05/28/2008 What is the role of local city municipalities in all this?

FAQ #18: What is the role of local city municipalities in all this?

The SwapRent (SM) program is meant to be a Main Street solution, rather than another Wall Street gimmick. Despite many people’s infatuation with the Wall Street investment banks, there are indeed some credibility issues if we try to rely on these financial institutions to launch these new programs now. The blind infatuation and admiration will come to a sudden halt when you yourself become one of their victims. Having burnt many innocent investors’ billions of dollars around the world could you imagine these once high flying investment banks got something new again to sell to you now? On the homeowners side, could you trust those once high flying subprime underwriters to come up with a new invention that could really help homeowners more than helping themselves?

We have been in touch with most of the major commercial banks, mortgage lenders and Wall Street investment banks since as early as mid 2006. Many of them went to their demise as their staff continued to study to death our SwapRent (SM) proposal. Two years have passed since then. Many of these remaining financial institutions are having enough trouble fighting for their own survivals at the moment because the monthly expense burn rate could not justify their continuing operations since the previous mortgage underwriting and securitization money trees had withered. They are obviously not in the mood to talk about anything the could help our society in the long run rather than where and how to find the next credit line for their own survival at the moment. Helping homeowners and the local city economy obviously does not seem to be high on their current corporate agenda.

We have indeed been trying to engage the active participation of many municipalities. It makes perfect sense for local cities to play a major role to try to mitigate our current economic and soon to be social crisis for the benefits of their local citizens. It is a perfect opportunity for some of them to pro-actively set an example for the rest of the nation that indeed a privately funded free market program without spending any single cent of taxpayers’ money could solve both our nation’s worsening economic problems and social problems by helping homeowners prevent foreclosures and hold on to their own homes. Municipalities would as a result no longer fear the possibility of bankruptcy (e.g. Vallejo, CA) due to the decreasing tax revenue base derived from declining property value and increasing number of empty boarded homes in many of their cities.

Although we have spent tremendous efforts trying to inform and make our detailed solutions available to the US lawmakers, federal government officials, banking regulators, GSEs and housing agencies about the merits of SwapRent (SM) and HELM, we do not really have to rely on their direct help to get the program started in order to provide the economic benefits to the homeowners. Since the SwapRent (SM) based approach is a pure free market based solution, we do not need the lawmakers to make any new legislation to force anybody to do anything. The intention is primarily to inform them that a free market solution is indeed possible and currently available. Therefore there is no need to overreact and make any restrictive new legislations or to spend billions of taxpayers’ money to do charity work.

The benefits that SwapRent (SM) could provide to homeowners will have to start from somewhere locally. Engaging the municipalities will provide them a crucial role as the game keeper to weed out other potentially unscrupulous foreclosure scam artists to take advantage of an apparent demand of services and assistance in the local community. If the local city governments do not actively provide a credible solution their local citizens they may end up easy preys to those con-artists in addition to the risk of the increasing economic and social problems brought about by more empty boarded homes in their cities.

This could also be a good opportunity for many public state and local pension funds to get involved to act as the initial "economic landlord" investor to provide the homeowners with the necessary fair and equitable monthly subsidies in order for them to hold on to their homes by acting as the “economic tenants” of their own homes. This would not only help the residents and the local economy of the city but also could fit very well with the pension funds’ normal financing/investment objectives. Residential real estate investment such as single family houses has never been available as an asset class for institutional investors in the past due to various logistic problems until the “economic landlord” advantages offered by the SwapRent (SM) contracts become a reality. By adding the residential real estate exposures in their long term investment portfolios it will enjoy even more risk diversification benefits. The transparent market pricing provided by REIDeX will ensure that this would be a bona fide free market based solution, not tainted by a tax payers bailout or even an unnecessary charity image.

From our recent discussions with many of these local cities, it appears there could be many other immediate more urgent needs to apply the proposed SwapRent (SM) program. One such thing is to use the “shared appreciation” features of SwapRent (SM) for low income housing or first time buyers assistance program, in addition to the potential assistance for defaulting homeowners. Many already foreclosed or empty homes could be purchased by responsible city citizens due to the opportunity created by this new alternative way of offering housing affordability. The neighborhood and the local economy will therefore enjoy a major economic revival without having to commit lots of taxpayers’ money to redevelopment projects.

In the UK many local governments have always been very actively involved in all kinds of shared appreciation, shared equity or shared ownership schemes to offer alternative ways of housing affordability. As a result, irrespective of the increasing number of their own version of subprime defaults, the foreclosure problems will not reach the same biblical proportion that the US will experience in the near future.

