This is an old topic but here it is explained from a sell side broker-dealer’s perspective in order for them to generate more trading commissions from their mortgages or MBS trading clients. The interests from their fund management clients would help generate liquidity of the troubled legacy mortgage assets currently held by the banks, the insurance companies, the fund managers, the GSEs and the Fed.
As an example, either their financial institution or individual clients could act as “economic landlord investors” to offer monthly payment assistance to credit worthy homeowners and enjoy part of the future appreciation of their properties. The homeowners who may want to receive monthly subsidy assistance could be any property owners whether with good credit or not and the pricing will reflect their credit worthiness. The program will not be restricted to the distressed homeowners only as it is not a bailout, so that this new housing finance system will operate under a pure free market mechanism, i.e. people with bad credit records or indecent behaviors may not even qualify.
We have heard that Congressman Gary Miller from California is contemplating on introducing a Bill to require the banks to let homeowners rent for 5 years after foreclosure. It is a great new initiative. If a homeowner is currently paying 5% per annum of his house value for mortgage payments every month after he switches to renting it could be only 2% per annum for monthly rents and therefore he could save 3% per annum to stay in his house. For a house that is worth $800,000, the monthly payment will be reduced from $3,333 to $1,333. It will be a $2,000 saving every month.
If the Bill lets the bank have a 5 year rental contract “after foreclosure” it could definitely stabilize the property market, create social value for both the homeowners and the neighborhoods. However, the financial value of the mortgage would have been totally destroyed and the high transaction cost will make both the homeowners, banks and mortgage loan or MBS investors lose money. In addition, homeowners’ credit records will be severely impaired.
Why not let the homeowners stay in the house, make the new lower monthly rent payments to the banks and save the cost differential between owning and renting for the next 5 years “before foreclosure”? It could accomplish exactly all the same objectives of this proposed Bill and in addition, save the value of the mortgages and avoid many administrative hassles and high transaction cost typically associated with a foreclosure. It will make both the homeowners, banks and mortgage loans or MBS investors happy under an absolutely pure free market principle.
This description above is exactly what the newly created “temporary own-rent switching” or “economic renting” concept as facilitated by the SwapRent contract and its related consumer financial product HELM (Home Equity Locking Mortgage) could do. In the same example above, homeowners could have much more flexibility in partial renting and for different maturity terms in a SwapRent contract, e.g. he could decide to only do a 25%, 50% or 75% temporary own-rent switch and therefore share only 25%, 50% or 75% of future appreciation of the property by receiving only $500, $1,000 or $1,500 monthly assistance from the investors for various maturity terms, … etc.
The business opportunity to broker-dealers to derive more trading commissions or advisory fees is to help their clients make more money. They could simply advise them on how to trade distressed mortgage debts, MBS or other structured products by adding value through offering the new SwapRent loan workout program to homeowners. The following old blog post explains how a low-risk arbitrage trading opportunity could be developed for a mortgage loans or MBS trader through offering SwapRent transactions to homeowners directly.
As a very simple example, after buying the distressed mortgage loans or MBS at deep discounted prices, by offering a $500, $800 or $1000 monthly subsidy through the SwapRent contracts to a distressed homeowner, depending on his/her particular need, in order for the homeowner to have enough monthly subsidy to hang on to his/her home, an investor or current holder of the mortgage debt could get to avoid an expensive foreclosure. The value of the distressed mortgages will recover immediately once the uncertainty of potential defaults/foreclosures is removed by closing the SwapRent deal with the homeowners, at least for the next 2, 3, 5, 7 or 10 years (whatever maturity term of the chosen SwapRent contract). The investor could then immediately sell these worked-out mortgage debts back to other longer term fixed income institutional investors to realize a short term trading profit.
After that, the investor could also resell these SwapRent contracts (the equity piece, so to speak) which retain the financial value of the future appreciation potential to other free market investors through REIDeX to get the money back in order to recycle the capital or to simply put the SwapRent contracts in a longer term home equity appreciation fund mentioned above and wait for future appreciation. The point is that chances are they may have already made enough money from the short term arbitrage trading of the mortgage loans or MBS, whether or not they could further make more money on this equity piece might not have been an important motivating factor for them to initiate the transaction to begin with. The much larger short term trading profit has already been realized on the mortgage trades. That is what matters most. The carrying cost of holding on to the SwapRent contract is low anyway as it was specifically designed as a stream of small monthly cash flow to each homeowners spread out throughout the life of each of the SwapRent contract.
By adding this short term trading profit motives may help eliminate the need to find third party investors to come up with month cash subsidies to help the homeowners in need to hold on to their homes. Under this arrangement, the current risk holders of these troubled assets would be the ones that would come up with the cash monthly subsidies to homeowners so that the mortgages they currently hold would recover in value. The broker-dealer will make money from increased trading commissions or from investment banking advisory fees. Their trading clients will be able to make a lot of money and those investors who already got stuck with the troubled assets would be saved. Most importantly, the distressed homeowners would be rescued from being foreclosed. Their children will get to continue to go to the same schools.
It is indeed an opportunity to do good while doing well for both the broker-dealers and their clients.
Tags: Arbitrage, Broker-dealer, HELM, MBS, Mortgage whole loans, Short term trading, Structured products, SwapRent
