Innovation Trio: SwapRent, FARJHO & TARELV


07/20/2008 An SSE (State Sponsored Enterprise) or called LGSE (Local Government Sponsored Enterprise) to replace the GSEs

FAQ #23: (originally posted at on July 20th, 2008) Why are you championing the idea of getting the local state, county and city governments involved in a new national housing finance system for our country going forward, given the failure and pending collapse of Fannie and Freddie? What does de-centralizing or localizing credit risk management of home mortgages mean? Why are the new SSEs (State Sponsored Enterprises) or LGSEs (Local Government Sponsored Enterprises) that you proposed better than the current GSEs?

Yes. This is something new and few have been convinced so far. Ruthless critics said the effort would prove to be as futile as teaching pigs how to fly. Many local governments officials themselves are not excited about the ideas either. Most of them are quite scared by the thought of having to do something new themselves, out of their 9 to 5 daily routine. Job security, not flying with innovative accomplishments, is usually what their priority is. They either try to push this to be a private sector business or even if government needs to get involved it should be the federal government’s job to do something about it. They failed to understand that these wrong ideologies and hands-off approach in the past contributed in a major way to our nation’s housing finance problems. Many of them bureaucratically viewed adopting an innovative approach to save their own government finances, their homeowners and their local economies is not worth granting a favor to a private business. Similar to the refusal of the parents of a cancer child to buy a cancer cure from a pharmaceutical company which has diligently invested heavily in the past to develop a viable solution, they seem to rather let the child die than taking up the offer to help, unless the pharmaceutical company turns to be a non-profit organization and practice socialist medicine. Wrong ideology or personal emotion like that is often what kills, not the lack of innovative solutions. Banks and mortgage lenders such as American Home Mortgage, Bear Stearns, Countrywide and IndyMac may have gone to their demise in a similar way, despite the tremendous efforts we had spent to visit and communicate the worked out SwapRent (SM) solutions with the executive management teams since mid 2006.

Fannie and Freddie will be gone for sure. Many still try to fool themselves and are not willing to face up the reality. We saw recently that the Treasury Secretary went to Congress to beg for a blank check to back them up. It looks like a gambling addictive son trying to ask daddy for his blank check book in order to bluff his fellow poker players. It may have bluffed some naive folks for a short while but many would see through it soon that daddy is more broke and full of debts than the son is. It won’t last.

I bumped into such an idea of getting the local governments involved by accident or by fate, depending on how you look at it. Let’s simply view it as a side effect derived from our tenacious efforts to promote the implementation of the SwapRent (SM) methodology. As we had come to the realization in early June, 2008 of the fact that many of the major banks and mortgage lenders we have had consulting/licensing discussions to for the last two years no longer have the credibility or ability to launch any new consumer financial products to save themselves (let alone our national economy), going through the financial institutions route to launch the SwapRent (SM) project will only be possible for a newly set up financial entity. That requires major capital investment and regulatory hassles which may further delay the offering of a timely help to the homeowners.

On the federal government and the congressional law makers side, they seem to have their own political agenda of doing things. For example, within the last two years we have approached the White House, the Fed, Treasury Department, HUD, all banking regulators, GSEs and the FHLB system with almost no stone unturned. Although many of the Republican administration officials loved the ideas of SwapRent (SM) and appreciated the fact that it could really help solve our current economic problems, some of them told us their positions may be too low at the totem pole to help put this proposed solution on a high political priority. We were advised to approach the congressional law makers and their staff members at the House Financial Services Committee and the Senate Banking Committee. We naturally made a lot of effort in that regard. Among all the numerous academic referrals and social introductions to approach the decision makers, our Boston-based business partner even went as far as attending a gay party event trying to hand-deliver a copy of our SwapRent (SM) proposal to an influential Congressman! I don’t have much detail on what exactly happened next later that night. My poor straight partner may have had to bend over backwards to please some Congressmen, literally … and so forth. My point is merely that those federal people who need to know were indeed all well informed about the availability of the viable SwapRent (SM) solution to effectively stem mortgage defaults and foreclosures during the last two years already.

Despite all these efforts, Congress only came up with a Housing Bill which was given to a few well connected bankers to draft to save themselves and their earlier bad investment in a major defunct mortgage lender. The only conclusion we could draw is that the Democrat-controlled Congress may not have the urgency or intention to really solve the current economic problems before the 2008 national election in November. The worse the state of our economy the better chances there may be for a Democrat president to be elected in November. Although a speculation, there is really no other reason that could explain why they would not adopt some worked out innovative solution, no matter where it comes from, as they should not have the same mental block of a wrong ideology as mentioned above. Perhaps they do too and I may be wrong on that assumption.