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05/27/2008 What about those shared appreciation mortgages, aren't they options, or derivatives too?

FAQ #16: What about those shared appreciation mortgages, aren’t they options, or derivatives too? If so, aren’t Fed Governors and Presidents recommending the use of these derivative products for homeowners to solve the current housing crisis?

Yes indeed you could call them derivatives. This could well be a case in point of how derivatives can provide good economic value to consumers. Technically speaking shared appreciation is in fact a call option on the property value of your home that you will share in part with someone else for a certain period of time. For example, a typical shared equity or shared appreciation mortgage would be to share xx% of the legal interests in your home. In return, they will get 2 or more times the xx% in upside appreciation of you home in the future. Because it is similar to a "covered call option" concept which means that the homeowners will give up partially only something that they may or may not gain in the future, it will not create economic hardship when that indeed happens. Meanwhile they could enjoy all current benefits received now from giving up this "potential", irrespective whether this future potential financial gain happens or not.

The big questions are a.) how do they put a fair value of such an option without a transparent traded market place to be able to both buy and sell? (no price discovery mechanism) and b.) once the provider financial institution does the transaction with you what could they do with it, in terms of handling risk management for themselves (risk transference and financial institution regulatory issue), realizing a profit on the transaction and generating liquidity by passing the exposure to someone else to scale up the scope and do more deals (scale issue). These are, among many other issues, the unsolved economic problems that have hindered the wide use and acceptance of these conventional shared appreciation mortgages (SAM) in the past in many other countries.

On top of all that, what do you, the homeowner, do after you have shared part of upside appreciation potential with some one else, will you still love your home the same way as before (moral hazard issue) and will you still go to Home Depot or Lowe’s to make home improvement projects on weekends (various home improvement issues), … etc. all need to be properly addressed before they could receive wide acceptance. SwapRent (SM) and its embedded mortgage, HELM were since day one, created to deal with these issues and therefore have properly solved all these problems.

The recommendation of the use of shared appreciation by the Fed officials is a defensive reaction from the sudden crisis created by the mortgage default blow-up. As mentioned before, there weren’t any wide use of these more conventional ways of offering housing affordability in the US as it has happened in other countries and therefore unscrupulous mortgage professionals resorted to providing fictitious housing affordability by simply playing tricks with interest rates alone (e.g. teaser rates). That has, in a major part, contributed to the current massive mortgage default crisis.

Now with the crisis the politicians are perceived to have to come up with something that could solve the problems. For example, many mentioned the use of a 2nd mortgage to do the shared appreciation in order to buy out the negative under the water (or called upside down) part of the mortgage value, but how? What is a fair way to value them? What percentage of appreciation, for how long? How to create a secondary market for it? … etc., etc. Without a systematic, quantifiable way to create a transparent marketplace and the ability to extract out the risk elements these answers could only be drawn arbitrarily from thin air. As they do more research in this direction, they will eventually come to those worked out ideas and methodologies which were already incorporated into SwapRent (SM) and HELM. Through the past year, we have provided many of them the details of our solutions. I sincerely hope by then they will appreciate and respect the time and efforts that we have already devoted to the development of these intellectual properties.

Should the Administration officials propose to go back to use these old arcane conventional recycled British shared appreciation mortgage products and concepts that were developed long time ago and have been practiced for more than 30 years already or should they go for a better improved version of them in the new era? We all know that the last greatest inventions we got from the respectable British people are the steam engines and locomotives. If you want to build a new high speed train now do you want to use the latest French TGV, Japanese bullet train maglev technology or do you still want to rely on those old locomotive technology? (No offense intended. Apology if offensive to anyone who reads English.) These conventional shared appreciation mortgage products and concepts in their current forms will not be able to help solve our current mortgage default crisis anyway.

Derivatives concepts exist everywhere you look in our daily lives. Every conditional sentence you speak in your daily conversation has an option component in it. You could consider them derivatives but they provide little economic value. Similarly, the derivatives practiced in the financial markets, like those in daily life, will offer little economic value if there is no systematic way to create a liquid secondary market to provide price discovery and the risk transference functions.

Again, SwapRent (SM) and its associated consumer finance products were specifically created with these issues in mind and therefore have already solved these problems perfectly.

05/27/2008 Is it potentially dangerous and troublesome to market derivatives based financial products to consumers?

