Guest OpEd published by Commercial Finance Association

By SDH | Published: July 27, 2011

The following editorial opinion was published by the Commercial Finance Association in the July/August edition of The Secured Lender.  To read it at the TSL site click here.  To view a pdf version of the TSL publication click here. 

Want to Stimulate Economic Growth and Job Creation?  Try Reinvigorating Capitalism

Over the past year the budget debate in Washington has heated up – driven by an angry populist energy that screams out at our political class demanding government reform its profligate spending.  For the first time in my recollection Congress is seriously considering substantive cuts in the scope and cost of government programs.  It is understandable and appropriate.  It is commendable.  But it attacks only one side of the problem – and perhaps the less important side. 

Effective fiscal reform cannot be achieved by focusing on just the expense side of the equation.  We must demand Congress address the revenue side of our tax policies, not just because we need to generate more revenue, but more importantly because our current policies are deeply inequitable and riddled with misguided incentives. 

Incentives matter.  And the incentives currently imbedded in our tax code are stimulating speculative, non-productive trading activities, driving jobs and investment overseas, and obstructing the fluid reallocation of capital to more productive uses.  The unintended consequences of existing investment tax policies have been instrumental in destabilizing our economy.  High nominal corporate tax rates discourage domestic hiring and investment and encourage tax avoidance activities, including off-shore transfer of profitable operations.  Reduced tax rates on investment returns and deferral of taxes on “unrealized gains” subsidize low profit and loss operations, discourage capital reallocation and actively stimulate asset valuation bubbles.  We are crippling our economic engine. 

As to equity:  We lie to ourselves and pretend we have a progressive tax system, but inclusive of employment taxes, the working middle class bears a marginal federal tax burden twice as high as that imposed upon their more affluent neighbors.  Where is the public rage against this inequitable assessment of our tax burden?  Today a large part of our population argues against their own principles of equal treatment and personal self-interest because our leadership pretends employment taxes are ‘contributions”, not taxes.  But Washington, beware – someday the public will wake up to this deception and the resulting demands for change will be far louder and insistent than anything seen from the Tea Party so far.    

Why do Warren Buffett and his fellow billionaires pay tax rates only half as high as the working middle class?  Why does our society, founded on the principles of democracy and capitalism, perpetuate policies which provide preferential treatment to the wealthy, distort investment decisions, and are resulting in an ever-increasing concentration of wealth? 

Justification certainly can’t be found in the theories of Adam Smith, who advocated, “Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest in his own way, and to bring both his industry and capital into competition with those of any other man or order of men.”  I’m confident Mr. Smith wasn’t contemplating an unequal competition in which the wealthiest and most privileged among our society are subsidized with preferential tax rates. 

True believers in capitalism, who understand how entrepreneurial vitality in pursuit of competitive self-interest drives economic growth, should recognize that preferential tax policies offered to an elite class of citizens are incompatible with the core premise of capitalism.  It constitutes cronyism; and cronyism is not just ethically wrong – it destroys the vitality and benefits of capitalism. 

Effective tax revenue reform will require structural change, not just a change in rates.  But if we reform investment tax policies and eliminate the subsidies and mis-incentives that currently distort investment decisions, we can normalize tax rates between labor and investments while simultaneously stimulating more productive investment in America.  We can once again unleash the full entrepreneurial energy of capitalism. 

Douglas Hopkins

President – Kestrel Consulting, LLC

Author – A Citizen’s 2% Solution:  How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6 www.2pctsolution.com 

For an expanded discussion of a potential alternative tax structure designed to stimulate more productive allocations of our national wealth, see -

Could Higher Taxes Stimulate More Productive Investments and Growth?

Posted in Commentary, Tax Reform | Leave a comment

A Citizen’s 2% Solution

By SDH | Published: August 10, 2010

I am pleased to announce the pending publication of my new book, A Citizen’s 2% Solution, scheduled for release on August 19th, 2010. 