After more than two years of our relentless efforts to spread the gospel, the economic merits and the social value of the SwapRent (SM) methodology have indeed been understood and acknowledged by most of the people who may hold the power to make a difference, it remains a challenge for us to get them to stand out from the shadow to help form that critical political force to have it implemented in a timely manner for the benefits of our nation. It is politics at work as usual. A few more years in the future, we might be able to look back at these people for political accountability based on hindsight historical chain of events, but that might be too little too late to save our national economy from spinning downward into a deep recession and the many displaced once homeowners along the way.

To understand the significance of the future roles of the local governments and a de-centralized homeowners’ credit risk decision making mechanism in a new national housing finance system, first let’s look at a few technical aspects of what the conventional mortgage really is. From a business risk management perspective, a conventional mortgage has financial risks, legal risk and operational risk for its providers. Within the financial risks there are credit risk, interest rate risk, prepayment risk and real estate market or property value risk all combined and mingled into one single financial product. The key to solve the current default/foreclosure crisis and to establish a healthy new housing finance system is to quantify and single out each of the four types of financial risks out of the conventional mortgage and manage them separately in a new approach.

When each individual risk of the home mortgage is properly identified and addressed by this “divide and conquer” approach, the chance of a potential systemic risk in the housing finance system that could bring down our banking system again in the future could be minimized dramatically.The interest rate risk will no doubt continue to be managed at the national level by the Federal Reserve or a central bank equivalent. The prepayment risk may be able to continue to keep the securitization game going and many in the industry employed. Both of these two risks will also continue to provide the investors the guessing games either through the secondary whole loans market or the new incarnation of a “Covered Bonds” market borrowed from certain European countries. The real estate market or property value risk will be best managed by the new SwapRent (SM) methodology to extract them out of a conventional mortgage as explained above in details. It will not be repeated here again. Local governments at all levels, on the other hand, will be the best candidates to participate to assume an active role to manage the homeowner credit risk since they have the vested interests and the geographical convenience to perform the due diligence required to ensure a sound new housing finance system.

The emphasis here is to create a new role or to expand some existing practices for the local governments to assume a stronger economic function of policing the granting of credit to homeowners and get compensated for it either as a non-profit agency or as a for profit entity similar to Fannie and Freddie.There are many ways this new role could be accomplished. The simplest way may be to assume the modified but similar mortgage insurance function of the FHA without the capital providing function rather than underwriting the entire mortgages directly that the Fannie and Freddie have been doing. They could set up new local state agencies to perform those similar roles of Fannie and Freddie at the local level and they could be called SSEs (State Sponsored Enterprises) or LGSEs (Local Government Sponsored Enterprises). The modified state version of a new Fannie or Freddie so to speak, with the homeowner credit decisions made at state or even county and city levels. Critical mass and scale of the operations could be accomplished through re-insurance at a national level or to private sector entities. In fact, at most states the state housing finance agencies may not be new but we should let them take on more active new roles. Extra care should be taken for the local governments not to repeat Fannie and Freddie’s many mistakes and abuses.

This new involvement by the local governments will not crowd out the existing private sector business by the financial institutions and will only perform the complementary functions that the original intentions of Fannie and Freddie were set out to deliver.

The main benefits of this approach will speak for themselves. Real estate business will go back to a be a regional or localized business as they used to be and where they belong. The unscrupulous behaviors of a few individuals in the mortgage system will no longer affect us as a nation. This could easily be understood if you look back at what had happened within the last few years. The disconnect of credit risk monitoring brought about by the securitization business and the personal abuse of the system by some mortgage brokers and underwriters had quickly brought the whole country down. Moral hazards were created by these centralized housing finance agencies. National monetary policies were held hostage by these inter-linked nation-wide epidemics. Forced low interest rate policies then brought about the sinking US dollar and the ensuing run away inflation led by high commodity prices … etc.

