The US housing crash has been devastating. Frankly, I think the related government financial rescue plans for this extremely complex issue have not been very effective, and also very costly.
This proposal addresses financial relief for the housing crisis broadly, and I think is an effective initiative in starting to get to the core of solving this devastating multi-faceted problem, which negatively impacts so many people, and which is intertwined with the very troubled jobless recovery picture, with both sky-high unemployment and underemployment, and with very little hope of much improvement on the horizon for quite a while.
My proposal here has the US Government granting substantial incentives to financial institutions, with the result being that the principal balances of many underwater home mortgages will be written down.
I would give financial institutions both of two very attractive tax incentives. They both deal with granting very attractive accelerated loan loss provision federal income tax deductions. And they both shouldn’t cost the US Government a dime. The second tax incentive actually should result in substantially positive CBO scoring to the US Government over the next 10 years.
When you think about it, there are all kinds of wise tax incentives that the country uses to stimulate the US economy....100% tax expensing of equipment, bonus tax depreciation, accelerated tax depreciation (both method and life), R&D tax credits, just to name four. Incentivizing write downs of underwater home mortgages by providing Accelerated Bonus Loan Loss Provision tax deductions is consistent with this, and frankly, given the horrible housing crisis, much more of a job creator than the first three.
Under US generally accepted accounting principles, financial institutions must properly reflect in their audited financial statements, the economic amount of the Loan Losses on their home mortgage loans that they hold.
With all of the underwater first and second home mortgages that exist, the amounts of these Loan Losses is clearly gargantuan.
The problem is that even though they have booked these economic Loan Losses, these financial institutions have refused, for the most part, to write down the principal balance of these underwater mortgages.
In my first proposal here, to highly incentivize these financial institutions to write down underwater home mortgages, for the remainder of 2011, and all of 2012, financial institutions would be allowed a substantial Accelerated Bonus Loan Loss Provision federal income tax deduction for some multiple of the amount of principal underwater mortgages they write down, not to exceed the write down to below the value of the home.
The amount of this Accelerated Bonus Loan Loss Provision is clearly open to debate. I just think the focus must be on solving the horrible housing crisis as quickly as possible, which is weighing so very heavily on consumer spending, on consumer confidence, and even more importantly, on both unemployment and underemployment.
Thus, I would consider allowing smaller financial institutions a Triple Accelerated Bonus Loan Loss Provision federal income tax deduction, and larger financial institutions a Double Accelerated Bonus Loan Loss Provision federal income tax deduction for all underwater mortgage write downs in the remainder of 2011.
For write downs in 2012, I would consider allowing smaller financial institutions a Double Accelerated Bonus Loan Loss Provision federal income tax deduction, and larger financial institutions a Single Accelerated Bonus Loan Loss Provision federal income tax deduction.
And for any smaller financial institution in a federal income tax loss situation, I would make the tax benefit of these Accelerated Bonus Loan Loss Provision federal income tax deductions refundable on the front end.
Under my proposal, because of the magnitude of these front-end tax deductions, there are clear economic incentives here for financial institutions to write down underwater mortgages. So, given how huge these tax deductions would be, wouldn’t this just put a severe strain on the US Debt?
Well, I have a fair way to do it at no CBO scored cost to the US Government over the next 10 years.
For 2011 write downs of underwater mortgages, my proposal would also require this Accelerated Bonus Loan Loss Provision federal tax deduction to turn around and increase taxable income by 25% of the amount of the Accelerated Bonus Loan Loss Provision tax deduction to the financial institution in each of the years 7 through 10.
For 2012 write downs of underwater mortgages, my proposal would also require this Accelerated Bonus Loan Loss Provision federal tax deduction to turn around and increase taxable income by 25% of the amount of the Accelerated Bonus Loan Loss Provision tax deduction to the financial institution in each of the years 6 through 9.
Let me illustrate.
Say, a home is now worth $200,000. And there is a first mortgage at Financial Institution (FI) #1 of $240,000, and a second mortgage at Financial Institution (FI) #2 at $30,000. Assume that FI #1 is a small financial institution and FI #2 is a large financial institution.
In 2011, assume FI #2 elects to write off the entire principal balance of $30,000, and FI #1 elects to write down $40,000 of the mortgage.
In 2011, FI #2 would get a Double Accelerated Bonus Loan Loss Provision federal income tax deduction of 2 X $30,000, or $60,000. In each of years 2017, 2018, 2019, and 2020, FI #2 would increase its federal taxable income by 25% X $60,000, or by $15,000 per year.
Also, in 2011, FI #1 would get a Triple Accelerated Bonus Loan Loss Provision federal income tax deduction of 3 X $40,000, or $120,000. In each of years 2017, 2018, 2019, and 2020, FI #1 would increase its federal taxable income by 25% X $120,000, or by $30,000 per year.