Commencing in the fall of 2009, appalled by the growing fiscal profligacy of Congress, I turned my 30-plus years of crisis management and analytical experience toward the federal budget process in search of more rational and equitable alternative tax policies.   My analysis led me to two primary conclusions: 

1)  America’s vaunted Progressive Tax system is a Myth.

2)  Our founders’ vision of a government composed of Citizen Representatives is being corrupted by money in politics. 

 A Citizen’s 2% Solution sets forth the analysis and reasoning which led me to those discoveries and proposes specific policy reforms which I believe follow rationally behind those factual realizations. 

First, America needs to substantially restructure its federal tax policies.  We need to flatten and reduce personal income tax rates, and eliminate the unequal treatment of preferential, complex and often contradictory investment income tax policies which facilitate and encourage tax avoidance.  I propose we replace corporate and investment income taxes with a 2% tax on net assets.  This is a strongly pro-growth proposal.  By modifying investment and business taxes to an asset-based formula, we can

  • stimulate investment and job growth,
  • remove tax penalties on productive enterprises, 
  • reduce the most regressive elements of our current tax system and shift more of the burden of government to those most able to pay, and
  • protect the long-term  stability of the U.S. dollar. 

Second, we cannot achieve real political progress unless we unlink the connection between our Representatives and the moneyed interests they rely upon to obtain office.  We need to provide public forums and funding in support of political campaigns.  Campaign finance reform is a prerequisite to improving the quality of our government. 

But more important than the specific policy proposals set forth for consideration, A Citizen’s 2% Solution is my Call to Arms to American Citizens from both parties to explore and examine these challenges themselves and then to Seek Change:

Demand a return to honest discourse in public policy discussions, and

 

Initiate debate aimed toward achieving Rational and Equitable Tax Reform. 

 

 If you share my belief in the importance and need for reforming America’s tax and fiscal policies, I urge you to explore these perspectives and suggestions about how to attack the problem. 

Posted in Tax Reform, Uncategorized | Tagged | Leave a comment

Renewing the Mortgage Credit Boondoggle

By SDH | Published: November 6, 2009

Where but Congress could you find a group of ostensibly intelligent people so willing to address a crisis situation by duplicating the original cause of the problem?

Yesterday, with only 12 dissenters, the House approved a bill extending unemployment benefits – the most notable bipartisan action taken by Congress I can recently recall. Congratulations on a job well done! The rationale and benefits of that extension surely deserved that bipartisan support.

Attached to the bill, however, was an extension and expansion of the Mortgage Credit program. Unfortunately, it’s impossible to know how many dissenters might have voiced their opinion if it hadn’t been attached to the unemployment bill.

A year ago, our mortgage markets tanked. They tanked for good reasons. Mortgage values had been actively and aggressively stimulated and inflated by policies which mistakenly valued Home-ownership above affordable housing. Since that collapse the official responses to the crisis appear to be consciously directed toward prolonging and exacerbating the problem. It seems so obvious to me that I have a difficult time in even describing these effects as “unintended consequences”. Instead of seeking to flush the collapse through the system and let values stabilize at more rational levels – the government has been directly and aggressively trying to re-inflate the bubble.

They established programs to prop up the balance sheets of major banks and investment companies by transferring private losses to the public coffers and sought to prolong the agony by forestalling foreclosures and leaving control of debt restructurings in the hands of the lenders – where incentives drive toward minimization of acknowledged losses rather than effective resolution of the underlying problem. I have not seen recent figures upon the number and value of completed debt restructurings, but it is far less than was needed or had been projected. On the other hand numbers that have been circulated indicate that re-default rates on lender restructured mortgages remain near 50% – suggesting that this approach is not only slow but highly ineffective.

The Administration and Congress tout their first time buyers’ credit as a successful program benefiting homeowners. That claim falls somewhere between nonsense and wishful thinking. The buyers’ credit is directed toward lending institutions, not homeowners. It accomplishes nothing more than inflating the price of current home purchases.