By having the credit risk management function performed at the local levels with different regional decisions being made independently we could have a much more diversified, resilient and stronger national economy. Economic problems such as what had happened recently could be compartmentalized at a regional level and will not trigger the ominous collapse of the entire empire that many wise guys having been predicting. National monetary policies and fiscal policies will no longer be held hostage by their failures since incompetent or abusive local housing finance agencies or these new SSEs could be punished and left hung dry without batting an eyelid by the politicians. “Too big to fail” will also no longer be a common phrase for the lobbyists or a convenient excuse for the special interest groups. Taxpayer bailout may be reduced to a regional or state issue. Pensioners in Norway, small bank depositors in Germany or central banks in China and around the world may also finally get to be spared by the consequences of local American’s credit indulgence.

To further use an analogy to compare practices in other countries, it may make sense to have one single interest rate policy for the entire Euro zone, but try to imagine how ridiculous that could be to set up one Europe-wide agency to offer mortgage insurance and make homeowners credit granting decisions based on one single standard to all European homeowners from Southern Italy to northern Lapland in Sweden and from remote Romanian villages to metropolitan London area in the UK? That would really be a paradise for the opportunistic local mortgage brokers and underwriters if they could simply sell the mortgage loan credit risks away to a centralized European version of Fannie and Freddie the same way they have been doing in the US all along. Pent up problems would similarly be waiting to explode if this were real. That is how ridiculously these GSEs in the US have been run in the past and grew to become such humongous monsters.

The recent discussions of borrowing the Covered Bonds market concepts as practiced in certain European countries may offer some cosmetic technical changes to the mortgage securitzation practices in the US. If these fundamental credit risk management issues are not properly addressed, letting local underwriters continue to sell homeowners default risks away to a centralized agency, developing a new Covered Bonds market will not be able to help change the situation. Changes in the technicality of the securitization process and methodologies may be helpful but the real evil is the idea of a centralized GSE itself to let the local underwriters off the hook so easily. Credit risk underwriting and monitoring will have to be kept locally, either with the original underwriters or with somebody who may have assumed these homeowner credit default risks subsequently but could continue to make decisions on monitoring and taking rescuing measures when necessary.

Put simply, accountability and responsibility of underwriting these credit risks should not be sold away or securitized away to people who do not have the ability to perform ongoing management. The responsibility of granting credit risks to homeowners and performing ongoing monitoring, in whole or in part, has to stay local with either the financial institutions or the local governments. Equipped with the flexible new housing affordability tools such as SwapRent (SM) and its embedded new mortgage products (HELM), they could also further provide timely assistance to financially distressed homeowners on an on-going basis. All this will happen naturally because they are made and remain the risk holders and will have the natural motivation to perform the required due diligence of risk underwriting and subsequent risk monitoring.

There seems to be many further research opportunities of the details in this de-centralizing or localizing of homeowner credit risk decision making process could be pursued. There also appears to be many options on how this could be best executed, both through the way how the mortgage credit risk insurance practice by financial institutions are structured and a much more active participation by the local governments in the housing finance process in order to set up a stronger and healthier new national housing finance system. Creating new State Sponsored Enterprises (SSEs) or Local Government Sponsored Enterprises (LGSEs) is just one of such ideas meant to be seeds for further discussions and debates.

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07/19/2008 A lifesaver in the flood or stopping the snow from melting?

I would like to continue the blog posting by bringing up an old conversation I had with a once young, energetic and visionary CEO of a once high-flying mortgage lender whom we have been dealing with within the past two years. The initial introduction of SwapRent (SM) and HELM was made and proposed to them in July 2006. During the course of the past two years, upon first learning about the SwapRent (SM) methodology the CEO sent the following email to his board members and all his managers:

“I love this…I have toyed with this idea for awhile….in fact I mentioned it this week to a group of managers….swapping some equity upside in the home for a lower rate for a period of time. This would help people who have problems with ARM resets, people avoid foreclosure, and people who are first-time home buyers. If these guys have developed a derivative…let’s get on it and not “study it to death” like we did the ABX. Thanks.”

Studying it to death was in fact what the staff managers did afterwards. But before they went belly up during the last few days of their existence I had a following email exchange with the CEO.

“Ralph, ….. We have our hands full fighting this crisis. … We are filling sandbags and plugging the serious leaks in our dam that we need to plug for immediate survival and you have stopped by and are telling us that you have something better to fill those bags than sand or how to build a better dam. ”

And my response was: “…. I may not be able to help you with another sandbag but I could certainly help you stop the torrents by stopping the snow from melting. Others see that you have the power to do so now may give you more sandbags that you’ll need for a survival.” No action was taken by them. The firm succumbed to the short sellers’ judgement and power a few months later.

