Taleb’s Fix for Housing: Convert Debt to Equity
Nassim Taleb, the author of the Black Swan and Fooled by Randomness, has a proposal to fix housing: Convert most of the debt to equity:
“The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.
It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialise in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.”
The entire piece is worth a read . . .
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Source:
Time to tackle the real evil: too much debt
Nassim Nicholas Taleb and Mark Spitznagel
FT, July 13 2009
http://www.ft.com/cms/s/0/4e02aeba-6fd8-11de-b835-00144feabdc0.html
July 14th, 2009 at 6:43 am
When banks have equity, they are landlords, homeowners are renters, and there’s a whole new dynamic in the property tax world.
This real estate bubble is a learning experience, people will be much more cautious in the future. As foreclosures dwindle, the system heals. No need to turn the real estate-forced-savings for Americans on its head.
July 14th, 2009 at 7:01 am
Wut? The solution to cratering home prices is to induce banks to trade a questionable stream of future cash flows for an equity instrument that – in the aggregate – is guaranteed to lose value in markets such as Vegas and Phoenix? Again, it’s early Barry, but I’ve actually had my coffee this morning and I can’t see how this does anything but push paper around. The way that bankruptcy laws are written, the de- leveraging taking place will wipe out all kinds of debt and ensure that only the most credit-worthy buyers become homeowners for a decade, effectively accomplishing the same thing Dr. Taleb desires, albeit in more punitive terms for consumers.
I’ve made the modest suggestion, not wholly my own, that we flip the script in the tax code and make principal payments on car and home purchases tax deductible subject to a progressive scale that eventually phases out the breaks (I don’t think any thinking person wants millionaires buying McMansions and getting a write-off for it). Doing so would make people more circumspect about their purchase decisions, deflate our debt culture and create a rising tide for the low and middle class. You could even structure it so that if people tried to game the system by using one type of debt to pay for another (i.e. running up their plastic to pay down the car) the tax break would be offset dollar for dollar against the revolving credit lines.
Jus’ sayin’
July 14th, 2009 at 8:21 am
What would this look like? Liens on property that lie dormant until the homeowners buy the equity back or sell? That encumbers the RE market.
And obviously banks would want to be able to cash out at a discount on a secondary market. Would equity be combined with the mortgage revenue stream in a single instrument? And what is the banks’ remedy — foreclosure? Doesn’t that bring us back to where we are now as a practical matter? A distressed sale is a distressed sale. This is too theoretical for me, I guess.
July 14th, 2009 at 8:24 am
Taleb has now succumbed to the same sin as the economists he so despises: hubris and arrogance.
July 14th, 2009 at 8:28 am
…meanwhile, Eliott Spitzer provided some very frank and honest commentary on Bloomberg this morning…Maybe you can put that up…
July 14th, 2009 at 9:02 am
So does this mean the bank gets to mow my lawn and put up a fresh coat of paint when it’s needed? There is no solution other than going through a severe debt/credit crises. The debt must be written off. If the banks actually owned the equity in the homes, the individuals in said homes wouldn’t really care about the appearance or upkeep–”no skin in the game.” One of the hidden costs of “home ownership” is the big maintenance bills, something not included in those optionARM loans….
Also from yesterday…this was sort of predictable I guess….
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Andy T Says:
July 13th, 2009 at 3:08 pm
CIT bonds trading very heavily today….huge losses…..but guess who’s the biggest bondholder?
Not surprisingly it’s Pim(p)co. My guess is that Tim Geithner comes up with some kind of plan to save CIT…..It’s strictly forboden that Pim(p)co can lose money….
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July 14th, 2009 at 9:12 am
… provided they can police themselves (HA!) or rather that some way could be found to audit this process to prevent banks from “buying out” desirable properties using a variety of techniques, most of which would be designed to push the homeowners deeper and deeper into unsustainable levels of debt, all the while hollowing out their home equity, until the homeowners were transmogrified into renters in the fullness of time, without any protection from the rapacious banksters … this scheme presumes the banksters to be honest, upstanding corporate citizens, intent only on grinding out a bit a profit for their stockholders. A glance at teh headlinesa over the past years should dispel THAT notion.