How does this happen? Are the Administration and Congress being willfully obtuse? Probably not. Certainly the politics of appeasing certain core constituencies (ie well-heeled donors) plays a role. But I attribute the basic problem more to group think. Despite the Administration’s claim that they are open to all voices, policy analysis and decisions are being driven by a narrow range of voices; Wall Street Traders and Academics, whose Ivy League educations taught them to read profit and loss statements and balance sheets but gave them little experience with the mundane nuts and bolts of the underlying transactions.

So they do what they know – tinker with complex valuation models and try to manipulate balance sheets. And they listen to each other, reinforcing their over-sized egos and misplaced confidence in too narrow perspectives.

So far their manipulations have led to a resurgence of Wall Street profits (and attendant mega-sized bonuses) but done little to stem the loss of jobs and pain inflicted on the general population.

For the record, this is not a political commentary targeted toward the Obama administration – many of the key voices and constituencies with which he has surrounded himself were prominent in the prior administration as well. But until and unless our leaders step back and broaden their circle of advisors I’m afraid all we will see is more high level manipulation attempts and no substantive progress on the underlying challenges.

There are better ways to spend our money than propping up inflated bubbles and Wall Street profits. To Congress’ credit, extending unemployment benefits in the face of double digit unemployment was certainly one of them. However, continuing its attempts to re-inflate the bubble by extending the mortgage tax credit was not.

There are also better ways to tackle mortgage restructuring than placing control in the hands of the parties more interested in perpetuating denial than acknowledging reality. As example I would urge you to examine the proposal originally circulated on February 17, 2009, and recently reposted nearby as A Citizen’s Proposal.

As any experienced workout advisor could tell you, no amount of tinkering with peripheral issues or balance sheet presentations will lead to effective change if you fail to confront and address core, structural problems.

Comments, replies and discussion will be greatly appreciated. Even more importantly, if you should happen to both 1) find any of these observations intriguing, and 2) have suitable contacts in Treasury, the Fed, or the Government – I would appreciate any introductions or referrals to contacts within those institutions who might be interested in joining and participating in such a dialogue.

SDH – 11/6/09

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A Citizen’s Proposal

By SDH | Published: September 18, 2009

A Citizen’s Proposal to Facilitate 
Rational Mortgage Restructuring

An Open Letter to:
Timothy Geithner – US Treasury Secretary

Issued & Delivered February 17, 2009

From its inception TARP (the Troubled Asset “Recovery” Program) has actually been an investor “Relief” program.  Responding to a crisis triggered by valuation uncertainty, the process was purportedly intended to stabilize lending markets by getting toxic assets off of banks’ balance sheets, a solution which could only work if the assets were transferred out at prices in excess of their intrinsic value.  Forcing prompt transactions on hard to value, highly illiquid, assets can have only two possible outcomes; either it forces distillation of losses at the current depressed values, accelerating and exacerbating insolvencies, or it transfers losses from the current holder to the buyer – in this case the Treasury and American public – thereby “relieving” investors of the costs of their mistakes.

It should have been focused on mitigating the underlying financial problems while allowing the investor community the flexibility to hold the “toxic assets” long enough to establish and/or realize their fundamental value.

In implementation, the first round of TARP actually was more rational than in conception.  The Treasury allowed Lehman, who was apparently so weak that new funds would have simply been poured into a black hole, to fail, and shifted its attention to infusing preferred capital investments into the stronger banks – assuming that increased liquidity would jump-start the credit markets while providing time for securitization values to stabilize.  It did help increase total liquidity, but unfortunately had far less impact on unfreezing credit markets than expected.

One reason why it did not have the anticipated impact is that the primary attention remains on the trading values of the distressed securities – not the fundamentals of their underlying collateral and loans, and therefore has not significantly changed the valuation of these troubled assets.  A second is that most of the investment community is focused upon how much of the trillion-plus dollars of anticipated future government spending can be siphoned off into their own pockets.  As long as the investment community can expect the government to either step in and absorb more private losses or facilitate the transfer of assets at a discount, private capital will sit on the sidelines and banks will remain reluctant to lend into an accelerating recession and continuing asset valuation declines.

