In two ways. First as an immediate solution to the current legacy mortgage assets problems so that it could free up the Federal Reserve Board to manage interest rate levels in a more independent way. Second, use SwapRent rates for different contract maturity as a new economic stimulus policy tool going forward to adjust the property value levels as a source of our national wealth that could stimulate or restrain the economic activities in local communities.
There have been many writings in the SwapRent web site or SwapRent.com blog sites about how SwapRent and HELM could be used in a concept similar to a debt-for-equity swap so that homeowners could hold on to their homes and mortgage investors could avoid financial losses. It will not be repeated in details here again. The most direct consequences of this new non-lending but rather co-ownership based housing finance system for GSEs are that homeowners will get to de-leverage through this new realization of the debt-for-equity swap concept, Fannie and Freddie could de-leverage because the mortgage assets would get to be fixed up and sold to other free market investors, and our nation could de-leverage because taxpayer’s money would no longer be tied up to rescue these troubled financial institutions. Nothing is more effective than tackling the problem right at its roots, i.e. to help homeowners avoid foreclosures and design new ways to increase home property value without inappropriate borrowing.
In this blog posting, I would like to focus on the second most important way that a liquid SwapRent rates market could help our nation’s policy makers manage the national economy. Let’s have a quick review what a SwapRent contract is first.
What a SwapRent contract does is to allow both existing and would-be property owners to switch between owning and renting economically back and forth with a very low transaction cost at any time they want for a specified period of time for whatever reasons they may have. Therefore the pricing of a SwapRent contract relies on the cost differential between the cost to own a property (say 5% of the current house value per annum) and the cost to rent a property (say 2% of the current house value per annum) for an intended period of time.
Using the same numerical example of a $800,000 house in Southern California, the annual 3% (difference between 5% to own and 2% to rent) own-rent cost differential will translate into a $2,000 monthly for a 100% “temporary own-rent switching” or “economic renting” for a period of time, say 5 years. That is where the monthly subsidy would come from. Whoever wants to own the future appreciation in 5 years’ time similar to a convention owner will pay the monthly subsidy to the current property legal title owner. For a 50% “temporary own-rent switching”, the monthly subsidy will be only half of that, i.e. $1,000 per month. Therefore the current property legal title owner could still enjoy the remaining 50% appreciation potential, hence the conventional understanding of the “shared appreciation” concept could be more flexibly and reversibly realized by a SwapRent contract.
The cost to own in the Western financial system such as the US is simply to current interest rate level derived from the interest rate term structure. The best proxy for the cost to own in the US is the corresponding Interest Rate Swaps (IRS) rate levels published by the Federal Reserve Board at its web site every day. The corresponding maturity SwapRent rate levels would be determined by participants at REIDeX or the interbank markets.
The Federal Reserve Board could go through GSE such as Fannie Mae, Freddie Mac or even government owned Ginnae Mae and let them act as one of the free market participants to assume the role of the “economic landlord investors” themselves first to provide the monthly subsidy to homeowners. They could alter the supply and demand factors through being either more or less aggressive in bidding for the SwapRent rates in this freely traded marketplace, not unlike how the Fed currently conducts its interest rate policy through the short term repo markets with the banks.
Using the same 5-year contract as the example, if the Government wants to stimulate the local economy at grassroots level it could be more aggressive in granting monthly subsidy through being willing to accept a lower SwapRent rate of 1.5% or 1% (instead of the previous starting point of 2%). Therefore the monthly subsidy the homeowners receive would be equivalent to a higher annual 3.5% or 4% of the current house value instead when the homeowner decides to enter into a SwapRent transaction with the GSE.
