08/18/2011 FARJHO – securitization of home equity vs. securitization of mortgages, SwapRent – real estate derivatives vs. mortgage derivatives

This is a short blog post to clarify the difference between the securitization of home equities (home equity securitization) and the securitization of mortgages (mortgage securitization) as well as the most commonly misunderstood term of real estate derivatives by the some people vs. what they really meant, mortgage derivatives.

The key to understand the difference is to know that the underlying assets are quite different. One is equity in nature, the other is simply a debt. While there are often blatant abuses of debt by both the borrowers and the lenders through loose credit policy and practice, it is not possible to abuse the equity in the same way.

As I mentioned before in many earlier blog posts, securitizations and financial derivatives are extensions to either equity or debt like how glass-and-steel buildings could be built upon a foundation. If the foundation is a solid rock then the chances of the building to collapse is not much a concern as it would be if the building was built on slippery quick sands. So the problem is not the building but rather the foundation where the buildings are located.

Similarly the problems are not as much with either the securitization concept or the financial derivatives rather as with whether they were built on plain equity, conservative low leveraged debt or the risky over-stretched debt conducted on a loose credit practice.

FARJHO LLC member interests are ownership in the equity form just like corporate shares listed in the stock exchanges are in the form of equity. The purpose of FARJHO is to “corporatize home equities” or to “securitize home equities” for the various economic and social benefits discussed in details in earlier posts. It has nothing to do with any debt, loans, mortgages or financial derivatives. It is definitely not in any shape or form, a securitization of mortgages again.

It is as simple as a common stock of companies but the ownership represents a fractional interest in a homeowner’s home property instead, that is made possible by this new FARJHO concept.

SwapRent, on the other hand, is a new consumer version of equity based real estate derivatives or alternatively called, property derivatives. It is not a mortgage or a mortgage derivative. It is the various forms of mortgage derivatives, credit derivatives, CDOs, Credit Default Swaps etc. that have played a major role in the financial crises within the past few years, not these new “real estate derivatives”.

Therefore, although there seems to be plenty of hostility by certain people about financial innovations, mortgage securitizations, mortgage derivatives, the responsible, intelligent and educated consumers should have no problem in understanding that FARJHO and SwapRent are not related to any of those that have caused controversies in the past. Furthermore they should be regarded more as social innovations in housing and new home ownership concepts than purely another financial innovations for facilitating investors to make money more easily. Even though they do that as well, and they do it much more efficiently.

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08/13/2011 Weekly round-up of FARJHO discussions from various Linkedin Groups

On Section 8’ed FARJHO to let Section 8 recipients have a partial ownership of the property that they rent:
Ralph this sounds like a great idea, and many belong to some kind of neighborhood beautification program as well.

Reply:
Yes, let free market capitalism to create the motivation for the renters to beautify the properties and neighborhoods on their own, at their own cost, by simply turning them into partial owners of the properties. Let them share a little bit potential financial value appreciation helps but injecting pride and self prestige of being one of the owners would really be the main driving force.

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On PeoplesAlly’s role to educate the working class families to let them join their fair share of the benefits of capitalism:
Interesting conflict. The point of the PeoplesAlly is to support the working class. I am not sure the description above or on the blog comes close to being understandable by anyone without a serious financial background.

Reply:
Right on target, a mission no one else has tried or been willing to do before. That is why Wall Street has been holding intellectual hostage of Main Street, getting the better part of capitalism. I hope you can see why we have created our foundation slogan as – The Intellectual Ally behind the People and the Capitalist for the Working Class!

PeoplesAlly’s main tools are education of and counseling to both aspiring home owners and joint property investors for putting together fair and equitable FARJHO structures based on free market principles to own homes and hence increasing housing affordability and social stability.

So far we have had long line of applications from aspiring home owners and not enough joint property investors. It appears that we need to beef up our efforts on the more intelligent investors, rather than the working class home owners at this stage. Thanks.

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On technical details and examples of the new Borrow-Pool-Buy (BPB) of FARJHO vs. the old Pool-Borrow-Buy (PBB) practiced by other property equity sharing schemes:

Reply 2:
That is still different from the proposed new FARJHO method to co-own homes. In a FARJHO transaction, each individual member co-owner can decide whether to borrow for their portion or not. Cash rich investors do not have to borrow. No group decisions or actions to borrow together. If some of the co-owner members want to borrow individually for themselves, then the borrowing leverage (LTV) is up to each of the members individually and their individual lenders.

