Executive Essay By R o b e r t M .

Pa rd e s

The Subprime Crisis—the Path to

Helping Borrowers Lies in the Truth
U
p to now, the debate on what, if any, measures are Having spent the better part of 10 months buried in
appropriate to assist overextended homeowners (whom the morass of toxic mortgages created in the latter period
some would describe as victims, others as co-conspira- of the securitization and real estate boom, it becomes
tors) has minimized any detailed factual discussion of the full apparent that the layering of risks embodied in ill-con-
circumstances of many of the borrowers and the related loans. ceived loan products laid the foundation for a loose con-
After all, why cloud the issue with facts? The sport of debate is spiracy among some buyers, sellers, real estate and mort-
more engaging and capable of politicization when the gap gage professionals to exploit these flawed products in
between the opposing sides appears sizable and black-and-white. pursuit of the greater American dream—not homeowner-
For the sake of this debate, let’s call the opposing camps the free- ship, but a quick buck.
market advocates versus the proponents of a homeowner The common characteristics driving the alarming rate of
bailout. defaults and foreclosures are the combination of little or no
Only recently has there been greater dialogue recogniz- equity (i.e., 100 percent financing) coupled with little or
ing the role that intentional malfeasance or
fraud has played in the present and anticipated
r a t e o f d e f a u l t s a n d fo r e c l o s u r e a c t i v i t y
adversely impacting real estate markets across
the nation. This is akin to a client informing
his attorney midway through the trial that he
committed the crime—leaving his attorney
handicapped in providing the client with the
I n the case of the subprime debacle,
the political pendulum was in
best strategic representation, had he or she
known the truth in advance.
In the case of the subprime debacle, the
full swing before any practical
political pendulum was in full swing before
any practical understanding was fully devel-
understanding was fully developed
oped as to the facts surrounding the origina-
tion of the related loans and which homeown-
as to the facts surrounding the
ers were in need of, or otherwise deserving of,
assistance. This prompted politicians, regula-
origination of the related loans.
tors and other interested parties on each side
of the equation to rush to propose dramatic
measures to remediate the perceived disaster—including no documentation as to the assets or income needed to
freezes in interest rates, bankruptcy reform, a moratorium afford the purchase over the longer term. A typical sam-
on foreclosures or a taxpayer bailout. One political leader pling of defaulted loans will fall into one of the following
even characterized the crisis as requiring a bailout that categories:
called for the creation of an agency similar to the Resolu- ■ Multiple undisclosed real estate purchases accompanied
tion Trust Corporation (RTC) formed in connection with by the related undisclosed mortgages, all acquired at the same
the savings-and-loan crisis. time or within a short time frame, rendering the lender inca-
Loose references to a bailout calling for such meas- pable of assessing the borrower’s capacity to carry a portfolio
ures, in my view, is inflammatory, in that it creates of properties and a seven-figure debt burden;
visions in the minds of the public of hundreds of bil- ■ Misrepresented intent to occupy as a primary residence,
lions of dollars in taxpayer subsidies, assuring polariza- allowing the borrower to utilize the more aggressive features
tion, extended debate and flawed recommendations for of an owner-occupied financing;
resolution. Playing fast and loose with the facts has only ■ Grossly exaggerated representations of income (sometime
fueled the fire and created roadblocks to compromise, five to 10 times actual earnings) and fabricated employment to
and delayed the development of solutions that are tar- provide the color of reasonableness to the represented income
geted and capable of implementation fast enough to level; and
help the intended constituency. ■ Collusion among appraisers, title companies and sellers
R E P R I N T E D W I T H P E R M I S S I O N F R O M T H E M O R TG A G E B A N K E R S A S S O C I AT I O N ( M B A ) M O R TG A G E B A N KI N G / M A R C H 2 0 0 8
 Executive Essay
to create fictional or “straw” buyers to abscond with
the inflated mortgage proceeds.
In most cases, the borrowers had good intentions of
repaying the debt once the properties were flipped for a
handsome profit. Clearly, the group of participants
described here are not deserving of assistance and, in the
current environment, have long abandoned the desire to
keep the subject properties. With respect to borrowers
falling into the first category, one borrower may account