This was very typical of our many experiences dealing with banks, mortgage lenders and Wall Street firms during our effort to introduce the SwapRent (SM) methodology and the related consumer financial products within the past few years.

Now that the entire Wall Street and financial markets are scrambling to fight for survival, people tend to lose track and not realize the fact that if no effort is made to stop or slow the snow from melting upstream at the mountain top, efforts to fight the flood could prove to be futile at best, Those who could manage to get a lifesaver would be those who have more than just the capital needed to survive for today but also a managerial will to adopt new innovative solutions to stop the root cause of the problems and to build a brighter new world tomorrow.

For the time being the federal government has timely opened up its own backyard to let the flood in so that the remaining private sector financial institutions may not all be drowned. If the federal government like these banks and mortgage lenders before them spends all its time worrying and fighting the downstream flood problems, yields to legislator politicians’ demand to waste tax-payer’s money and time to build more unnecessary downstream dams and levees, it may repeat the same mistakes as the banks had done before it.

Meanwhile maybe all we needed all along was simply to focus on stopping or at least slowing the snow from melting upstream at the mountain top. All these downstream flood problems might not even have been systemic life threatening problems if the upstream snow melting problem had been addressed and properly dealt with in a timely manner.

What started out may be just a simple mortgage default and foreclosure problem. Nobody had the incentives and responsibility to fix it so people started to blame it on securitization. The federal and local governments thought it was a private sector problem and stayed on the sideline for the private sector to sort it out. Economist pundits said it was a good correction that the bubble burst and it would be a good self-cleansing mechanism. It subsequently triggered the too big to fail issue. Taxpayer’s money was used to bail out the situation, so people started pointing fingers and blame it on derivatives again. When our capitalism financial system finally collapses then people will say, see, I told you that capitalism will not work in the long run. Now the favorite quote of the day is that the Wall Street greed has privatized all the upside gains and American taxpayer’s money was used to socialize all the downside risks. Irresponsible people who say that usually has nothing else creative or productive to offer other than making a demagoguery comment.

Maybe instead of spending time making all these hindsight comments we should re-focus our national efforts to get some really creative effective measures taken and implemented soon to stem the mortgages defaults and foreclosures? If not, in another few months time it may be the US federal government itself, not just Morgan Stanley who will ask CIC to take them over next. Will the Chinese, the Russians and the Saudi Arabians inevitably be the one who will own the US federal government in a debt for equity swap deal in the near future? You can only ask other people to take on so much of your debt until they will eventually wake up and ask “When will this stop?” Maybe the SwapRent (SM) contract could be the financial means for them to own a piece of America instead of continuing to own only Americans’ debts? Letting them be the economic landlords could be just one of the really viable solutions to bring fresh money into the American society to stop the snow from melting further.

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07/10/2008 What are the advantages of the SwapRent (SM) program over the new Housing Bill?

FAQ #22: What are the advantages of the SwapRent (SM) program over the new Housing Bill?

SwapRent (SM ) and its embedded mortgage product HELM were originally created to offer people better ways to manage their property ownership. Low income families could use it to enjoy bigger and better homes due to the true housing affordability offered by the SwapRent (SM) methodology (leveraging function). Affluent people could also use it to prevent the potential wealth erosion due to property value loss created by incompetent national economic and monetary policies (hedging function). The SwapRent (SM) business methodologies are the results of over 6 years’ dedicated independent and privately funded research, not an emergency plan hastily put together by unprepared people to deal with these issues in response to a national crisis. The major ideas in the SwapRent (SM) related pending patents were to come up with a better plan than the conventional shared appreciation mortgages that the solution in the new Housing Bill really belongs to. Here are a few examples of the most obvious advantages of SwapRent (SM):

1. It saves homeowners money and hassle. There is no need to do re-financing at all for the defaulting homeowners to get assistance to hang on to their homes. They could save plenty of unnecessary re-financing cost to be paid to the financial institutions, including the 1.5% mortgage insurance fee to be paid to the federal government.

2. The SwapRent (SM) program could offer transparent fair value pricing for the shared appreciation and contract early termination possibilities. The homeowners could simply get a fair value monthly subsidy in return for sharing part of the appreciation with the local city and county governments for a certain period of time so that they could continue to afford the mortgage payments and hence continue their home ownership and residence. The local city and county governments in turn transfer that shared appreciation potential to other free market investors for a fair value which represents the monthly subsidies that the homeowners would receive. SwapRent (SM) and HELM simply quantify the shared appreciation potential and its associated risks, extract them out from the shared appreciation mortgages and form a secondary trading market to offer fair value price discovery and early termination possibilities for homeowners.