I don't personally have an underwater home mortgage, but from a fairness standpoint, if the country can bail out big financial institutions, which played a major role in causing this horrible housing crisis, then I think it is only fair for the country to also provide wise, cost-effective tax incentives that can help at least some of these many unfortunate home owners, suffering desperately with underwater mortgages.
My second tax incentive is a bit more complicated.
The first part and bulk of this second proposal relates to all financial institutions holding home mortgage loans on principal home residences, in which there aren't second mortgages, and where the principal balance of the mortgage loan is more than 90% of the Fair Market Value (FMV) of the home. Thus, this would include all underwater home mortgages and also ones only slightly above water, which are less than 10% above water.
Toward the end of this post, I also have a proposal for the many underwater home mortgages in which there are second mortgages.
This proposal would apply to the remainder of 2011 and all of 2012, and relates to any financial institution that sells to the US Federal Government the entire portion of any mortgage loan that exceeds 90% of the FMV of the related home.
The selling price would be at the Fair Market Value of the principal balance transferred, and thus should approximate the excess of the mortgage loan principal balance transferred over the Cumulative Loan Loss Provision (or Expense) that the financial institution has already reflected related to this mortgage in its income statements through the most recent audited financial statements (Dec 31, 2010, in most cases).
If this Loan Loss Provision reflected on the books doesn’t represent the financial institution’s best estimate of its loss on its mortgages, then this financial institution better clean up its books and also fire its external auditors.
Let me give an illustration of how this proposal would work.
Say on November 1, 2011, Wells Fargo has a mortgage loan receivable on its books with a principal balance of $300,000. The related home has a FMV of $200,000. The interest rate is say 6% fixed and the remaining mortgage term is say 15 years. Also, assume Wells Fargo has already recorded a Loan Loss Provision on this loan cumulatively of $90,000 in its audited income statements, and thus probably also has included a related $90,000 in its Allowance for Loan Loss on its audited balance sheet at Dec 31, 2010.
The maximum amount of the principal loan balance transferred, or sold, under this proposal is $120,000 (i.e. $300,000 minus 90% X $200,000). The selling price would be approximately $30,000 (i.e. this $120,000 minus the $90,000 Loan Loss Provision).
Wells Fargo should have no significant income statement impact on this mortgage sale. It is very important to companies to not get income statement earnings hits for transactions like these. For you financial types, Wells Fargo’s accounting journal entry to record the sale is simply:
DR…Cash………………………….....30,000
DR…Allowance for Loan Loss…90,000
…..CR…Mortgage Loan Receivable……120,000
And after this sale, Wells Fargo is left with a first mortgage with a principal loan balance of $180,000, with the interest rate remaining at 6% fixed, with the term still for 15 years, and with as security, a home with a FMV of $200,000, and thus its initial loan principal balance after sale is precisely 90% of the FMV of the home.
The US Federal Government acquired this mortgage loan and gets a second mortgage on this same home, with a term of 10 years, which also is the CBO scoring period. It reduces the $120,000 loan principal amount down to $30,000, its purchase price. Whew, the homeowner here is elated. But there’s more to this story.
The US Federal Government charges no interest to the homeowner in the first year, when the US economy is so weak. In the second year, it charges only interest for 50% of the interest rate the home owner is paying to Wells Fargo. Thus, interest for the second year would be $30,000 X 50% X 6% = $900, or $75 per month. In the third year, it charges only interest for 70% of the interest rate the home owner is paying to Wells Fargo. Thus, interest for the third year would be $30,000 X 70% X 6% = $1,260, or $105 per month.
For the next seven years, when hopefully the housing crisis is completely over and the US economy is running on all cylinders, the interest rate is 90% of the interest rate paid to Wells Fargo on the first mortgage, or 90% X 6% = 5.4%. The $30,000 is payable monthly with 5.4% interest compounded monthly as an annuity over 84 months (or 7 years), with the resultant monthly mortgage payment of roughly $438.
If all of these payments are made, the US Federal Government would net a positive cash flow over the next ten years of $8,952, the cumulative interest received. And also the $30,000 loan principal was repaid. Thus, the US government would have a reduction in its federal deficit of $8,952 related to this loan over the next ten years. Thus, the total interest income of $8,952 represents a cumulative 30% return on the $30,000 loan bought.
If you wanted a higher total income return than that, then it would be necessary to step up the interest rates used over the 10 year term.
Now let me address the front end CBO scoring of this entire program.
There will be some loans that won’t be repaid, and these would reduce the positive CBO scoring. However, for all loans combined, the US Federal Government should have substantially positive net cash inflow, and thus there should be some pretty substantively positive, in the aggregate, CBO scoring on the front end. The cumulative interest received should trump the cumulative loan losses.
And with its second mortgage, the Federal Government has some very nice credit protection, particularly since after the sale, the first mortgage loan is initially only at 90% of the FMV of the home, and as loan payments are made, this 10% cushion will grow, thus also benefiting the credit protection of the second mortgage-holding US Government. And then this cushion will also grow for any subsequent home price appreciation over the ten-year period.