for five foreclosures.
After excluding the loans that fall into one of these
categories, the balance of loans held by bona-fide home-
owners comprises a much smaller fraction of the total
population of defaults. While it is difficult to provide
hard numbers, experience tells me that less than 30 per-
cent of the existing or anticipated defaults relate to
homeowners with a deep desire to preserve their home-
ownership and the economic means (even on a subsi-
dized basis) to stave off foreclosure.
What does this mean in total estimated dollars on a
nationwide basis? Well, using the often-quoted 2 million
foreclosures and a relevant average loan amount of
$170,000, we can estimate a total population of foreclo-
B
y rightsizing the issue and getting
to the facts, a persuasive case can be
made even for a diehard free-market
proponent (like myself) to consider
government intervention in the form
of a structured taxpayer subsidy.
sures in the $340 billion range—of which perhaps 30 per-
cent, or $102 billion, have borrowers who arguably warrant
assistance. Let’s assume that the economic equivalent of
proposed assistance is 30 percent of the mortgage amount.
That would leave a total cost in range of $30 billion, accord-
ing to my rough estimation.
While $30 billion is no doubt a huge sum of money for
taxpayers to shell out, it does not come close to the dollars
associated with a bailout of the savings-and-loan crisis
($200 billion in early-1990s dollars). To provide some per-
spective, it is not unlikely that the total write-offs by New
York–based Citigroup Inc. and Merrill Lynch & Co. Inc.
alone will far exceed that number. Simply put, by rightsiz-
ing the issue, a palatable solution is realistic, and fewer
resources should be devoted to rhetoric and proposals that
have far-reaching and long-term adverse implications for
M O R TG A G E B A N KI N G / M A R C H 2 0 0 8
the credibility of U.S. capital markets.
Lest I be accused of adding to the rhetoric without
offering a tangible recommendation, one possible solution
may be the resurrection of a form of the shared apprecia-
tion mortgage (SAM).
The SAM was a short-lived byproduct of the high-inter-
est-rate environment that prevailed in the late 1970s and
early 1980s. In exchange for a significant reduction in
interest rates (designed to be the “real” interest rate—mar-
ket rates less the inflation rate), the lender participated in
the appreciation of the home at the time of sale.
In the modern version, the lender (let’s say a mortgage
insured by the Department of Housing and Urban Develop-
ment [HUD]) would share in appreciation in exchange for a
principal reduction at the time of origination (say 15 per-
cent). The balance of the loss would be borne by the fore-
closing lender. Another version of the SAM would be
made available to purchasers of foreclosed properties, par-
ticularly in urban communities hard-hit by the crisis.
By mitigating a portion of the foreclosing lender’s loss,
the product would be aggressively promoted by the pri-
vate sector to the existing borrower base for redeemable
borrowers, and to prospective purchasers of the outstand-
ing inventory contributing to the oversupply
of houses for sale and urban blight.
The 15 percent principal subsidy would be
recorded as a lien on the property, but would
not be considered in the indebtedness to be
carried by the borrower during the life of the
loan. When the property is sold in the future
(and given historical expectations of apprecia-
tion in the range of 3 percent to 4 percent
over the long term), the subsidy could be
recouped at the time of sale. The creation of a
product tailored to distribute homeowner’s
assistance to deserving families and move fore-
closure inventory would serve to hasten the
liquidation of distressed assets and accelerate
recovery of the housing market.
For certain, there would be many details to
work out and/or other creative and suitable
options that could achieve the intended objec-
tives. The harsh reality is that there is no easy
solution to avoid the pain that will have to be absorbed
over the next few years to correct past excesses in the hous-
ing and related credit markets. However, by drawing on the
talent and creativity of market participants, regulators and
political leaders to quickly arrive at compromise, consensus
and practical solutions, we can avoid unnecessarily
extending the duration of the crisis while providing expe-
dient help for deserving victims. By rightsizing the issue
and getting to the facts, a persuasive case can be made even
for a diehard free-market proponent (like myself) to consid-
er government intervention in the form of a structured tax-
payer subsidy.
Robert M. Pardes is a certified public accountant (CPA) and attorney with more
than 20 years of management experience in banking and real estate finance. He
can be reached at robertpardes@yahoo.com.