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Homeowners for Fair Public-Private Investment Program |
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On 03/23/2009 the government
announced the Public-Private Investment
Program. As part of the program private
entities, called Public-Private Investment Funds or PPIFs, will be able to buy
mortgages classified as ‘toxic assets’ from the banks. These entities will use
money from their sponsors/organizers, as well as government’s money. The
government will be providing money in the form of equity capital matching 1:1
the private investment. The government, FDIC in particular, will insure loans
for these PPIFs. The amount of these FDIC insured loans would amount to up to 6
times the capital of the PPIF. The actual sale will be done at an auction
organized by the government. In that auction the highest bidder is the one that
purchases the loans. These PPIFs will benefit if the
borrowers on the purchased mortgages pay off their loans and will loose if they
are incorrect in that assumption. Details of the government plan can be found
here: www.financialstability.gov
Let me try to explain this in
simple words. Let’s say you bought your house in 2006 for $250,000 and took a
mortgage loan for $240,000 putting $10,000 down. The real estate prices since
then have declined 20% and your house is now worth 80%*250,000=$200,000. You
owe $230,000 on your loan as of today. If the bank decides, it can sell your
loan for $205,000 ($205,000/$230,00 that is 0.89¢ on every dollar that
you owe). The bank gets all the money as if it has sold your house, at the
moment at the current price, plus some $5000 profit. The buyer/PPIF gets your loan at a discount and hopes you will
repay all of the $230,000 - no matter how much your house is worth and thus
make $25,000 ($230,00 - $205,000). The PPIF is making $25,000 if
you, the mortgage borrower, is a responsible one and you pay off your debt if
full… So, we at ‘Homeowners for fair Public-Private Investment Program’ (FairPPIP.org) ask the following questions – Why somebody
else have to benefit from the fact that you are a responsible borrower?
Isn’t it possible to make the PPIP works in a way that rewards the responsible
borrowers instead of somebody else? We
believe we have found a way to make the system works in a way that awards the
responsible payers. The idea is pretty simple, indeed. What if you/the borrower can find an entity
that buys your loan from the bank, for the abovementioned $205,000, and offers
you to repay just that amount - $205,000, instead of the whole $230,000 you
currently have to pay. Well, our goal is just that, to organize such entities -
PPIF’s, which will buy, mortgage loans from the banks at a discount and pass
the discounts to the responsible mortgage borrowers. The reason why this is possible
is in the way the PPIP is designed to work. It provides significant incentives
for ‘toxic mortgage’ buyers! Normally
the buyer of your loan, described above, will have to come with $205,000 in order to buy your loan from the
bank. But, no the PPIP government program have made the things easier for such
a buyer. If the organizer of the PPIF comes with $100, the Treasury will
participate with the same amount, so we have $100 plus $100 or total of $200 of
equity capital in the new PPIF. Next, the FDIC will guarantee loans for this
PPIF up to 6 time the equity - 6*($100+$100) = $1200. So this PPIF will be
effectively able to purchase up to $1400 of loans for every $100 a private
party is willing to invest, or $14 worth of loans for every $1 of its
investment. So in order to purchase your loan, on which you still owe $230,000,
the sponsor/organizer of the PPIF will need $205,000/$14 = $14,643. He
will need only 6.37% of what you owe, to purchase your loan! Here is our proposal: -To organize charitable
organization “Homeowners for Fair Public-Private
Investment Program” (HF PPIP) -
The HF PPIP organizes/sponsors PPIFs. We are currently considering sponsoring
several different PPIFs, which will be based on the location of the properties
and types of mortgage loans to be purchased. - Based on members assessment
and other available tools and methods determining the fair bid price for the
pools of mortgages offered by the banks for sale in the PPIP. Buying such
mortgage pools at these discounted prices. - Passing the saving to
all willing, responsible homeowners whose mortgages have been bought by
our PPIFs. Here is an example how it works: Our charitable organization “Homeowners for fair Public-Private Investment Program” organizes PPIF,
which buys a group/pool of 100 mortgages from bank XYZ in the PPIP. All
mortgages are in Chicago area, the properties securing the loans are bought in
the first 3 months of 2006. The loans are with 0 down payment and have and
average principal outstanding of $240,000. The interest rate on those loans is
6% average (let’s say the rates range from 5.75% to 6.25%). Using real estate
indexes we see that the property values now are about 75% of what they were in
the first 3 month of 2006. So the average borrower on those 100 loans owes
$28,000 more on every $100,000 of his/her mortgage then their property value.
