Play It Again, SAM

So I believe that we need SAM to come to the rescue. Some, but not many, economists and academicians have already suggested that SAMs should be used to ameliorate the existing foreclosure problem — and I agree. Although many scenarios are possible, I would recommend that SAMs — let’s call them DistresSAMs — be issued to any homeowner who could demonstrate at least some level of financial responsibility, but who cannot make the payments on a home that is worth less than the current principal amount of the mortgage against it. In such a case, monthly payments would be structured to carry the newly reduced value of the home, but the lender would be entitled to collect most of the original principal amount when the home is sold or eventually refinanced in 10 years, and a piece of any profit as well. This would allow millions of people to stay in their homes, and create a strong incentive for the lender to stay in the game as well.

Assuming that the housing market in the U.S. recovers at some point during the next 10 years (and the jury is still out on that), there might be little or no loss to the lender at all. It’s certainly better than the alternatives that the lender has right now, which are to simply swallow the write-down without foreclosing, or to foreclose into a market where there are precious few buyers. From the standpoint of the homeowner, not only does he or she get to stay in the house, and for a significantly lower monthly payment, but the possibility of an eventual profit still exists.

[Related Article: A World Without Fannie and Freddie?]

An additional sweetener could be added to the rescue recipe. After the DistresSAM is put in place, and if timely payments are made for some reasonable period, why not delete from the borrower’s credit report all negative information relating to the now-unnecessary foreclosure proceedings? We as a society recognize that some court records are properly expunged after a period of time, and that some things that happen don’t really relate to the fault of the person to whom they happen. In many states, auto insurance companies don’t consider a collision with a deer to be a chargeable accident. I believe that many of the homes in foreclosure today are owned by people who were really deer in the headlights of the new millennium’s borrowing, lending and spending frenzy.

Of course there is no “one SAM fits all.” That said, we need both government and the financial services industry to start coming up with ways to implement DistresSAMs right now. It may not be easy. The IRS will have to cooperate, financial institutions will need to take steps to create liquidity for these instruments in the secondary market, and underwriting and valuation criteria will have to be accurately developed. I do believe however that all of these things can be done quickly — quickly enough to have a real impact on the current foreclosure crisis before it gets even more out of hand, assuming it hasn’t already.

Some far less tangible things may also have to happen — Americans will need to conceptualize homeownership in a different way than they did before; financiers and government may have to conceptualize the notion of a mortgage very differently than they have for decades.

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I also believe that a non-distress SAM might just become a most-requested tune pretty soon, to replace the cacophony of the current situation. But that’s another topic for another day. For now, we must focus on minimizing the misery wrought by the scary din of foreclosure.

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