So let’s say a home which is worth $100,000 is being bought by a FARJHO LLC. Three members, A (20%), B (40%) and C (40%) pooled the capital to form the LLC to begin with so that the LLC had the money to buy the home. LLC did not and will not borrow any money or use the property as collateral to borrow any money. Since neither the FARJHO LLC nor the home property owes money, therefore there is no possibility of a foreclosure of the home property, ever.

Member A was supposed to be the home occupier (AHO), so he pays the LLC a market based rent every month for 3 years say in a 3-year lease as an example.

In terms of borrowing, Member A did not borrow to come up with the $20,000 since he would not want to pay a loan payment in addition to the rent payment very month. Member B does not like to be burdened by the debt service so he did not borrow to come up with the $40,000 cash either. Member C likes to punt and strongly believes in using leverage to achieve high returns. On the other hand, he does not have enough money for the required $40,000. Say he only has $10,000 in savings so he borrowed $30,000 from a lender using his 40% share or member interests in the LLC as the collateral for the lender. The leverage that Member C uses is 75% LTV of his member interest in the LLC and his down payment is 25%.

So in the example above, cash was used to purchase the property and no borrowing using the property as the collateral. Borrowing activity, if any, will be conducted only at the member level at each member’s discretion only. That is exactly the spirit of the newly created FARJHO concept and method to own homes, irrespective which country the homes or the home owners are located.

Reply 1:
Oh no. What you described is still the old conventional way. The newly created concept is for people to pool money and use a legal entity to buy one property only as a home using cash. One of the co-investors will rent it from the legal entity. After that there is no more borrowing using the property as collateral. Therefore, no banks or any lender will ever get to foreclose this property.

The borrowing, if any, will only be done by each individual member of the legal entity before they come to the table to form the legal entity to buy the property using the pooled cash. The liability is for each individual only. They can each use their fractional interests in the legal entity as the collateral. Nobody use the entire legal entity or the property per se as the collateral.

All co-investors and lenders, if any, are done based on a pure free market basis. No society, self-help and any other charity groups or concepts will be involved in this unique new free market solution to home ownership.

In the US we have decided to use the convenient LLC structure as the legal entity since real estate investors are already familiar and comfortable with it.

0806 2011 From the old Pool-Borrow-Buy (PBB) equity sharing concept as in a SEM or SAM to the new Borrow-Pool-Buy (BPB) concept as in a FARJHO – A simple innovation in housing finance that could eliminate home foreclosures all together

This is one of my most popular blog topics being repeated many times but with a different way to explain this new concept each time. Many new way of explanations were in fact inspired by many questions raised by my blog viewers.

In the current practices of our Western banking industry and our real estate investment industry until today, people always use the property directly as a collateral to borrow money to purchase and own a real estate property. Tax codes were also often designed by the lawmakers to give preferential treatments to investors who have borrowed using the property as a collateral to invest.

As far as the equity sharing or shared equity concept goes, it is usually a common practice in commercial property investments rather than residential real estate investments such as home purchases. This is due to the fact that commercial investment projects are either of a larger investment amount or they are usually made for investment purposes only. Unlike commercial properties, many purchase decisions of homes are made more for sheltering reasons. Home owners could also afford to own the home directly without other investors’ help since the investment amounts are usually smaller when compared with commercial property investments. In addition, home owners usually have a natural desire to have a full control of the property.

The problem with using the property as the collateral to borrow in the old shared equity property financing method of Pool-Borrow-Buy (PBB) is that if the property value declines, it may automatically trigger a massive selling either voluntarily or involuntarily, which will feed on itself and create a market collapse. It makes no difference whether there are any equity sharing in the down payments or not. Foreclosures will happen either way and hell will break loose either way. The equity sharing concept as practiced in those old methods were therefore naturally deemed useless.

For commercial real estate market, foreclosures usually immediately create a economic problem. For home ownership or residential real estate market, it will present not only an economic problem, but also a severe social problem as well. These problems have been clearly illustrated in many of the financial crisis events within the past few years.

