Monthly Archives: November 2007

11/15/2007 FAQ #11: How can the existing banks and mortgage lenders find the SwapRent (SM) receiving "economic landlord" investors to pass on their real estate exposures so that they could offer these advantages to the defaulting homeowners for them to avoid foreclosures and hang on to their homes?

Providing trading liquidity for SwapRent (SM) contracts is what REIDeX is set up to do. Matching buyers and sellers (SwapRent rate receivers and payers) often sounds like a chicken-and-egg problem. However, the current mortgage default crisis seems to have made the answer rather simple.

The banks who are currently holding the defaulting mortgage loans do not have to go far trying to find other investors and hope for a quick fix that somehow others may want to clean up their mess for them for some magical unknown reasons. The quashed hope and failed attempt of trying to sell even more toxic securities to more innocent foreigner investors in a “Superfund” could attest to this point well. The lending banks themselves could actually be the best temporary “economic landlord” investors. By receiving SwapRent (SM) payments and paying MFC (in effect granting monthly subsidies to homeowners) to rescue these mortgage loans from defaulting it will certainly beat holding the physical individual REOs (Real Estate Owned, i.e. bank-owned properties) and trashing their mortgage loans in an actual foreclosure scenario. This is especially true when there are negative equities already in many of these defaulting properties (more explanation on this later).

In a free market investors will only come to them when there are no more foreclosures and forced sales in the future automatically, without a government intervention scenario. Nobody will be silly enough to come to them to solve their problems and buy away their problems for them at the current time when there is still a lot of future uncertainty, unless the price levels of these physical REOs or SwapRent (SM) contracts are so low that the investors think they could get a steal in a deal which could somehow overcome these future uncertainties.

The main advantage of using SwapRent (SM) contracts vs. buying REO foreclosed properties for investors hoping for long term returns is one of those common economic advantages of using a derivative contract. SwapRent (SM) by nature could lock in a longer term returns (say 3, 5 or 10 years). Without the SwapRent (SM) contracts, the real estate investors will have to wait for a long time before they would consider coming back to buy in the spot market when they think the housing market bottom has been reached. By using SwapRent (SM) contracts they could come in to buy today because a.) they do not have to wait for an unknown market timing bottom to buy as they could simply profit from long term recovery without a precise entry point; b.) they do not have to wait for 5 or 10 years to realize their views for an eventual recovery are correct as they would have to if they had bought the physical individual REOs; and c.) they get to avoid the high transactional cost associated with buying the physical individual REOs. Six months, one year or two years down the road when the sentiments have changed it will be reflected in the pricing of these SwapRent (SM) contracts of similar remaining maturities already. The “economic landlord” investors could easily take profit on their views at that time already, with a much lower transactional cost as well.

That is why for the banks and mortgage lenders who act as temporary “economic landlord” investors will have a much better chance (and at a much better price level) to off-load these long real estate exposures through the city level price index based SwapRent (SM) contracts than the physical individual REO bank owned properties. By curbing further foreclosures through SwapRent (SM) contacts it will also provide the stability and hence the future certainty that average investors are typically looking for.

As for those mortgage loans that had been securitized into MBS/CDOs, the credit risk holders/investors of these securities could simply set up a joint real estate recovery fund and implement the same strategies through and with the original lending banks and/or their mortgage servicers. Through cherry picking in the implementation order, this “economic landlord” fund will receive SwapRent (SM), pay MFC and thus provide netted monthly subsidies to those homeowners whose mortgages had been securitized into the MBS that the investors own so that these homeowners won’t have to default. In effect, the MBS/CDOs holders will simply swap a major part of their credit risks of holding these securitized mortgage loans into a purified liquid form of transferable and quantifiable market risks through the SwapRent (SM) contracts, which will be much easier and cheaper to offload than the physical individual REOs. Meanwhile, the value of the MBS/CDOs the investors are currently holding will recover in a very big way, once the default / foreclosure possibilities of the underlying mortgage loans have been completely removed, or at the minimum, postponed for 5 or 10 years.

This again, is especially true in the current environment when more and more properties fall into negative equities, i.e. the unpaid balance of the loan amount is higher than the market value of these properties. Whereas fresh third party investors may not be able to benefit from the recovery of the negative equity which is associated with the existing first mortgages so easily, the existing credit risk holders of these existing first mortgages will have all the incentives to potentially recoup their mark-to-market negative equity losses first and then benefit from the potential appreciation from the 2nd contingent mortgages that are typically built into HELMs, the SwapRent (SM) embedded new mortgage products. Otherwise they may have to take current losses and end up with maybe only a few cents on the dollar when the properties are foreclosed and sold into an already depressed market where negative equities already pervasively exist.

The total cost to the banks and mortgage lenders is also much less in the SwapRent (SM) scenario than for the physical REO scenario, especially when the holding cost of these REOs is taken into consideration. They key thing is that the foreclosures have been avoided all together in the SwapRent (SM) scenario. Homeowners will get to keep and stay in their homes and investors will no longer suffer any losses on the mortgage loans or MBS/CDOs. In fact the investors may even enjoy a gain because the real estate market risks have been taken away from these mortgage loans.

After the market scare has calmed down, the mortgage loans and related derivatives will have recovered in a big way and will become saleable at a much better price level. The lenders could sell them or securitize them again if they want to. Business will be operating as usual again. Later on they could make the decisions at their pleasure on whether to continue to hold on to these long term recovery (5 or 10 years) residential real estate property exposures expressed in the city level SwapRent (SM) contracts all across America. Since the dark clouds over the real estate markets will have already been over many traditional long term investors such as private pension funds, state public employees and teachers pension funds and insurance companies may step in and bid up the prices of these SwapRent (SM) contracts again. The speculators and hedge funds will also become itchy and eager to get in as well, and voila, the crisis will be all over. Free market capitalism will once more triumph again.

The point is, there may not seem to be a need to waste time now begging for investors, governments, tax-payers, foreigners or any others to help the lending banks or MBS holders solve their mess. If the original or the current existing lending banks and their servicers simply start offering SwapRent (SM) contracts and/or the SwapRent (SM) embedded mortgages (HELM) to homeowners to use them as an economic version of holding the traditional physical REO properties without the actual foreclosures their problems could be solved automatically. The initial cost to them is much lower as compared to any of their other alternatives. They could easily afford it by themselves temporarily to get the programs started. The various third-party investors may come in droves even without invitations once the market has been restored to normal.

This will happen once homeowners get their fair monthly subsidies through the SwapRent (SM) contracts or the embedded mortgages (HELM). All defaults and foreclosures could be avoided immediately. If there are no defaults and foreclosures, there would be no more investor losses, no more credit crunch, no more turmoils in the financial markets and our nation will get to avoid the severe social and political consequences down the road …

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