3. There are a lot more options or choices for the consumers and potential investors. The shared appreciation agreement maturity could be 2, 3, 5, 10, 15, 20 or 30 years as compared to the one and only 30 years fixed rate mortgage option offered in the Housing Bill. The shared appreciation percentage could also be selected by the homeowners such as 10%, 20%, 30%, … 50%, 60%, 70%, … or 100% as compared to the one and only fixed schedule offered by the Housing Bill. To draw an analogy, if the Housing Bill offer is like one molded plastic toy, the SwapRent (SM) approach could be considered as a LEGO (TM) approach which building blocks could be put together to recreate any color, shape or form of a particular toy when necessary due to its quantified-component approach. SwapRent (SM) rates and flexible contract terms are completely negotiable between homeowners and investors in a free, open and transparent market. It is not a “take it or leave it” one recipe rescue plan approach as offered by the Housing Bill.

4. The housing affordability offered by the SwapRent (SM) program could be offered to all people, either the defaulting homeowners (including some of those who may have made mistakes in the past about their personal income data in order to obtain the troubling mortgages they have now) or anyone else who may like to use the fair market value subsidy to buy up a foreclosed home with no bells, whistles or any stringent restrictions attached. This will definitely cover a lot more ground than the current Housing Bill could ever do to save our economy. The potential uses and their associated economic benefits of SwapRent (SM) go way beyond the current foreclosure prevention but all these other benefits could all be established and realized in just one single set-up effort.

5. The patent pending SwapRent (SM) approach will allow the federal or local government shared appreciation mortgage providers to recycle the assistance funds. By extracting out the appreciation potential in the form of the SwapRent (SM) contracts, selling them in a secondary market to other investors and getting the capital back to benefit other potential homeowners in need, the governments would not have to use more taxpayers’ money as locked up fund to punt for potential future real estate market recovery. This new economic function of capital regeneration through a tradable secondary market that a SwapRent (SM) transaction provides to the shared appreciation component is similar to what securitization used to provide to the underlying mortgages per se in the past.

There are a lot more advantages but they are too numerous to list. Please feel free to contact us for further information. All in all it is a great thing now that the masses have to start learning and accept the generic shared appreciation concept as a viable way for housing finance going forward in the US. In short, the true housing affordability could be realized when potential homeowners learn not to bite more than they could chew. If the homeowners do not have the income ability then either they don’t buy at all or they should agree to share the potential property value gain with other people in order to live in a bigger home and to enjoy at least a part of the potential appreciation.

We have in the past two years spent tremendous amount of time to educate people about the simple shared appreciation home equity finance concept. Now that the shared appreciation genie is taken out of the bottle through the introduction of the new Housing Bill, we may no longer have to sell the simple shared appreciation concept anymore, but rather to focus on selling why the SwapRent (SM) approach is better than the conventional non-property derivatives based shared appreciation mortgages which again the Housing Bill solution belongs to. To draw another analogy again, it is like we no longer have to sell to people why mobile phones are better than fixed line corded phones, but rather only to spend time on explaining why an iPod may be better than a bulky platform shoe Motorola cell phone. Let’s hope it will be all downhill from here …

We currently offer the SwapRent (SM) Project as a licensing consultancy project to help city and county governments set up their own private label brand of homeowners assistance program since obviously the Housing Bill will not be sufficient to rescue the deteriorating city or county government finances as a result of the property value erosion. The longer they wait, continue to put the false hope on a miracle federal or state help and use it as an excuse to take no initiatives themselves to fix the local economic problems, the closer they may get to follow the City of Vallejo’s foot step. It is not private sector business’ responsibility to fix the local economy either. The free market capital will only flow to those communities that the free market investors think that the local governments do care and indeed are committed to do something about the serious problems in order to maintain and promote the local economic prosperity.

Our subsidiary REIDeX, Inc. helps the municipalities with all the transactional logistics and operational support as well as finding potential matching institutional investors so that no taxpayers’ money will ever be necessary to get their local communities and our nation out of this current mortgage mess. Here is a chance for the local governments to prove they could be better public servants than those federal folks by putting the necessary political will and managerial power behind the SwapRent (SM) plan to create an operational success, set an example for the rest of the nation and turn our national economy around.

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