Office of Thrift Supervision, I have a question for you. What in the world is this?
CNN reported that the OTS is in the early stages of a plan that would give some lenders an incentive to write down mortgages where the value of the debt now exceeds the value of the home. According to CNN, if a home was worth, say, $100,000 and if the mortgage was $120,000, the lender could write down the mortgage to $100,000 and get a $20,000 warrant. If the house later sold for more than $100,000, the warrant would entitle the lender to receive up to value of the $20,000 warrant plus interest. The OTS also is suggesting that these warrants could trade on a secondary market. The idea is the lender would be able to share in any recovery in the value of the housing market.
I don’t get it.
I am very much in favor of any plan that would help the U.S. out of its mortgage mess, especially potentially innovative solutions that harness the power of the marketplace. I really want to believe the OTS plan would work, but isn’t there a huge stumbling block? Once a warrant is given, the owner of the home knows he or she would not share in any upside appreciation. In our example, what is the incentive of the owner to sell the house for more than the $100,000?
Two possible solutions came to my mind. One is that you might allow the owner to share in some of the upside appreciation. I don’t think that fixes the problem, however, as it still diminishes the incentives of the owner to sell for the market price. The math is just more complicated to get to the same point.
We also might give the holder of the warrant a right of first refusal to purchase the property at the proffered price, but I can’t imagine that would work in the reality of the residential housing market. Home purchasers are not going to want to put down bids on housing subject to a right of first refusal. Maybe investors would do this, but then we are talking about a radical reshaping of the residential housing market. Do we really want a housing stock that has a substantial ownership block by real estate speculators?
I must be missing something. (Hat tip to one of our regular readers for pointing the way to this story.)
Comments
5 responses to “OTS … ?4U … WITW”
Think of it as being like a warrant to buy stock in XYZ Corp. on or before a fixed date, for a fixed price. Those stock warrants are publicly traded, and their value depends on the value of the underlying stock, compared to the price to exercise the warrant. If the warrant gives the right to buy a share of XYZ for $20, and XYZ is trading at $10, the warrant is worthless. But if XYZ is trading for $50 a share, the right to buy the stock at $20 per share is probably worth $25 or so. The buyer buys the warrant for $25, uses the warrant to buy the stock for $20 more, then sells the stock for $50, and makes $5, or about 11 percent on the $45 investment.
I see two problems. These real estate warrants need to be time-limited, though (5 years, maybe). I also think they would have to be recorded in the land records office, like deeds, each time they are issued or transferred, to be effective as against the owner or any subsequent buyer. The recording requirements and fees could hamper their marketability.
The description by the previous comment is not how I understood the OTS warrant would operate. Surely the OTS can’t be proposing that the warrants would trade out in the marketplace giving institutional investors a call option on people’s homes? I had understood the proposal to be that these warrants would represent a contractual right to recover the excess over a given price the owner might get in a sale of the home.
Mr. Lawless, I think your analysis of the warrant proposal is spot on. However, I don’t think the warrant scheme is a very serious one. I think it is motivated by two ideas: (1) lenders (and bond insurers!) want a red herring to draw Congress off the idea of permitting mortgage cramdowns in bankruptcy. They will argue that the warrant scheme offers a way to rewrite mortgages without going through bankruptcy, so why bother to revise the Bankruptcy Code? (2) Lenders want some scheme approved allowing them to rewrite mortgages (to keep whatever payments are available flowing) while still dodging originators’ liability to bondholders for unpaid principal. They’re trying to move public opinion their way by stages, working from nugatory “interest rate freezes” to the impractical (as you pointed out) warrant scheme, toward what they really want: cramdown that shafts bondholders but leaves them without recourse to loan-writers or bond syndicators or insurers. I expect the final scheme to be “leaked” in another little while.
Actually (I just thought of this), maybe lenders really would like some changes to the bankruptcy code, changes to let them bathe in the warm suds of Chapter Eleven and emerge with all their unsecured liability to bondholders washed away.
Yep, because the last change to the bankruptcy law–which made mortgage debt pari passu with credit card debt worked so well.
Oh, wow. Today we see the follow-on proposal: lenders want US gov’t to buy troubled loans out of pools– bondholders to take losses, without recourse to insurers– and then gov’t will rewrite mortgages with new principal balances matching home values:
http://www.nytimes.com/2008/02/23/business/23housing.html?_r=1&ref=business&pagewanted=all