Therefore, sharing equity to qualify for borrowing or to borrow even more will not help much economically and contribute almost nothing socially to home ownership for our economic society. Unfortunately these SEM (Shared Equity Mortgage or Modification), SAM (Shared Appreciation Mortgage or Modification) or factional interest home equity investment schemes are exactly what have been touted by many other practitioners, governments and academics alike until today. Those structures will not solve our country’s home financing and home ownership problems socially or economically.

Governments who set up policies using those ill-advised methods (e.g. the original HAMP proposal in 2008) have only destroyed people’s confidence in the equity sharing concept to solve the problems and let the mortgage foreclosure problems deteriorate further day by day.

Why is FARJHO different? The differentiating concepts created by the new FARJHO (Flexible And Reversible Joint Home Ownership) structure are explained here below again.

First, it corporatizes home ownership one home at a time so that it will create a familiar and convenient legal vehicle for other investors to share the equity of the home property with the home occupier who is also a co-owner of the property.

Second, it offers the real estate investors a chance to use leveraging to enhance investment returns through a new Borrow-Pool-Buy (BPB) concept over the conventional Pool-Borrow-Buy (PBP) concept used in equity sharing methods which has been practiced until today for both commercial property investments and most of the other equity sharing schemes or some other proposed factional interest home equity investment and financing schemes.

By using this new BPB method, it means that the factional or partial owners in a home, either the Joint Property Investors (JPIs) or the Aspiring Home Owners (AHOs) could all have a choice to borrow against their individual member interests in the FARJHO LLC structure so that they could pool the money to purchase and own the home property in cash together. The AHO who will be the sole home occupier will simply pay the legal entity property owner FARJHO LLC a market based monthly rent as a usual tenant of the property.

When home ownership and housing finance practice have been transformed to this FARJHO way, pretty soon there would not be home foreclosures any more. It is really as simple as that! For more details on how this new BPB home financing method under FARJHO could be done, please see some of the earlier blog posts on this issue below. Thanks.

https://peoplesally.wordpress.com/2011/07/04/0704-2011-confusion-on-various-equity-sharing-schemes-why-farjho-and-swaprent-are-more-social-innovations-than-simply-financial-innovations/

https://peoplesally.wordpress.com/2011/02/28/0228-2011-farjho-opportunity-for-gaining-political-credit-for-politicians-and-the-innovation-role-for-banks-credit-unions-or-other-mortgage-lenders/

https://peoplesally.wordpress.com/2011/02/27/02272011-farjho-and-the-corporatization-of-american-homes-yes-but-only-one-home-at-a-time-and-no-corporate-financing-necessary/

0802 2011 Implementation Strategies of FARJHO and SwapRent – good economic stimulus public policy or cornering the real estate market by investors for profits?

A very obvious winning strategy of implementing either FARJHO and SwapRent alone or together is to simply concentrate the investments and focus on a few selected neighborhoods in the US, perhaps some mid-sized cities in Southern California.

Let’s have a quick review on the economic concepts of the investing dynamics first. Real estate market as an investment asset class is often more about the Beta than the Alpha as compared to investing in the stock markets. Although that sounds a bit academic to many people but what it means is actually very simple. The way the real estate market moves ups and downs depends more in sync with the country’s economy policies made by the government as a whole, even with the consideration of regional economic factors and/or individual homeowner’s specific maintenance and caring of their properties. The residential real estate market in the US normally behave with a much higher correlation to government dictated lending policies than individual home improvements.

On the other hand, individual companies could much easily out perform or under perform the US stock market and behave individually based on their own individual earning power, management merits and demerits, irrespective what the government’s fiscal or monetary policies are.

As a result, whenever there is a lack of prudent and wise governments policies, the entire country’s homeowners in America suffer. The supply and demand factor of the residential real estate market has always been solely determined in the US by the interest rate levels and the degree of the looseness of credit for people to borrow to own homes.

In the past, local governments or free market based private sector investment companies could not alter the local market supply and demand factor since the interest rate levels and home mortgage credit policies have been determined solely at the federal level and by the big banks on Wall Street. In addition, single family houses are much more difficult to manage than apartments as income producing investment properties in the past since people who could rent were usually urged to buy with or without the ability to service the mortgage loans. As a result, renters for single family houses in the suburbs are difficult to find and keep. The arrival of FARJHO and SwapRent have finally found a way to change that situation.