Wells Fargo gets no significant earnings charge on its income statement from the partial mortgage loan sale. And economically, it benefits because it now has a Mortgage Loan Receivable on its books at 90% of the FMV of the home, and also pocketed $30,000 of cash.
Now let me address the highly-charged tax incentive to get the financial institution to sale portions of these underwater home mortgages to the US Government. It would work similarly to how my first proposal works.
In this second proposal here, to highly incentivize these financial institutions to sell portions of these underwater home mortgages to the US Government, for the remainder of 2011, and all of 2012, financial institutions would be allowed a substantial Accelerated Bonus Loan Loss Provision federal income tax deduction for some multiple of the Loan Loss Provision on their books related to the portion of the underwater home mortgages they sold to the US Government.
Thus, I would consider allowing smaller financial institutions a Triple Accelerated Bonus Loan Loss Provision federal income tax deduction, and larger financial institutions a Double Accelerated Bonus Loan Loss Provision federal income tax deduction for the Loan Loss Provision recorded on their books for the portions of all underwater mortgages they sell to the US Government in the remainder of 2011.
For similar items in 2012, I would consider allowing smaller financial institutions a Double Accelerated Bonus Loan Loss Provision federal income tax deduction, and larger financial institutions a Single Accelerated Bonus Loan Loss Provision federal income tax deduction.
And for any smaller financial institution in a federal income tax loss situation, I would make the tax benefit of these Accelerated Bonus Loan Loss Provision federal income tax deductions refundable.
Under my proposal, because of the magnitude of these front-end tax deductions, there are clear economic incentives here for financial institutions to sell portions of their underwater home mortgages to the US Government. So, given how huge these tax deductions would be, wouldn’t this just put a severe strain on the US Debt?
Well, I have a fair way to do it at no CBO scored cost to the US Government over the next 10 years.
For 2011 sales of portions of underwater home mortgages, my proposal would also require this Accelerated Bonus Loan Loss Provision federal tax deduction to turn around and increase taxable income by 25% of the amount of the Accelerated Bonus Loan Loss Provision tax deduction to the financial institution in each of the years 7 through 10.
For 2012 sales of portions of underwater home mortgages, my proposal would also require this Accelerated Bonus Loan Loss Provision federal tax deduction to turn around and increase taxable income by 25% of the amount of the Accelerated Bonus Loan Loss Provision tax deduction to the financial institution in each of the years 6 through 9.
And the real beauty of this second proposal is that you not only get substantially positive CBO scoring, but you also get a substantial amount of Juice added to the US Economy….just think of all the cash going to the banking system from these sales of clearly troubled part of these mortgage loans. This cash will be available to be lent out to businesses, particularly to smaller businesses, and also will be available to finance new and existing home sales. Further, the private banking system gets significantly strengthened by getting rid of the toxic parts of so many of its mortgage loans.
To be able to move the needle on these many underwater home mortgages even more, my proposal also addresses all home mortgages that have second mortgages and where either the first mortgage alone, or where in combination with the second mortgage, create an underwater situation.
If their accounting is proper, the financial institutions holding these second mortgages should have already recorded a 100% loan loss provision for most of these underwater loans. Thus, they would have no income statement accounting hit if they were to forgive the entire principal balance of the second mortgage loan.
In those cases where there is not a 100% loan loss provision already on the books, then my proposal would be to permit the financial institution holding the second mortgage to sell this loan to the US Federal Government for the Fair Market Value, which should be approximately the excess of the loan principal balance over the loan loss provision already recorded. The US Federal Government would then roll this homeowner loan acquired into the loan acquired from the first mortgage holding bank.
To incentivize the second mortgage financial institution to totally forgive, or in some cases to sell, the loan amounts of these underwater mortgages, I would give them the same Accelerated Loan Loss Provision federal income tax deductions explained earlier for the financial institution holding the first mortgage, and selling a portion of the underwater home mortgage to the US Government.
And then these Accelerated Loan Loss Provision federal income tax deductions would turn around just like I explained earlier for the financial institution holding the first mortgage, and selling a portion of the underwater home mortgage to the US Government.
I fortunately don’t have an underwater mortgage, but I think if the US Government can bail out AIG, Fannie Mae, Freddie Mac, and many other mainly financial companies, surely the US Government can also help out its many US citizens with underwater home mortgage loans, who have been financially devastated by the housing market crash, caused in large part by the very same companies the US Government bailed out.
Further, I think this proposal would be dynamite to the very troubled US jobless recovery, and particularly light a fire to the very depressed housing market, and to the smaller bank community, as well as to many small businesses.
Homeowners with Underwater Home Mortgages are not doing much in the way of consumer spending now. With the fiscal relief provided by this proposal, these homeowners will be much more likely to step up their consumer spending, thereby spurring the US economy and US job creation.