FAQ #15: Is it potentially dangerous and troublesome to market derivatives based financial products to consumers?

There are indeed many unjustified public misconceptions about financial derivatives. Every time the public heard of derivatives in the press was when some derivatives traders played mischief and caused troubles to others. They are usually headline news materials. Few reporters will spend time to write about how good derivatives are other than those sponsored by the industry promoters.

Banks have in fact been marketing derivatives to consumers for decades without calling them derivatives and have provided enormous economic value to homeowners. For example, a 30 year fixed rate mortgage with a prepayment option is nothing different from a fixed rate loan together with an interest rate derivative. However as you would recall that last time when you refinanced, the bank did not ask you to sign a derivatives contract on top of your loan contract. In addition, I am sure that you have never heard of any consumers ever got hurt by these benign interest rate derivatives that have already been built into the consumer financial products. That is the spirit behind the invention of HELM (Home Equity Locking Mortgage), the SwapRent (SM) embedded mortgage product, to package the economic benefits of real estate or property derivatives into the consumer financial products in a fool-proof, easy to understand and simple to use way.

Some market guru once called financial derivatives the WMD or Weapons of Mass Destruction. On surface it is actually technically correct (or he won’t be a market guru anymore). Same thing could be said about the real nuclear power. They could indeed be the powerful destructive weapons but as the Iranians or the North Koreans would be eager to tell you, they could also be powerful tools to generate electricity to benefit many of their citizens. A big percentage of many advanced economies’ electricity is actually being generated this way. So the question is really who are using it, how they are using it and what they are using it for. Same arguments apply to derivatives.

On the other hand, the ignorant interpretation of the guru’s comment to generalize that all derivatives are bad is a bit naive. It would be equally naive to call guru’s Graham & Dodd investing style stupid and bad simply because the guru had made many investment duds that the public have not yet focused much on. It is a perception or maybe a PR issue. Few people know that there are in fact good cholesterols and bad cholesterols but few have vested interests to defend and change the public image of the poor cholesterols.

Having said that, overly complicated structured derivatives are prone to be abused because they may be more difficult to understand. That is the root cause of most of the derivatives troubles, i.e. human abuse. So CDOs and CDS could be the case in point. Simple, transparent and well designed fool-proof derivatives such as fixed rate mortgage with prepayment options on the other hand, mostly deliver good causes and have less opportunities left open for participants to abuse than their more complicated counterparts.

SwapRent (SM) and its associated consumer finance products were specifically designed and created to keep only the economic benefits of financial derivatives in a fool proof and simple way for consumers to utilize. As fully explained in the various patent applications mentioned above, they were intentionally designed to be very different from the OTC derivatives practiced in the institutional inter-bank market, which are absolutely too complicated and dangerous for public retail consumption. To use another analogy again, if those interbank derivatives are race cars which could only be used with a stick or manual transmission to operate by sophisticated drivers, SwapRent (SM) and its embedded mortgage product HELM could be your auto transmission equipped sedan with anti-lock brakes and air bags for more consumer user-friendliness.

05/26/2008 What is the difference between HELM (Home Equity Locking Mortgage) or the SwapRent (SM) embedded mortgage product and the Shared Appreciation Mortgage (SAM) that politicians are proposing recently?

FAQ #13: (added on May 26th, 2008) What is the difference between HELM (Home Equity Locking Mortgage) or the SwapRent (SM) embedded mortgage product and the Shared Appreciation Mortgage (SAM) that politicians are proposing recently?

From our numerous earlier efforts and attempts to bring up the public awareness since early 2006, many politicians and academics responded very positively to the use of “shared appreciation” concept to solve our current economic crisis brought about by the increasing number of homeowner/borrower defaults.

Fed Chairman Bernanke has repeatedly recommended the use of the shared appreciation concept and related products to solve the delinquency/foreclosure problems. The most recent one was during his speech at the recent ICBA’s conference. The SwapRent (SM) based approach with its embedded new mortgage product, Home Equity Locking Mortgage (HELM) is a major implementation of these concepts. He first mentioned the use of shared appreciation as a potential solution in a letter to Senator Schumer on August 27th, 2007.

Separately, Boston Fed President Eric Rosengren suggested the use of shared appreciation products in his speech on March 6th, 2008 as well.

Similarly, Fed Governor Randall S. Kroszner proposed to use shared appreciation in the recent Federal Housing Administration Housing Stabilization and Homeownership Act on April 9th, 2008.