Now through the new FARJHO structure, SwapRent transactions and their secondary markets, local government housing agencies, pension fund managers, free market based private sector investment companies and/or individual investors could finally alter the local property supply and demand factor and drive the prices of the local property markets up (and down if necessary) irrespective of what the federal government’s fiscal, monetary and housing policies are at any given point in time.

The very simple concept for local community economic growth is that the more fresh new money pumped into the local economy the more likely the local economic activities could be revitalized when the money is put in good productive use. The FARJHO structure and SwapRent transactions could make this simple economic concept a reality and make the economic miracles happen in the local communities without having to rely on tax payer’s money or risking a hyper inflation by altering the interest levels further.

First FARJHO could help any new home buyers and joint property investors buy more homes using cash on hands without relying on credit for debt financing and hence create demand for homes and support the local property price level.

Second, on top of the demand created by FARJHO, SwapRent could help distressed homeowners hang on to their homes and hence remove the selling pressure in the local property markets. In addition, as also explained before, SwapRent could also help speculators buy more properties by sharing partial appreciation with other free market investors and hence increase even more buying demand for homes. Furthermore, SwapRent could also be used to finance local small business investments by entrepreneurs who are property owners and hence create more jobs. Even rich home owners who do not need the cash could also take advantage of the free market based SwapRent program and hence increase dispensable income and create higher consumption powers in the local communities. These were all fully explained in previous blog posts.

http://swaprent.com/blog/2011/02/19/02202011-it-is-not-keynesian-it-is-not-monetarist-perhaps-we-could-call-it-swaprentism-any-better-suggestions/

http://swaprent.com/blog/2009/12/06/12062009-how-small-business-owners-could-use-swaprent-transactions-to-create-jobs-at-grassroots-level/

The main reason why the FARJHO structures, SwapRent contracts and the associated secondary markets could work much better in bringing back the local economic prosperity than the conventional ways of property ownership is that they could attract much more fresh new investors’ money through the ease, the flexibility and the reversibility features with which the real estate investors could manage their investments much better, faster and cheaper. FARJHO and SwapRent in a sense will make the previously “un-investable” single family houses an “investable” new asset class for institutional investors around the world.

As some free market based investors are currently comprehensive about the lack of obvious immediate appreciation potential for the US residential real estate markets due to the current unhealthy government sponsored economic policies, aspiring home owners, local government agencies and free market based investors could indeed create by themselves the demand for properties in the local market through FARJHO and SwapRent. When the more fresh new money has been poured into the local economy, the more likely the property value would have been driven up, the more free markets investors would be further drawn to investing in the local markets and the more aspiring home owners from neighboring communities would also choose to relocate to these local communities to own homes. Creating the local property appreciation and economic prosperity in a confined geographical area could indeed become a self-fulfilling prophecy.

The key concept here is that smarter investors would most likely want to focus all their investments in a few selected neighborhoods with those wise local government officials who want to help facilitate these investment and economic revitalization processes to attract fresh new money so that there would be enough gun powder concentrated on these selected area to get the bang on the buck to artificially create the necessary debt-free property appreciation. With the local property value appreciation, all the current local government deficits, local economic weakness, local resident’s joblessness and the associated social problems could all be eliminated in one fell swoop.

In a sense, maneuvering these property price dynamics could be interpreted as cornering the market for illicit profit by a few individuals to benefit themselves. However if the end results are to benefit not the privileged few but the majority of the home owners in these local communities and the local governments, then cornering markets could indeed be euphemized and re-termed “economic stimulus” to bring back local economic prosperity instead.

In reality, cornering the markets of stocks and bonds was exactly what our federal government and the Federal Reserve Board have successfully tried to do in order to make the Wall Street folks richer and the big businesses awash with cash in recent years with their wasteful fiscal policies and unconventional monetary policies that have built up our country’s uncontrollable national deficits. Since the bubble building techniques that they have employed were based on money they did not have, those bubbles are doomed to burst some time down the road. Perhaps they had hoped for that there would be enough bread crumbs to fall to Main Street for people there to survive but that did not happen and of course would not happen.

What they had failed to find a solution for is a viable way to reinstall the debt-free or less debt dependent property-based wealth in local communities and to revitalize the economic prosperity on Main Street throughout the country to make the majority American people rich again. FARJHO and SwapRent were designed to accomplish just that.

If the incumbent Administration officials could not understand and handle this, certainly the new generations of aspiring politicians should take heed of it before it is too late.