It’s bad enough that a borrower has to be on the lookout for treachery amid an impenetrable fog of lending offers (especially when virtually no sound, solid loans are being offered), but to then require the borrower to assess whether the kindly, genteel bankster facade conceals a corporate Hannibal Lecter seems a bit much to me.
Have we learned nothing about the need for mechanisms to police the corporate community?
July 14th, 2009 at 9:15 am
I agree with Byno, I don’t really understand how this is a real solution.
The idea of giving the tax deduction for p payments instead of interest on the home, deductible p payments on a car I would think would also help the auto industry sales in the near term given many households are almost certainly facing a tax increase in the coming years.
July 14th, 2009 at 9:28 am
I think a massive intervention by the executive is necessary to cut the Gordian Knot and do a reset. I don’t see the sense in Taleb’ proposal. I don’t expect the empty suits in charge have the clarity of thought and decisiveness to do what needs to be done.
The answer is still to strong-arm lenders into re-underwriting mortgages in exchange for federal guarantees that make a percentage of renegotiated mortgages recourse loans that are nondischargeable a la guaranteed student loans.
July 14th, 2009 at 9:30 am
>>It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy.
Not so much SAD as completely and absolutely insane.
July 14th, 2009 at 9:30 am
I’m with Byno too (I think) sounds simpler .. and I think the tax code should start treating a family unit like a business or corporation .. ie business expenses of living are tax deductable .. a equilibrium will develop to a fairness for all*
coda* – since we will not develop a new system all together .. that removes a cash payment for labor to buy stuff to live with
ps – I copied this from the link:
“We need to do the opposite to what Mr Greenspan did: make the economy’s structure more robust to bubbles.
The only solution is to transform debt into equity across all sectors, in an organised and systematic way. …. banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming binary in default or not it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action.”
I intended to ask what you all .. in more detail (sop) what that meant? .. and the comments so far have helped
July 14th, 2009 at 9:33 am
Please, we need to SIMPLIFY the tax code, not complicate it… mtg interest never should have been a deduction in the first place! that was one of the feeding tubes of the housing bubble…
July 14th, 2009 at 9:50 am
karen,
I agree completely that the mortgage interest deduction was one part of the problem with the housing bubble as well as the fact that the tax code is too complex.
that said, I think by taking away the mtg. interest deduction and switching it to a p payment deduction it doesn’t make it any more complex and I’d like to think it also promotes financial responsibility. Maybe I’m not thinking it over enough.
July 14th, 2009 at 9:59 am
Little problem… those 60-100K granite kitchens… well, they won’t be worth 60-100K in 10 years unless there is huge inflation.
We’re not looking at producing assets here, we’re facing depreciating assets (apart from the land) that will need future resources to maintain.
Debt to equity conversion just look like alchemy to me.
July 14th, 2009 at 10:07 am
We have an excessive supply of homes. We need the world’s best & brightest to move here. We currently forbid that by way of caps in immigration quotas. We need to get out of our own way.
Similarly: Robert Prechter gave testimony before his state’s (Georgia’s) legislature that they should do away with property taxes entirely. Why? To cause a influx/flood of businesses and people into their state, thus creating strong demand for both housing and commercial properties.
We may yet see the states engage in this sort of rob-Peter-to-pay-Paul behavior, but it’s simply what nature has had in place for quite some time: natural selection. Done on a grander, national scale — with strong selectivity for the best & brightest — and we may be able to pull out of this.
July 14th, 2009 at 10:13 am
(1) Do you believe we we still facing catastrophic collapse fed by declining RE prices and unemployment?
Rather than a Yes/No answer, the more “correct” answer is probably a probability.
(2) Would a decisive and massive federal intervention in mortgage lending reduce that probability?
For example, although the banks and Fed argue that redefault is as high as 50%, when you are not talking trivial numbers of renegotiations (130,000 over a three year span from 2005-07, for example) but are talking millions of renegotiations, then 50% success rate (albeit an underestimated figure) is worth the cost for the public good in a time of crisis. And further, you are defining “renegotiation” to mean re-underwriting pegged to prevailing market pricing including reductions in principal and excluding opportunistic borrowers by implementing screening.
IMO folks need to segregate blame from exigency. Blame is appropriate for criminal prosecutions and careful post mortem of how we got here and how we can prevent it in the future. Exigency is a multi-trillion dollar bubble just collapsed/continues to collapse largely as a result of failure to appreciate risk by borrowers and lenders alike.