As explained many times before, given an interest rate level fixed at 5% for a given contract maturity, the more aggressive (i.e. the more generous) the government is willing to offer the monthly subsidy amount to homeowners in the form of a lower SwapRent rate it is willing to receive, the more likely more property owners in the community will take up the offer as a free market choice, the more people have signed up that would create buying demand the more likely there is a perception that the local properties will indeed appreciate in the future and the local economy will indeed strengthen, the more likely the SwapRent contracts that capture the financial value of partial future appreciation of these underlying properties will then increase in value and the more likely the GSEs could sell them at a higher price to other free market investors in order for the GSEs to regenerate the capital to provide more assistance to other American homeowners to own homes. It is indeed a self-fulfilling expectation and perhaps reality, exactly similar to what adjusting the interest rate levels by the Fed could do to the investment psychology and perhaps reality of our future national economy.
From a local property owner’s perspective, a 100% ownership of future appreciation potential in five year’s time will mean zero financial gains when there is no appreciation at all. There could even be further losses when the property value further depreciates. Sharing and maintaining a remaining 50% appreciation potential in order to help stop foreclosure selling and increase overall buying demand in the local community may still entitle the property owner a 10% gain when there is an overall 20% rise on the value of the specific property or on a house price index. In short, 100% of zero is still zero but 50% of a 20% appreciation will be a 10% gain to enjoy. Not a bad deal when you are also getting paid handsomely every month for that to happen.
The homeowners could do the SwapRent transaction with GSE directly or the GSEs could decide to engage a fee-earning local financial intermediary, housing agency of a local governments etc. in order to better administer and better monitor the on-going credit risks.
The GSE or financial intermediary could also better manage the transaction through converting the homeowner’s existing mortgages into a SwapRent imbedded HELM (Home Equity Locking Mortgage). A HELM could simply take on the legal format of an AITD (All Inclusive Trust Deed) which would be a wrap-around package of the existing first mortgage and a contingent second mortgage that settles the payoff of the SwapRent contract at contract maturity date automatically as the new unpaid balance of HELM at that time, to accomplish all the desired economic outcomes with very little or no cost and admin hassles to the homeowners.
After offering that new HELM to the homeowners either directly or through local financial intermediaries, the GSE itself could then use another new offsetting SwapRent to cancel out the exposure of the embedded SwapRent contract in the HELM in order to lay off their property value risks and appreciation potentials (similar to an equity co-ownership piece) with other free market based investors through the inter-bank market or REIDeX. These ultimate investors of these co-ownership SwapRent contracts could be state and local pension funds, hedge funds, insurance companies, foreign sovereign wealth funds or in short, any free market participants.
As explained before, many state, county and city pension funds could benefit directly by acting as the ultimate “economic landlord” investors to provide the needed monthly cash flows to homeowners for a fair share of the future appreciation potential of the property in return. A successful implementation will not only help many state/county/city treasuries and the state employees’ pension funds with higher returns, but also it may help stabilize or boost the local property value and hence the entire state’s economic prosperity. At the same time, the program will get to accomplish its goal of maintaining social stability through helping the distressed homeowners in their state hang on to their homes very effectively without having to spend any taxpayer’s money for preferential bailout treatments that cause moral hazard and make things worse.
In a sense, as a temporary conduit, GSEs will finally be able to provide funding for American homeownership not just in the form of debt, but also through a new additional form of a non-lending based economic version of tradable home equity co-ownership. The new alternative system could greatly lower the chance of a repeat of the previous subprime mortgage lending abuse fiasco in a purely lending based housing finance system that may often create boom-and-bust cycles and hence social instability.
After understanding the transaction mechanics, let’s take a look at how policy makers could influence SwapRent rates traded in the free marketplace in order to use it to stimulate or restrain economic activities in the local communities through out the country. As explained in blog posts before that in order for the SwapRent market to work as a policy tool the politicians will have to break out of their socialist mentality and treat the new SwapRent program as a 100% free market operation, i.e. let the local property speculators and entrepreneurs participate freely. Make the SwapRent transactions and the monthly subsidy available to anyone who wants it as long as they have a property to be able to share a part of the future upside appreciation with another investor, not just whoever needs it for survival purpose. There should not be any restrictions other than the credit quality, moral, ethical or legal eligibility to participate. Entrepreneurs who are willing to trade off some of the future appreciation potential of the properties they own in order to receive current monthly cash flows so that they could use it to start a new business or to hire more people represent a major target users profile that this SwapRent program is intended to accomplish with.
