Bostock Williams PDC (UK) – House Property Search.
                 Adrienne Harte–Davis - Chance Dice Lottery Ticket.

This ambitious post will:

• Describe the latest prospects for mortgage modifications and their potential effectiveness;
• Review the massive size and use of extracted homeowners’ equity that halted when the housing bubble popped; 
• Sketch out the potential economics and attractiveness of a national housing lottery that could fund targeted homeowner relief and encourage consumer spending; and
• Estimate the number of homeowners that could be helped with a lottery-funded modification program.

We will move quickly.

Citi – SITTING PRETTY?

Mods (i.e., modifications of mortgage loans) are much in the news.

The New York Times headlined on Friday, 9 Jan that Citigroup ( a TARP recipient) would be the first to break with other members of the Financial Services Roundtable.

As reported, Citi will support legislation permitting bankruptcy judges to modify the principal payments, rates, or other terms of existing mortgage loans. Lenders would have no say in, and would be forced to shoulder the costs of, bankruptcy-court-blessed mods.

It might have been difficult to predict that Citi would be the first to assume this position. But you could have foreseen this conflict between:

1. Lenders’ opposition to bankruptcy reform; and
2. Ineffective modification programs.

DBRS’ Kathleen Tillwitz did. On Monday, 5 Jan she released Is More Debt Forgiveness On The Horizon, reviewing year-end  figures on the performance of modified loans:

• … After 3 months, nearly 36% of the borrowers who had … [modified] their loans… had re-defaulted by being more than 30 days past due. After 6 months, the rate was nearly 53%, and after 8 months, a staggering 58%. [emphasis added]

The most recent data indicate that subprime modifications had been occurring at a pace of 30,000 loans per month. The DBRS report contained the following chart on subprime modifications:

Figure 1: Subprime Loan Mods By Type, DBRS – Is More Debt Forgiveness on The Horizon, 5 Jan 2009.

The chart demonstrates that “very few servicers’ [modification programs] used a principal reduction feature” [the red bars in chart] and this may have contributed to the “staggering” re-default rate.

Tillwitz suggested that banks, in an effort to limit the use of bankruptcy-blessed mods, might attempt to reduce re-default rates by being “more aggressive in using principal-forgiveness modifications in an effort to prevent borrowers from declaring bankruptcy…”

LOTS OF LUCK

Future events will determine if Tillwitz’ prediction is “on the money.” Unfortunately, the latest  research suggests that even under-utilized principal forgiveness programs may not prevent the bankruptcy of heavily indebted borrowers.

The American Economic Association held its annual meeting last week in San Francisco.

Three economists (Hankins, Hoekstra, & Skiba) presented their paper, The Ticket to Easy Street? The Financial Consequences of Winning the Lottery. They looked at heavily-indebted lottery winners who received significant prizes (between $50,000 and $150,000, large enough to pay off all of their debts) to see if this money prevented their bankruptcy.

Their findings should challenge plans to provide “additional resources to heavily indebted individuals with the hope of increasing their longer-term financial well-being.” Specifically:

• …While recipients of $50,000 to $150,000 are less likely to file for bankruptcy immediately following the receipt of the cash prize, this [merely postpones] … bankruptcy as it is followed by an increase in bankruptcy rates three to five years after winning…
• [This] suggests that winning the lottery does not yield longer term benefits with respect to avoiding financial disaster…

PICK A NUMBER

If principal forgiveness programs won’t work, what will?

Recall that borrowers cashed-in their “home equity” winnings during the post 9/11 housing boom that occurred despite no real increase in household income. (See No Pace Like Homes & No Place Like Homes  for the details.)

As noted in “No Place…”, the Fed’s Greenspan and Kennedy:

• …Focus[ed] on one of the key factors driving the US economy in recent years: the sharp rise in housing valuations and the associated buildup in mortgage debt…
• This enormous increase in housing values …  left households with a substantial pool of available home equity…
• Home mortgage debt is thus … funding … some consumer outlays originally financed by [banks’] extensions of credit card and other consumer debt …

Chairman Greenspan, American Bankers Association Annual Convention – Mortgage Banking, 26 Sep 2005. 

The Fed continues to update the figures contained in Greenspan & Kennedy’s Working Paper 2005-41. Let’s see what the end of the “housing lottery” bonanza means for the macro economy.

 
Figure 2: Annual Net Equity Extraction, Federal Reserve
(2008 my estimate, based on 08Q1). 

 
Figure 3: Personal Consumption and Repay Non Mortgage Debt, Federal Reserve,
(2008 my estimate, based on 08Q1).

Figure 4: Comparison Average 2001 – 2007, with Rough Estimate of 2008, $Billions.

These figures suggest that the end of the housing boom produced, in 2008, something like a $200B “hole” in consumers’ pockets. They cannot extract anything like the $251 B per year that they previously pulled from their appreciating homes to either:

1. Pay down non-mortgage debt (e.g., existing credit card loans); or
2. Buy stuff.

It will be extraordinarily difficult to replace this cash, particularly as the 2009 economy continues to weaken.

RUNNING NUMBERS

I wonder if a national lottery might recapture at least some of the good times that prevailed before the “housing music” stopped.

The seed money could come from assessments associated with, among other things, financing of new home loans and cars. To date, TARP/bailout funds have been confined to mortgage and auto lenders, but have passed over the borrowers.

