Two plans out there today to restructure US mortgages involving apparent negative equity whereby the home value is now less than outstanding debt. One of these is by Eric Posner and Luigi Zingales and involves offering mortgage holders in zip codes that have experienced 20 percent or greater house price declines to restructure their mortgage to current house values – i.e., zero equity. The catch would be that, if home values appreciated by the time they were sold, then their bank would get 50 percent of the upside. Of course, this the upside of a house price index and not the house itself so as to avoid moral hazard.
Sound familiar? [DDET Read more]
It is not dissimilar to Rismark’s equity finance mortgage except that is based on an equity holding of the house’s actual value. This has not been lost on Rismark’s Chris Joye who two weeks ago proposed a mortgage restructuring plan directly to the Obama Administration. Here is an account. His plan is to start with banks setting back mortgages to the zero equity position (like Posner and Zingales) but in return the government agrees to take a 25 percent equity finance mortgage on the adjusted principal so as to insure against this continuing on with further house declines or stagnation (something that Posner and Zingales don’t appear to allow for which is a bit of a worry). That mortgage means that should house prices appreciate above the readjusted level, the government gets 50 percent of the upside. But this is all distinct from Posner and Zingales as it is based on actual market transactions for homes rather than an index. You are trading off a risk of moral hazard with basis risk on the entire portfolio. Experience in Australia suggests that the moral hazard risk is low and so commercial products that could have been based on house price index have been marketed based on real transaction values.
Either way, we may come out of all this with some radical changes in home financing practices.
[Update: Chris’ post is now on ft.com]