There will indeed be many more questions left on the table on how to make this academic concept possible in the real world. Simple non-derivatives based shared appreciation concepts have been around for quite some time, especially in the UK for almost 30 years already. It did not grow to a stage where it should have been simply because there are still many unsolved economic issues that are waiting to be overcome.

When the generic “shared appreciation” concept gets accepted as a fair and equitable free market solution to solve the current default crisis, US lawmakers, Administration officials, academics and market practitioners may attempt to research further for a detail worked-out solution to make it practical and realistically implementable. The big question is that if there is already a proven, worked-out detailed solution made available through years of prior research, there may not be such a need to spend the time and efforts all over again to reinvent the wheels in order to come to the same conclusions. Our nation may not have the luxury to let the politicians spend time and money to engage researchers and practitioners who previously did not even see the need of these new inventions to do the fundamental research and experimentation from scratch again while our economy continues to hemorrhage on the verge of a major collapse. A timely implementation of an already created credible worked out solution with some real tangible actions by the Administration officials is crucial to close the mortgage defaults floodgate and save our national economy in time.

SwapRent (SM) together with its embedded mortgage product called HELM was exactly such a solution with a systematic quantifiable and implementable methodology that had been intentionally developed through many years’ dedicated research that first started way back in 2001, prior to when the real estate bubble that had led to the current credit crisis even got started. Relevant patent applications have also been formally filed with and published by the various patent agencies around the world such as US Patent and Trademark Office (USPTO Application No. 20070244780), WIPO (PCT Application No. PCT/US2007/007094) and agencies at a few other non-PCT countries through the years along the way.

Among many other advantages, the systematic methodology to quantify and extract the risk elements involved in these new kinds of mortgage products and the ability to develop a liquid secondary market of the extracted risk elements through the three SwapRent (SM) transactions (Generic, AG and DP) which in turn could offer risk management capability to the product providers as well as the transparent pricing mechanism offered at REIDeX.com for all participants are probably the most important improvements. In addition, the removal of the homeowner moral hazard related issues will be crucial to make such an implementation successful. SwapRent (SM) and HELM were in fact initially created as a replacement or alternative solution to these existing UK based shared appreciation mortgage industry to begin with. To a certain extent, HELM and FVCM were also meant to be the better alternatives to the existing overly expensive, inflexible and restrictive reverse mortgage products in the US.

05/25/2008 Doesn't Dean Baker's "Own-to-Rent" proposal have some similarity to your SwapRent (SM) plan?

FAQ #12a: Doesn’t Dean Baker’s “Own-to-Rent” proposal have some similarity to your SwapRent (SM) plan?

I have had email exchanges with Dean Baker since August 29th, 2007. He is quite familiar with the details of our SwapRent (SM) and its embedded mortgage product HELM as well as their economic benefits to help homeowners. Back then he said that he did not think a new financial instrument or contract that we had been proposing is necessary. Now he is proposing to modify the foreclosure rules, basically creating a new type of mortgage contract. The “fair market rent” is almost referring to the similar concept of the SwapRent (SM) rates in each neighborhood or in each city. This could create the need of a new type of rental contract that mimics part of what a SwapRent (SM) contract was already created to do.

I was pleasantly surprised to find out how similar to the SwapRent (SM) plan that his plan has evolved to be by now. As usual, people need time to learn, digest and appreciate new things. I am glad that he is seeing now the economic benefits what SwapRent (SM) could offer as he is a very well known, out-spoken and respected economist. If we could get his open support and endorsement it would be a true honor for us. Hopefully we could cooperate together and fine tune our plans to bring the urgently needed benefits to the homeowners.

05/25/2008 What is the difference between SwapRent (SM) and the recent promotion of an "Own-to-Rent" plan?

FAQ #12: (added on May 25th, 2008) What is the difference between SwapRent (SM) and the recent promotion of an “Own-to-Rent” plan?

There indeed seems to be a lot of effort to promote this variation of the conventional “Sale and Lease Back” concept, more often called “Sale and Rent Back” in the UK, as a new plan to rescue the homeowners since it would be a forced renting after foreclosures. On May 20th, 2008 Congressman Raul Grijalva from Arizona (D, AZ) even introduced a bill tentatively called “Saving Family Homes Act of 2008” to promote a similar plan and it has been in the news since then.