The bubble values should be pushed out of mind as too temporary/illusory to be meaningful. An outlier event. All those thoughts of market efficiency and fairness? Irrelevant in the context of crisis management.
July 14th, 2009 at 10:14 am
Abolish property taxes and institute a flat income tax? At least you’d know how the deck was stacked…
July 14th, 2009 at 10:26 am
Here here to the folks talking about a simpler tax code…..
If you want more of something, then subsidize it. If want less of something, then tax it. Period. But, what happens when you subsidize something (mortgage interest deductions) but then tax the same asset (property tax)? Well, you just get a bunch of layers of government created in order to deal with all the various tax schemes as well as an accounting profession created to help avoid/navigate the tax schemes. Wasteful all around….
There should NEVER have been a big mortgage interest deduction…it definitely juiced things and almost forced “on the fence” renters into buying a non-performing asset that could later become a liability. (Need to move in order to get a job? Forget it…you can’t sell your house.)
July 14th, 2009 at 10:51 am
“Please, we need to SIMPLIFY the tax code, not complicate it… mtg interest never should have been a deduction in the first place! that was one of the feeding tubes of the housing bubble…”
“Abolish property taxes and institute a flat income tax? At least you’d know how the deck was stacked…”
nice points~ karen.
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uno,
you too, that piece from Prechter, especially..I keep telling the Politicos, here in Allentown, that need to draw a circle around Downtown, call it a Tax-free (property) Zone, add, their allowed, 1 % to the Sales Tax, stand back, and let it roll..
but, much to AT’s point, this–”…when you subsidize something (mortgage interest deductions) but then tax the same asset (property tax)? Well, you just get a bunch of layers of government created in order to deal with all the various tax schemes as well as an accounting profession created to help avoid/navigate the tax schemes. Wasteful all around….” Truly, seems to be their ultimate goal..
July 14th, 2009 at 10:56 am
@uno lmao at the idea of all these underwater homeowners desperately trying to sell so they can move to Georgia and not pay taxes on their next underwater home.
July 14th, 2009 at 11:05 am
@Outlier: Only a small fraction of the nation is actually underwater (have negative equity) in their homes.
To be sure, it’s a vocal, media-connected group of people (CA, NY, etc.)…but about 30% of the nation’s homeowners actually ‘own’ their homes outright. And they pay taxes on them. And they don’t like that.
July 14th, 2009 at 11:15 am
What is the problem here? Why do we have to become contortionists for solutions?
Reduce principle to market value, reduce interest rate, if the homeowner still has a job, this should be enough to keep them in their home.
Banks and investors take the loss. Simple, fair, and no cost to taxpayer.
July 14th, 2009 at 11:21 am
yeah I’m aware of that, was just a flip remark that points to a larger issue which is that demand creation is a very complicated process. Lower costs of course does increase demand in many circumstances, but it’s not a linear relationship and in fact in some cases increasing costs increases demand. See for instance errr the entire last real estate bubble, and/or the entire island of Manhattan south of 110th St. As for Manhattan above 110th, if memory serves me right there was a very good case study on tax incentives not working very well in Harlem maybe 20 years ago. You don’t just magically cut taxes and create demand, especially with something like real estate where you don’t just have to live with your decisions you actually tend to live inside of them…
July 14th, 2009 at 11:24 am
On a different note, anyone remember a recent interview with Taleb where he mentioned he was thinking a lot about Islam’s ban on debt and the various financial solutions that emerged to take it’s place within that world? Maybe it was that big Will Self piece? This particular piece of his seems to stem directly from that line of thinking, no?
July 14th, 2009 at 11:29 am
@mknowles,
I’m not sure it’s this simple:
Reduce principle to market value, reduce interest rate, if the homeowner still has a job, this should be enough to keep them in their home.
I saw a chart not long ago that showed that many of these homeowners that are still in a major pinch have excess of 30% of gross income going towards the mortgage payment in many cases, and that doesn’t factor in the debt payment as a % of gross income on other debts such as auto and student loans or credit cards. You couple that with the fact that many households have to spend a very high portion of their income on needs items such as food and energy and I’m not sure it’s so simple to just reduce principle to market, even doing that reveals many of these homeowners still can’t afford at the current price.
