induce a mild (10% to 20% decline in housing production) housing cycle for the first time since the early 1990's.



Little did we know that the folks on Wall Street had managed to leverage the huge amount of mortgages generated by this "bubble" from 30 to 100 times, so that, when the market cools (not to mention collapses) the value of the investments they sold would go down to the degree they were leveraged, which generated TRILLIONS of dollars in investment losses, worldwide. Consequently, instead of a "normal housing cycle" required to bring supply and demand back in balance, we find that the entire mortgage market has been compromised, and the "sub-prime meltdown" gets the blame. The implication being that Joe Six Pack overextended himself with a greedy purchase of a new home, and he is the cause of the problem. In response to this definition of the problem, the Administration has crafted a housing rescue plan that forces banks to take more losses, the taxpayers to pay more money, and focuses on the person who owns an home and who is at risk of foreclosure.



While this may be an admirable goal, it does nothing to remove excess inventory from the market or to restore demand for the purchase of new and resale homes, or restore the millions of construction industry trade jobs that have been lost, due to the 70% decline in housing production, nor does it provide any help in restoring liquidity to the economy. Even the most aggressive foreclosure mitigation cannot prevent the millions of foreclosures that will result from job losses. If a home owner has no income, there is no reasonable subsidy that bring that home owner's debt service down to 35% of their income, short of giving them the home.



By the end of 2006, the housing market began to pull back from the extremely high production rates as buyers found that their existing home was not as easy to sell as expected and that there were actually several homes to choose from in the market in which they were interested. Production began to slow and absorption of existing inventory also weakened. The outcome of this condition was an aggressive upward move in inventory. However, at this point in the calendar, based on what we knew about the economy, the economic growth throughout the country would allow for this excess inventory to be absorbed over the coming year.



By the end of 2007, Wall Street began to hit the fan as investment banks and banks and hedge funds began giving the rest of the world a peek at the extent of the mortal (self inflicted) wound they had received from the hyper-leverage they had used to amass huge profits, bonuses and dividends. As the extent of the damage became better known (this process took more than nine months), the mortgage market for the lower income buyer evaporated, the investors bailed out and the conventional and Jumbo buyers found themselves faced with huge documentation requirements, very large down payment requirements, and, in some cases, no mortgage money availability at all. Lenders cancelled mortgage commitments at the close, and the absorption of new and resale homes plummeted, home prices collapsed, the derivatives market collapsed and all liquidity in the housing market evaporated.



So, the search for a solution leads to the two problems, too much supply and not enough demand. These can actually be boiled down into a single problem, not enough demand, because any increase in demand will automatically reduce the relative supply to a more normal level. So, let's concentrate on demand.



The primary throttle that can successfully impact housing demand is the availability of reasonably priced mortgage money. The more available, the greater the chance of housing demand going up. The more reasonably priced, the greater the likelihood of housing demand going up. The good thing about mortgage money is that it is a loan, not a gift. When a mortgage is made, there is no cost to the taxpayer. When the payments are made, the lender receives interest income. The role of the government in a mortgage availability program would be twofold; first, to insure the mortgages that are made (HUD/FHA) and, second, to provide the liquidity necessary to fund the mortgages at a low interest rate (Fannie Mae/Ginny Mae).

The governmental infrastructure is in place at HUD/FHA and at Fannie Mae and Ginny Mae. There is precedent for both government insured mortgages and direct lending, particularly after the 1974 crash when we had the Ginny Mae Tandem Plan with direct, below market loans for new housing construction. therefore, we do not have to make government any bigger. The loans can be made by banks, mortgage companies, savings banks and Fannie/Ginny. The term of the mortgages should be 30 to 40 years, and the interest rate should be in the range of 1.5% to 2.5%. Down payments should range from 0%, with the rate improving with greater down payments. It would be reasonable for the interest rate to adjust to market (at some graduated pace) after 5 to 10 years.

How do we implement such a program? First, Congress would DIRECT HUD/FHA to insure $1 TRILLION in new mortgages. Every time FHA insures a mortgage, the government will collect a fee. Cost to the taxpayer = $0. When a bank funds the mortgage, the paper is government insured, so the bank can sell the mortgage and recapture its liquidity. Based on a $200,000 average home price, this program will provide for 5 million new mortgages. Because the program would apply to reseal and new homes, the initial thrust of the program would go a long way toward removing the 2 million excess resale homes and 500,000 excess new, unsold inventory from the market. By quickly removing this excess inventory from the market, the primary problem of falling real estate (home) prices will STOP.

By arresting the free fall of home prices, the erosion of bank capital will also stop and further bank real estate losses will be mitigated.

