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Sunday, March 15, 2009

Message to Regulators

Tyler Cowan's article on the bailout continues to focus simply on the problem of the banks (Message to Regulators: Bank Fix Needed Quickly, New York Times Business Section, March 1, 2009). He does not explore options that might make the banks whole and also help individual homeowners and their communities. The best option with this win-win characteristic would be the Shared Appreciation Mortgage (SAMs).

SAMs are the perfect instrument to bail out lenders, prevent foreclosures and restore confidence. In a SAM, a government agency would join with the distressed homeowner in meeting payments on the mortgage. There is no write-down so that lenders and derivative owners are made whole again. There is no foreclosure so that the individual homeowner stays in his home. There is no foreclosure so that neighborhoods are not hollowed out by a proliferation of empty homes.

There is risk to the government. As time goes by, the homeowner and the government build up equity in the home; the share of equity based on their proportionate contributions. There is however no guarantee that the total equity will exceed the homeowner's original purchase price before the house is eventually sold. In the best case scenario, both government and homeowner would recover their investments; in the worst case they would not. The risk of government losses might be reduced if the government part of the mortgage stayed with the house after an underwater sale, though that would reduce the attractiveness of the house to the new owner and consequently reduce the funds received by the seller. But this would work -- the government has infinite patience; early payoff is not a necessity.

Why don't we intensively discuss this solution, or something similar (as suggested by Andrew Caplin of New York University), as part of the recovery efforts that are being made?

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