Current discussions re: round two of TARP and its potential alternatives now center around  two options, both still skewed toward shifting private losses to the public coffers;  1) the original concept of government purchase (or guarantee) of “toxic assets”, or  2) forced, mass write-downs of mortgage balances with the government sharing the write-downs.  I believe both of these options are misguided.

The U.S. Government should not be absorbing or guaranteeing investor losses.  It should not be buying or making bad loans.  It should not be deferring foreclosures or propping up inflated real-estate values.  (Remember, the irrational inflation of median home prices vs median income was a key source of the underlying problem and deferring unavoidable foreclosures inflates losses for both lenders and borrowers.)  The Government should not be forcing mass loan write-downs or kick-the-can temporary debt restructurings from its vantage point at 30,000 feet.  It should, however, be facilitating rapid resolution of the fundamental imbalances between collateral values, loan balances, and ability to pay which form the core of the problem.  The problem cannot be fixed by manipulating securitization values, but must be addressed through the under-lying mortgage problems.  The objective should be resolution and mitigation of the underlying mortgage defaults.

PROPOSAL:

The Government should facilitate resolution of underlying mortgage problems by providing a source of cheap mortgage re-financing based on strict underwriting standards.  Fannie, Freddie and the entire Sub-Prime Mortgage Industry did not get into trouble because they loaned money to Bad People.  They got into trouble because they loaned too much money and ignored sound credit practices.  These careless practices generated enormous origination profits but are now inflicting pain upon both investors and borrowers.  The problem was created by the utilization of complex securitizations which disconnected both the originators and the lenders-at-risk from the underlying collateral.  Bailing out holders of these ill-conceived and destructive securitizations is not an appropriate course of action.  Mitigating damages to both borrowers and investors by providing a stable source of refinancing is a far superior approach.

The excesses and errors of past practices must be eliminated.  But until someone steps up to provide a source of refinancing with which to resolve the underlying problems, the crisis will only accelerate.  Homeowners caught up in these problems have had their credit ruined and are currently unable to obtain financing of any kind – even if they have stable incomes which could support debt financing at lower levels.

The Treasury should offer a Government Sponsored Re-Finance Mortgage program of “GSRM” loans, 30 year fixed 4% to 5% mortgages, on sound credit standards – with fixed payments capped at somewhere between 28% and 34% of verified income.  GSRM loans should be made available to any borrower who believes the fair market value of his owner/occupied primary residence is less than the value of its mortgage; loan proceeds to be used to restructure and settle both their pre-existing mortgages and any outstanding high-interest credit card debt – which has typically also been stretched to unsupportable levels.

Applicants seeking to re-finance under this program would offer a loan repurchase proposal to their existing mortgage holder with said offer subject to either prompt acceptance or a prompt, orderly and consensual foreclosure sale at absolute auction.  Proceeds from the GSRM could be supplemented by the homeowner either with equity or debt, but any supplemental debt must be subordinated to the GSRM with cash interest not to exceed 5% and no principal repayments until the GSRM is repaid in full.  Proceeds from the GSRM and any supplemental re-financing must be used to retire all outstanding mortgage liens and any outstanding credit card debt.  (There is no point in restructuring a mortgage without restructuring any high interest consumer debt held by the borrower at the same time.)

If the Mortgagee declines the GSRM repurchase offer and opts for a foreclosure auction, the existing homeowner shall have the right to use the GSRM and qualified supplemental financing to bid at the auction.