As the excess inventory begins to experience accelerated absorption, the housing market will return to inventory equilibrium. As this occurs, buyers will find that to get the house they want, they will have to get a builder to build them a home. While this part of the program helps restore equilibrium to housing inventory and stabilizes home process, we have yet to address the 500,000 to 1 million jobs the national economy is losing each month, and will continue to do so for the rest of 2009. This program would provide mortgages for construction of 500,000 new homes per year for the next five years (5 million mortgages minus 2 million resale inventory minus 500,000 new home inventory leaves 2.5 million new home mortgages over five years equals 500,000 per year. So, we do another round of math.

If we estimate that there are 50,000 home builders left in the economy, today; down from 100,000, and if we further estimate that each home builder works with 10 sub-contractors (roofers, framers, masons, electricians, plumbers, HVAC dealers, flooring companies, foundation companies, excavators, and carpenters), then, as inventory drops and it becomes necessary for the housing market to build a new home to meet demand, all of these companies (550,000) are going to have to hire back the employees they have laid off in the last 18 months. If they hire one employee per company per month, we will create 6.6 million new jobs over the next 12 to 18 months. this job formation will be in addition to the jobs created by building highways, bridges, schools and infrastructure as planned in the Stimulus Plan passed by Congress.

So, with this program, bank capital is protected and restored, consumer confidence in the economy is restored, lost construction jobs are restored, lost building product manufacturing jobs (not counted above) are restored, banking and mortgage industry jobs are restored, bank confidence in taking lending risks in the US economy are restored. All at ZERO cost to the taxpayer. Not a bad program. However, there are some glitches in the way of implementation. The primary glitch is credit, or more specifically, credit scores.

Just using the more than 4 million jobs lost so far, and the slowdown in the economy, there are millions of people who have made their mortgage or credit card payments late. It is very likely that the credit scores of millions of families have dropped (although, we have no idea how these scores are actually calculated). Nevertheless, there are three credit reporting companies that control the purse strings of the US economy. Having mortgage money and low interest rates if the underwriting to obtain those mortgages prevents the working class buyer from qualifying. It is going to be very, very important that the buyers be qualified on a percent of their income, and not some calculation that is rife with penalties for being on a new job, being divorced, late payments and the like. It is necessary to broaden the access to these mortgages, not limit access.

Well, if we lower underwriting, and increase the percent of income that can be committed to the mortgage payment (say, 30% to 50%), then a lot of people are going to default, after all, this is sub-prime buying at its best. That's right, there will be defaults, and this is going to cost the taxpayers (here we go, more load in the taxpayer). So, let's assume that over the five years of this program, 40% of the $1 TRILLION in mortgages default; that's $400 Billion. That's a lot of money. However, HUD/FHA is going to foreclose on those mortgages, because they are the guarantor. then, HUD/FHA is going to sell these homes in an improving housing market. They are still going to suffer a loss, so, let's assume that these foreclosures, over five years, are sold for $0.60 on the dollar. This will result in a $160 Billion loss to HUD/FHA (code for taxpayer). So, the question is, does a $160 Billion loss, over 5 years ($32 Billion per year), when more than 6 million jobs are created and hundreds of billions of bank capital is saved or restored, make sense? In the Spring of 2008, the government mailed $600 checks to citizens nationwide at a cost of $180 Billion, with no justification for such an action, and no visible results. The program described herein makes a lot more sense than that. Our Congress and just passed the largest spending bill in the history of the PLANET, without even reading the document. This proposal makes a lot more sense than that.

Well, then, what's the problem? This program has no constituency, other than the American people. There is no banking lobby for the congress to turn to and say, "See what I did for you?", there is no United Auto Workers' Union for the congress to turn to and say, "See what I have done for you?" there are no political cronies that anyone can turn to and say, "See what I have done for you?" It will, however, give President Obama the platform to turn to the American people and say, "See what I have done for you?"

The second rub is that many home builders and sub-contractors are self employed entrepreneurs. This can be code for Conservative - Republican. Certainly, in the interest of good old partisan politics, it would be better to let the economy go into depression before doing anything that might help a Conservative Republican.

Right now, our economy is losing somewhere between 500,000 and 1,000,000 jobs per MONTH. The economy is going to go into a DEPRESSION, with 15% to 20% unemployment and all of the collateral social and economic ills that go with it. Building bridges, highways and slowing foreclosures does not reverse the trend. Stimulating 500,000 to 600,000 employers to hire one person per month over a year will quickly reverse the trend. Remember that the economy needs about a year (12 months) for the positive stimuli to show up on the street. We need to act now.