Play It Again, SAM

This country is in the midst of a housing crisis — a devastating housing crisis reminiscent of the 1930s — and no one, not the government, not private industry, seems to be able to fix it. Well, there is a strategy out there that has quietly been proposed that could stop the bleeding, and incredibly no one seems to be talking about it. First, let’s set the stage.

Right now, there are reportedly 4.8 million American homes in foreclosure — or close to it — with no end in sight. In fact, housing prices dropped another 3.6% in April 2011 compared to April 2010. Foreclosures are the financial Ebola virus of a modern economy. A foreclosure can destroy the lives of the homeowner and his family, but it doesn’t stop there. Because the virus is so contagious, a foreclosure on a given block immediately lowers the value of every other house on the block, which of course tends to induce more foreclosures. In this way neighborhoods or even towns can be ruined. The recent April housing price figures could signal the much dreaded “double-dip” in the American real estate market, which could seriously slow down or imperil the recovery as a whole.

Realizing the immense magnitude of the problem, the government has tried to help. The T.A.R.P. program was designed to give money to banks which presumably would then lend it out to people who needed it, including homeowners. The government also created a mortgage modification program, but it has been heretofore a dismal failure because it gave the banks — which have the money — little or no incentive to take immediate, upfront losses. This proves once again that what goes around doesn’t necessarily come around.

So is there any mortgage modification design out there that would both enable the homeowner to make affordable payments on a reasonably (and now lower) valued home, AND create a real incentive for banks to implement such a modification program?

My friends, say hello to SAM. I’m talking about neither the piano player in “Casablanca,” nor surface to air missiles. I am talking about the Shared Appreciation Mortgage. You’ve never heard of SAM, eh? As you’ll see if you keep reading, there are many reasons why you don’t know SAM; but I believe you’ll be hearing a great deal about him — I mean it — very soon.

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A shared appreciation mortgage is one for which a lender charges the homeowner a lower rate of interest in exchange for a piece of the appreciation in the home when it is eventually sold or refinanced. Very generally speaking, SAM interest rates are fixed, and payments are based on a 30-year amortization schedule, but typically the borrower must sell or refinance within a designated time frame, often 10 years.

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SAMs have had a relatively short history in the US. They were first introduced over 30 years ago, as a reaction to the astonishingly high interest rates of the late 1970s and early 1980s. But they never caught on, probably for several reasons, such as the economic reason that 18% interest rates happily didn’t last very long, and for the cultural reason that splitting the gain on your home with the bank seemed somehow un-American.

Recently Fannie Mae, long a major source of liquidity in the secondary mortgage market, has imploded at a cost to the taxpayers of nearly $1 trillion. Few people today remember that Fannie Mae and the whole idea of the 30-year mortgage were themselves brilliant and innovative New Deal responses to the last foreclosure crisis — in the 1930s. They didn’t solve the problem — it took a world war to do that — but they did help, in part by letting people know that the government cared about their problem. But they were great ideas then, not now. In fact I believe that those two ideas, over the course of seven or eight decades, helped create the problem we have today, but I will save that discussion for another day.

The simple point is that we desperately need brilliant and innovative — and different — responses to the current problem whose impact on this generation and the next cannot be understated. And I’m afraid that we need those responses last week.

Play It Again, SAM (cont.) »

Image: C.P.Storm, via Flickr.com