If the Mortgagee accepts the GSRM backed refinance offer or the existing homeowner prevails at the auction and retires the loan at a discount, Mortgagee shall be granted a secured interest in one-half of any equity appreciation realized by the homeowner upon eventual resale of the home.  If the Mortgagee opts to decline the GSRM offer and a party other than the original homeowner prevails at auction, then the Mortgagee shall waive its right to pursue any deficiencies against the original borrower (absent fraud on the part of the borrower).  To the extent a Mortgagee may have been induced by and relied upon borrower assets other than the home as justification for granting the loan, a Mortgagee appeal process should probably be instituted to allow Mortgage holders to petition against incurring inappropriate forced write-downs.

It should be noted that a potential obstacle to this proposal is that many securitization agreements make it difficult to identify the “mortgagee” or find anyone with authority to “accept” a restructuring or discount repurchase offer.   Reluctance or lack of authority on the part of mortgage servicers to act on behalf of mortgagees is one of the reasons recent proposals aimed at facilitating mortgage restructurings have thus far failed to gain much traction.  One benefit of this GSRM proposal is that it puts control of the process clearly in the hands of the homeowner.  If a homeowner can trigger a foreclosure sale by setting forth a GSRM backed minimum bid – it establishes a fast track to a fair market value restructuring.

I anticipate the primary outcry against a proposal of this nature will be a fear that it will depress rather than support real estate values.  Regretfully, all I can say is – it’s painful and unfortunate, but unavoidable.  The fundamental problem has been artificial inflation of real estate values.  Government policies erred in placing the goal of home ownership above that of affordable housing and were complicit in driving the unsustainable inflation of real estate values.  A reduction in both the cost of purchase and the carrying costs of home mortgages would provide a societal benefit.  Over-heating the economy by leaving real estate prices out of reported inflation numbers and encouraging consumers to borrow against artificial “equity” in their homes has proven to be an unsustainable model for growth.  The benefits of lower costs of living should provide some compensation for the decline of this fictional home equity.  If it is coupled with and constrained by sound credit practices, the availability of affordable mortgage borrowing will guide market valuations to a fair equilibrium.

A second complaint could be concern that this program invites the discounted refinancing of mortgages that would and should otherwise continue to perform.  I don’t believe it will.  Few homeowners will willingly put their homes at risk by submitting them to an absolute auction and cede the rights to 50% of any future appreciation, unless they are truly already at risk and significantly underwater.

The third outcry would likely be its costs and inflationary impact.  Here I have two replies.  First, the inflationary impact of making good loans is certainly far less than that of absorbing other people’s losses.  Second, I would strongly urge that Government backed mortgage assets be held in trust as property of the social security fund.  The liabilities are already there.  We just pretend that they’re not.  I concede the government will indeed print money to fund the program.  But it will receive assets in return, and the liabilities that are the real source of inflationary pressure already exist in the social security obligations, we will simply be moving them onto the Treasury’s balance sheet.

Every dollar of mortgage debt repaid will create new liquidity in the financial markets.  If the Treasury writes $300 billion dollars in sound credit-worthy GSRM loans, it will not only resolve the underlying mortgage problems for the related borrowers and illuminate the valuation uncertainties for the corresponding securitizations, it will infuse $300 billion back into circulation – all of which will need to be reinvested, and some of which will find its way back into treasury notes, helping to finance the program.  Therefore, I believe that the positive benefits of a program like this would be greater, and the net inflationary pressure would be less, than under any other alternative funding mechanism.

The primary downside I see is that it will certainly disappoint those members of the investment community who are salivating over the prospect of converting substantial portions of the anticipated government deficits directly into their private profits.

To the best of my knowledge, very little of what I have set forward above has received any public discussion or consideration.  I would welcome a dialogue or discussion on the concepts set forth.

************

As perspective – the author of the proceeding proposal has spent most of his life being studiously a-political.  He has provided turnaround and crisis management consulting services to middle market companies for over thirty years, including the workout of a large mortgage portfolio in the 1980’s, and is co-author of “Crafting Solutions for Troubled Businesses”, published by BeardBooks.

Posted in Mortgage Restructuring | 3 Comments