This heavily touted “Own-to-Rent” plan appears to be simply a forced extension of the conventional “sale and lease back” concept whereas the homeowners could have better done it with any other free willing parties in a “short sale” transaction prior to foreclosures. I am not sure about the innovativeness of such a plan or the need to promote it. Other than the existing common practice that the homeowners could have initiated a short sale and rent back on their own with any other third parties prior to foreclosures (which is often scam prone, see Forbes article on Rent-to-Buy scams), the lenders and the homeowners can at their own will, based on mutually agreed terms, enter into such a conventional rental contract upon foreclosures if it is indeed to both parties’ interests to do so under a free market. A better and more intuitive name for this “Own-to-Rent” scheme may be “Foreclose and Force Them to Rent Back”.

I am equally puzzled by the need to introduce a legislation to force the lending banks into such an obligation at their own expense. Banks these days have enough troubles to manage their own survival. When burdened by such a new legislation more banks and Wall Street firms may fall and more government led bailouts may be necessary further at taxpayers’ expense. When the assets are transferred to the government after these banks fall again the government will become the de facto landlord to millions of homeowners. So this “Own-to-Rent” plan seems to bring us further prepared to be a central planning state, away from our current free market capitalism based system.

The good intention of such an “Own-to-Rent” plan to help many homeowners be able to stay in their own homes seems to be laudable though. The spouse and kids may have emotional attachment to a place where they grew up or lived for a long time. This is exactly one major part of the many advantages that the SwapRent (SM) based solution could deliver, i.e. the social good to help homeowners continue to stay at their own homes. However, that is where the similarity ends.

The Own-to-Rent plan will not be able to deliver any of the other major advantages of SwapRent (SM) in terms of the ability to help solve our current economic crisis. In their plan the mortgages will continue to default, written down on the book by the lending banks and the properties will continue to be foreclosed, and hence the investors losses and the banking credit crunch continue …

It does not really make economic sense for a bank to trash its mortgage, incur lots of expenses and troubles to foreclose a property only to get stuck with the foreclosed property to become a landlord to an irresponsible borrower when it could simply leave its existing mortgage intact, give the homeowner in need a fair, quantifiable monthly subsidy and become a temporary “economic landlord” through a simple SwapRent (SM) transaction. The lending bank could subsequently transfer this newly obtained real estate exposure through another opposite off-setting SwapRent (SM) contract to some other investors much easier and much cheaper than trying to repossess first and then sell an actually foreclosed physical property. This is the essence of the newly created consumer finance concept of the “economic renting” of a property while letting the homeowners continue to keep the legal title ownership and stay in their own homes.

In the conventional “sale and lease back” transaction or this new “Own-to-Rent” forced contract there will be legal title transfers and hence the associated high transactional cost and hassles. In addition, the tax events will be triggered by these legal title transfers. SwapRent (SM) transaction is a synthetic version of the conventional “sale and lease back” transaction to be initiated by free willing parties in a free market. By separating the legal title ownership and the economic interests the new “economic renting” concept could be realized. Among many other advantages, there won’t be a default of the existing mortgages, hence both the credit records for the borrowers and the pockets of the mortgage lenders or the MBS investors will remain intact. The property will not be foreclosed and continues to be legally owned by the same homeowner. The bank will get to easily transfer these SwapRent (SM) contracts later on as a simple single combined trade or trades in the REIDeX.com marketplace with other long term real estate investors such as pension funds or insurance companies since banks do not usually want to treat long term real estate investment as their core business, nor do they want to be actual legal landlords and manage properties all day long.

In short, the homeowners will continue to keep and stay in their homes but act only as “economic tenants” of their own homes. The retail or institutional real estate investors will act as the “economic landlords” through the same SwapRent (SM) transactions. The cost associated with the management of an actual real estate property investment such as brokerage fees, property management fees, taxes, insurance premium and so forth could be totally avoided.

Again, all these could also be done partially, say 25%, 50% or 75% of the current house value and for a shorter period of time say, 2, 3 or 5 years only, depending on how much monthly subsidy (determined by the economic rent-own cost differential) that the homeowners may need. Furthermore, both parties could cancel and unwind the reversible SwapRent (SM) transactions any time based on pre-agreed terms or by doing off-setting transactions for the remaining maturity in the secondary market with any other free willing parties later on.

Therefore, if you like the charitable nature of Congressman Grijalva’s new bill to help the homeowners, you will love the additional economic crisis solving benefits that the SwapRent (SM) plan can further bring to the table. If you do not like the socialist tone of Congressman Grijalva’s new bill, then SwapRent (SM) could just be the free market alternative that you are looking for.