There are currently many other ineffective bailout plans that create moral hazards by giving preferential treatments to distressed homeowners already in place. That is a good thing since these politicians’ preceptory obligations are done and over with. Now the policy makers could put the free enterprise based SwapRent program in conjunction with or on top of those ineffective bailout plans to really get the necessary work done in order to be able to create wealth again.
So as explained above, when the 5-year IRS rate is at 5%, if the policy makers want to provide stimulus to the local economy they could bid for the 5 year SwapRent rate at 1.5%, 1% or even lower so that the monthly subsidy to property owners is larger (3.5% or 4% of the property value per annum). If they want to cool the heated economy down they could bid for it at 2.5%, 3% or even higher so that the monthly subsidy to property owners is smaller (2.5% or 2% of the property value per annum).
The most important intended concept to illustrate here is that all these could be done irrespective where the current interest rate levels are or will be at in the future. So that when the cost to own or the 5-year IRS rate moves up to 8%, the SwapRent rates would simply move up in tandem and be trading at 4.5% or 4% for a stimulative policy (the same larger subsidy of 3.5% or 4% of the property value per annum) or be trading at 5.5% or 6% for a cooling policy (the same smaller subsidy 2.5% or 2% of the property value per annum).
When the 5-year IRS rate moves down to 2%, the SwapRent rates would simply move down in tandem and be trading at -1.5% or -2% for a stimulative policy (the same larger subsidy 3.5% or 4% of the property value per annum) or be trading at -0.5% or 0% for a cooling policy (the same smaller subsidy of 2.5% or 2% of the property value per annum).
The main point is that the monetary policy of where the interest levels are will no longer be the main driving force of the property value any more. The property value in our nation could be determined in part by the SwapRent rates for local communities that the policy makers could use as an alternative to adjust. That is what it means to offer a new dimension in the economic policy tools for the policy makers. It would not just be the previous only two tools of using monetary policy on interest rates or using fiscal policy on tapping taxpayer’s money anymore.
The Federal Reserve could therefore freely increase the short term discount rates or fed fund rates to curb bubbles from happening in the stock markets, the precious metals markets and the commodity markets in order to avoid a possible run-away hyper-inflation. The high interest rates will no longer hurt the property value or be the sole force to negatively impact the economy anymore as the property value and job creations at the local communities through out the country could be accomplished separately through a very generous co-ownership monthly subsidy offered through influencing lower SwapRent rates in the marketplace by the GSEs. The Fed could finally be freed up to make these monetary decisions on a much more independent basis.
Through influencing the SwapRent rates, it is likely that we may have a double digits long term interest rates to fight inflation and still have a strong property market and a robust economy as the local home value could finally be properly detached partially from the Fed’s short term monetary policies. This is exactly the third dimension as a policy tool that the new SwapRent based non-lending or co-ownership housing finance system could provide as a part of its many advantages.
The beauty of this new SwapRent housing finance system is that capitalism will also be able to best manifest its value and become more politically popular with the mass population as the profit driven motives will allow the Main Street local property investors, speculators and business entrepreneurs at the local community grassroots level, instead of always having to rely on the fat cats on Wall Street as in the past in a primarily securitization based housing finance system, to all participate and to become the locomotive engine to help create wealth for our nation.
Adding this new alternative SwapRent housing finance system would only make everybody happier since it makes not only economic but also political sense due to its inherent more democratic way of wealth sharing capability. By helping create wealth at the grassroots local community level first to drive our country’s economic recovery and growth will certainly help de-polarize the current imbalance and tension between Wall Street and Main Street.
PeoplesAlly Foundation 