How low can you lower the rates anwyay? Weren’t a lot of the borrowers that ended up in foreclosure already paying extremely low rates on some sort of ARM?
Sadly if banks take the loss as you state above, I don’t know why you’d believe there would then be no cost to the taxpayer, we already are paying for the subprime mess the banks helped create.
Maybe you have some data that would show your solution would actually work?
July 14th, 2009 at 11:31 am
@mknowles:
Exactly. My contorted presentation of what you stated very succinctly anticipates the crap that the banks and Fed are throwing at the issue.
July 14th, 2009 at 11:35 am
I’m not sure Prechter’s idea would work either.
Home ownership after all is about much more than the taxes, or lack thereof. I might prefer to pay a few thousand a year in property tax for example to live somewhere where it isn’t so hot in the summer. Seems simple but stuff like that is a main consideration for a home purchase, the property taxes, unless extremely high, are typically not the main reason people buy a certain home.
July 14th, 2009 at 11:41 am
@ben22: read the Boston Fed white paper posted yesterday. 50% success rate is the Fed’s own worst-case figure. The data supporting win-win benefit to all parties is not otherwise in doubt.
July 14th, 2009 at 11:43 am
@mknowles:
We’ve already seen 57+ bank failures this year. Write homes down to ‘market’ (whatever that is, and wherever that stops) and you’ll see GreatER Depression fairly quickly. You can’t hammer the banks, much as they are culpable in this matter, and not see credit completely dry up and blow away.
Banks are in reality a quasi-governmental thing, m’lady. Witness the various bailouts, including Citi. And when/if the internally-funded FDIC becomes the taxpayer-funded FDIC, taxpayers will pay in spades for domino-falling bank failures.
At the end of the day we’re dealing with a cash crunch during a monumental de-leveraging (de-loaning) period of time. Short of a revolution (likely inadvisable), you can’t fix that by blowing up the banks (likely enjoyable).
July 14th, 2009 at 12:01 pm
can we Remember that Businesses pay ‘Property Taxes’, as well? and, with that, at Higher Rates, usually, than ‘Homeowers’ ??
July 14th, 2009 at 12:05 pm
Transor,
Thanks, I’ll check that out. Though, last time I read a worst case scenario, which was in the Stress Test report, it wasn’t exactly reality based.
I’m with uno on the bank comments towards her as well. As much as we’d all love to see the banks eat it on these, does anyone really believe that
a. that is going to actually happen and
2. that if it did happen it wouldn’t do anything but lead to more pain for the average Joe
the size of our debtload should help people understand and grasp how desperate many households are to access credit on a regular basis.
July 14th, 2009 at 12:53 pm
@ben22:
50% as worst case in the sense that half of defaulting borrowers relapse after “renegotiation.” But take a good look at how that term is used by the Fed. The 50% rate was supplied by Barclay’s in a different piece and applies to Countrywide…
No one suggests the banks be “blown up.” The fact is the recovery on foreclosure is lower than preserving the revenue stream by making the terms affordable. But uno accurately points out that the banks are clinging to relaxed accounting rules and mark to model to boost balance sheets. Thus their accounting fiction fig leaf is threatened. That can be addressed in0 various ways, federal guarantees being just one.
IMO all of this that I’m proposing is academic if you rate the risk of further systemic collapse due to foreclosures as very low.
July 14th, 2009 at 2:30 pm
The answers aren’t that difficult. There are plenty of smart people who can come up with answer. But, tax deductions only work if you have a job or if the home is actually not vacant. Given the enormity of those problems coupled with the amount of people who don’t even pay taxes when the is decent let alone today, and no solution involving the tax code will work.
A simple solution would have just been to use the HOLC recommended by Blinder. Schiller has come up with ideas as well. Being able to suspend payments, reduce payments, increase payments according to ability to pay. Another solution would be to nationalize the mortgage business (the vast majority is anyway) and do a one time price adjustment and simply write it off of the government books. ie, Monetize it. It won’t cause inflation but the government would be forced to re-institute fiscal discipline because the market would demand higher rates.
There are hundreds of solutions. That isn’t the problem. The problem is that there is no political leadership beholden to the American people. Only to the crooks.