WHY OWN WHEN YOU CAN LEASE ? / THE NEW YORK TIMES OP EDITORIAL

August 1, 2009

Op-Ed Contributor

Why Own When You Can Lease?

By DANIEL ALPERT

BY providing financial institutions with enough capital to survive (and even thrive) over the past year, the federal government prevented the global economy from grinding to a halt. But it may also have unwittingly encouraged banks to slow the resolution of delinquent, defaulted and underwater loans secured by homes and commercial real estate. Such “extend and pretend” behavior does little except delay losses — which helps explain the recent crop of prediction-beating, market-rallying bank earnings reports — while prolonging and worsening the damage done by bad loans.

Just this week, the White House met with a gaggle of mortgage company executives to discuss why their loan modification programs have been so ineffective. In fact, a recent study by the National Bureau of Economic Research illustrates that these programs haven’t been ineffective so much as unused: only 8 percent of seriously delinquent borrowers have received any form of mortgage modification and fewer than 3 percent of such borrowers received a concession on principal or interest payments from their lender. By contrast, about 50 percent of those seriously delinquent loans had foreclosure proceedings initiated against them. That’s a record rate of 1.9 million foreclosure filings in the first half of this year.

Banks, of course, typically lose more money by foreclosing on a home than by renegotiating the principal of a loan — but, as foreclosure timelines often run 12 to 18 months, that loss takes far longer to show up on their balance sheets. As a result, banks are pushing the mess (and the attendant additional losses) well into 2010 while they maintain the fiction that borrowers will be able to repay severely underwater loans in full. Banks are even beginning to turn down borrower requests for immediate “short sales,” in which homeowners sell for whatever they can get and then give all proceeds to the lender, because this, too, means that the bank must record a principal loss at once, rather than down the road.

The sheer magnitude of the debt bubble — doubling to $11 trillion in home loans and adding tens of trillions in total American debt in the past decade — along with the collapse of real estate prices, make it extremely unlikely that any of these houses will recover their value soon enough to mitigate the losses embedded in banks’ balance sheets. And by stretching out the time over which banks will continue to have their capitalization hit by losses, banks cannot soon fulfill their mission of providing new capital for the recovery and growth of the economy. Fearing for their own solvency, banks are instead salting away enormous, record-setting reserves.

To put the bubble behind us, we need to place mortgage lenders on a path to settling up with underwater homeowners. One of the few viable ways to do this is for banks to accept the voluntary surrender of deeds and then lease the homes back to their former owners. The former homeowners should then retain a right to purchase their homes back at fair market value, after, say, five years, during which time they would need to get their financial affairs in order.

Congress could pass legislation, within the bounds of constitutional protection of contracts, that would require lenders to provide such a lease-back arrangement to any borrower who wants one. The former homeowners would pay rents set in accordance with local rates (which in almost all cases would be considerably lower than the total of their former bubble-era mortgage payments, taxes and insurance premiums).

Homes subject to such lease-back arrangements might also enjoy some unique tax benefits, like accelerated depreciation, and be eligible for mortgage financing from Fannie Mae, Freddie Mac or the Federal Housing Administration. This would spur an investment market that would help lenders get the properties off their balance sheets by attracting investment in leased-back homes.

Those homeowners who are gainfully employed and less underwater require a different solution. The administration needs to move beyond a policy encouraging mere payment modifications and toward one pushing hard for a renegotiation of principal based on lower, post-bubble values. In exchange, lenders would share in any eventual sales profits — a restructuring similar to the debt-for-equity swaps imposed by the government on some creditors of General Motors and Chrysler.

If banks can’t bring themselves to do that, then the loans should be sold to those of us in the private sector who will. That’s what the firm I work for is already doing: buying the few distressed loans banks will sell and offering principal modifications that help keep people in their homes.

I realize I am proposing the biggest controlled debt restructuring in history, and I expect none of these suggestions will be welcomed by banks, which would be forced to recognize their losses sooner rather than later. Nevertheless, banks need to be freed of the bad loans embedded in their balance sheets — if not for their need or willingness to do so, than for the economy’s need to have it done.

Daniel Alpert is a managing partner of an investment bank.

Copyright 2009 The New York Times Company