Thursday, April 16, 2009

Could SwapRent stop the foreclosure crisis?

Posted on American Banker's BankThink by Emily Flitter:

In the swarm of ideas for how to stop the financial meltdown, there’s one from a small company in California that seems to have gotten lost in the mix—a tragedy for the country, according to its creator. Though there are obvious barriers to the scheme’s success, it’s worth asking whether Ralph Liu’s SwapRent product, reviewed in a report by the Aite Group this month on new financial products, could really stop home price depreciation.

Liu, who founded Advanced e-Financial Technologies, Inc. to develop the product, says it could not only stabilize the housing market; he claims SwapRent could also halt the slide in the fair value of mortgage-backed securities as well.

Technically, SwapRent is a derivative with a home as the underlying asset. It allows investors to take a stake in the future appreciation of home values without actually purchasing a property. Instead, an investor and a borrower sign an agreement saying that the investor will pay the borrower a fixed monthly sum of cash in exchange for a percentage of the eventual sale price of the house.

This, Liu argues, is the way to solve the foreclosure crisis. Borrowers who are delinquent on their mortgage payments can sign agreements with investors for extra cash each month, while still maintaining ownership of their homes. They also maintain a share in the price growth that many believe is an eventuality in the housing market. Instead of getting 100% of the value of a home upon its sale, however, a borrower who signed a SwapRent agreement would only walk away with 50% (for example).

Liu’s idea may not go over so well with politicians, and Liu himself seems like he needs a lesson in finesse. “The more generous, the more dumb the government acts,” he explained while walking BankThink through the SwapRent concept, “the more people will sign up to participate in this.” He said he thinks the government should use some of its bailout money to start signing SwapRent agreements with borrowers and should then try to recoup the money—with a profit—by selling the agreements to investors in a secondary market.

Each agreement signed would greatly reduce the chances of a foreclosure, since the borrower would have extra cash to pay his or her mortgage, Liu reasoned. The value of structured products backed by the mortgages would increase, too, once the mortgages in a given product were fortified by SwapRent agreements.

In contrast, Liu told BankThink, the Treasury Department’s public-private investment fund concept is riddled with “downstream problems,” and won’t do much to turn the tide of the crisis. He blames “politics” for the lack, thus far, of interest among government officials in his plan, but remains hopeful. “People have to learn, you know,” he said.

And it’s true. SwapRent, especially as it is described on Liu’s company Web site, is hard to follow. But stick with it and it somehow makes sense.

“Everybody knows what it is—it’s a public secret,” Liu said of his efforts to interest state governments and the Obama administration in the plan.

But the description of SwapRent did not ring a bell to an advisor to the federal government on housing policy. “I was intimately plugged into the development process” of the Obama administration’s foreclosure prevention plan, said the advisor, who wished not to be named, “and I don’t recall any idea of this sort being mentioned and certainly it was not discussed.”

A call to the office of Calif. Assemblyman Ted Lieu, D-Torrance, drew a similar blank. “It sounds like a good idea,” a spokesman said, “but I’ve never head of it.”

SwapRent’s creator Liu has received some recognition: He led a panel at Harvard Business School on housing derivatives last year, and he presented the idea to a housing finance conference called “Beyond the Crisis” at the Milken Institute Financial Innovations Lab. He also had some near misses with banks last year—he was trying to sign up IndyMac Bancorp to the idea before the bank went bust last summer, and he claims to have “almost” scored a deal with Citigroup before the crisis hit. But press coverage has been scant since Liu’s idea morphed from that of a quaint, rather hard to grasp hedging tool to a possible fix for the massive foreclosure crisis.

Perhaps Liu should redouble his outreach efforts. With foreclosures continuing to rise and loan modification efforts hardly making a dent in the problem, it isn’t hard to imagine that policymakers might be more open to wacky-sounding solutions than they were even six months ago.

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