In other words if somebody took 250,000 to buy a 250,000 house, he now owes
240,000 on his mortgage and his/her house is worth 187,500. If the purchase price is 77¢ on $1 of face value and
the government has determined that it will provide 6 to 1 financing, then
FairPPIP.org will need to come with $13,200 for each of these 100 loans, or
$1,320,000 for the whole pool. Here is how the numbers work -77¢ needed to buy $1 of
face value. Those 77¢ come from - 5.5¢ from FairPPIP.org + 5.5¢ from the government +
66¢ from
FDIC insured loan (loan in the amount of 6 times equity capital or
6*(5.5+5.5)=66¢). So for the average mortgage FairPPIP.org will
need 5.5¢ on a dollar, or $13,200 (0.055*240,000=$13,200). Next, our PPIF approaches the
homeowners that have their loans purchased by the organization, with the
following offer: “We (PPIF) will modify your loan in the following manner: 1st We will reduce
your principal to 77¢ on every dollar you owe and the new loan will be
at a fixed rate of 5.25% *(1) 2nd For the
remainder of what you owe on your current loan $1 – 77¢ =23¢ plus 5.5¢ or total of 28.5¢, PPIF will also
give/have a second mortgage on your property. That is 28.5¢ on every dollar you owe
on your current loan. This, second mortgage will be 0% interest loan
requiring no payment until your first mortgage is paid in full. You will need
to repay your second mortgage in 5-year period after paying your
first loan. 3rd You will use these extra 5.5¢ on the dollar of this
new second loan to acquire capital in the PPIF.” Let’s take a look at the
concrete numbers for an average mortgage borrower in our pool of 100 mortgages. Our
homeowner took a 30-year mortgage at 6% fixed rate in Feb’2006. His payment
is $1498.88 monthly and he still owes
about 240,000 on his loan. With
the proposed modification the principal of his new first mortgage will be
0.77*240,000 = $184,800 and his monthly payment for the remaining 27 years will
be $1068.13. This is a $430 reduction in his monthly payment, or about 28.7%! The second loan will be in the
amount of 0.285*240,000=$68,400 of which 0.23¢ on a dollar are the
reduction of the first loan with $55,200 =$240,000*0.23; and 5.5¢ on a dollar or
0.055*240,000 = $13,200 are an addition to his original obligations. With
those last $13,200/5.5¢ on a dollar, our homeowner buys part of/ownership
share in the PPIF. Effectively becoming shareholder in the PPIF that holds both
of his mortgages! Not only he is shareholder but also his ownership share is
proportional to the amount of his loan. This ownership will guarantee him that
after paying his second mortgage (remember 0% interest,) he will
effectively get half of the money of his second mortgage back *(2).
This of course is conditional on all 100 mortgage borrowers behaving
responsibly and paying all of their modified or not loans to the PPIF, but they
will have exactly the same incentives to do so as our hypothetical borrower
described above. What about the other half of the money on the second mortgage? The
government gets them as a fee for this excellent opportunity it has presented
to all mortgage borrowers participating in the program. Remember the nice
reduction of the loan payment from $1498.88 to $1068.13. This reduction amounts
to $139,500 for the life of this new loan. Compare this with what the
government gets - ½ of the second mortgage or $34,200. By the way using the
correct methods of comparing the price ($34,200) and the reward ($139,000) i.e.
accounting for the exact time when these amounts are actually received / paid
respectively, the deal is even better for our borrower! So good in fact, that
if he is the only borrower, of the 100 in our pool, that repays his second
mortgage - he will still be way better off compared to being left paying his
original mortgage. *(1) The expenses of the PPIF will consist of a small managerial fee (let’s
say 0.75% of total assets), and interest on the bonds issued. This is interest
on FDIC insured bonds, so it is reasonable to assume that these bonds yield 0.75% to 1% point more than an equivalent Treasury. Today’s 30 Yr T-Bond yield was
3.651%. In our example 6/7 of the purchase price is financed with bonds, so we
need cash flow of: managerial fee bond interest total 0.75% + (3.65%+1%) *
6/7=3.9857% = 4.7357% The expenses of 4.736% make the 5.25% interest
rate on the loan reasonable and achievable. The main point here is not the
exact the interest rate, but rather that the mortgage can be offered at
very affordable and competitive fixed rate. *(2) The PPIF will be closed and the available money
will be distributed to the shareholders after 32 years; In the case, where all
100 second mortgages are repaid in full, there will be 100*$68,400=$6,840,000
available. Our homeowner will be a shareholder having 1/100 of 50% of the
capital. He will get 1/100 * 50% *
$6,840,000 = $34,200. $34,000 is exactly half of his second mortgage. (Why 32 years - 27 years are
needed to pay off the first mortgages in the pool, plus 5 years for repayment
of the second mortgages.) Dimitar Kovachev, 03/25/2009 First published on FairPPIP.org
03/27/2009 LET’S DO IT! |
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