Consider the numbers.

Figure 5: Estimated 2009 Mortgage Originations.

Experts expect (see above) that just under 9 million mortgage loans will be originated this year.

Suppose that these roughly 9 million borrowers each received - in addition to a mortgage used to purchase a home or refinance an existing mortgage – one thousand  $1 lottery tickets to be issued under a new Federal Housing Lottery - “HomePower.”

The cost of these tickets could be paid either as an additional closing fee or could be added to their mortgage balance.

[Note: A similar tax was imposed to pay for the Spanish American War, which was partly financed by a telephone tax (see link) that lasted from 1898 – 2006.]

Consider how this would increase their monthly payment if borrowers did NOT pay for their prize tickets up front. To keep things simple, let’s assume that everyone financed their mortgage with a 6.00% 30 year fixed rate mortgage.

Figure 6: Bankrate Mortgage Calculator

As Figure 6 indicates, borrowers’ payments will increase by $6 per month. Can they, or you, afford this? Sure, why not. So what does this $1000 buy in terms of prizes? Well, since there could be about 8.9 million mortgages in 2009, $1000/loan creates an $8.9 billion gross pool.

HERE’S THE TICKET

Given lottery economics, only a portion of this goes for prize money. The following table breaks down the typical state lottery buck:

Figure 7: Lottery Money Breakdown, Reason.

Let’s suppose that the Feds are not any more efficient than the states with respect to lottery administration.

This means the annual prize pool, IF it were funded solely by “HomePower” closing fees, would be $4.45 billion, or about $370 million/month. However, as can be confirmed by a quick peek at either the Megamillions or Powerball websites, lotteries do NOT advertise the present (i.e., one time lump-sum) value of their prize, they promote the sum of the annual prize payments, which stretch more than 25 years into the future.

Based on today’s Powerball economics , this converts $370 million into a $590 million monthly “HomePower” lottery prize. Got your attention? You betcha.

About 10 million vehicles will be sold in 2009.  The collection of - say - $25/car or truck, in exchange for 25 “HomePower” tickets, would add $250 million – gross – to the annual pot.

Since two of the formerly “Big 3” US auto companies have poked their hands into the TARP bucket, they should be just as agreeable to this as Citi was to bankruptcy reform. The other domestic and foreign steelbenders will have to go along for the ride.

After allowing for the noted monthly-payout conversion factors, you end up with an additional $17 million/month in the “advertised jackpot” - pushing the total monthly pot to more than $600 million/month. This is getting really interesting.

Given Americans’ aptitude for math, at least some of the 300 million of us will figure out, sooner-or-later, that a “$600 million lottery jackpot is a lot of money.” Many will soon be lining up to buy “HomePower” tickets, whether or not they intend to take out a mortgage or buy a car.

Megamillion’s 12  states (CA· GA· IL· MD· MA· MI· NJ· NY· OH· TX· VA· WA) contain about half of the US population and/or income.  Recent jackpots for these states have averaged about $100 million. So, for a national “HomePower” lottery, let’s double it – $200 million/month. After you add this to the “fee-based” pot associated with mortgage loans and vehicle sales, you end up with a monthly jackpot of $800 million.

The $800 million is convenient, since it should permit the “HomePower” lottery to avoid one of the most pernicious aspects of smaller lotteries – regressivity.

Lotteries are vulnerable to the charge that exploit the poor or poorly educated.   But Emily Oster of Harvard was the first to examine the demographics of large jackpot lotteries.

In Are All Lotteries Regressive? Evidence from the Powerball, she examined whether the regressivity of a lottery changes with variations in jackpot size.

Using Powerball data from Connecticut - “a state with a wide range of income levels” - she determined that:

• Lottery regressivity decreases as the size of the jackpot increases, perhaps because richer individuals are only willing to play at higher jackpots; and
• Lotteries become progressive when the jackpot reaches $800 million (precisely the figure previously calculated for the national “HomePower” lottery).

Emily Oster, Harvard University - Are All Lotteries Regressive? Evidence from the Powerball, 2004.

All of the above, of course, refers to the economics of what would be an $800 million per month national lottery “jackpot”, i.e., about $500 million per month in “lump sum” terms.

This suggests that the direct government take, i.e., the “government programs” in Figure 7, would be about $350 million per month. Finally, income taxes on the $500 million per month would contribute something like an additional $175 million per month.

If America were to roll out a national lottery, as described above, it could produce a monthly lottery “jackpot” of $800 million. In addition, the government would collect an additional $525 million a month in “Program” costs and tax revenue. This money would be available to finance focused homeowner relief programs:

Figure 8: Monthly HomePower Lottery Breakdown and Federal Revenue

COUNTDOWN

I’ve worked up a rough estimate of what $525 million per month might “buy” with respect to the number of modifications in the following tables. 

 

Figure 9: Monthly Number of HomePower Financed Modifications

Let’s begin  with the assumption [see Lines 11 to 14 of Figure 9] that modifications will be somewhat less expensive than a foreclosure, at roughly one-half to one-third the direct costs of a foreclosure, as estimated by the US Senate Joint Economic Committee.  To keep the math simple, lets call it $25,000.

Note: This estimate is consistent with the $21,000 average cost figure used in Bank of  America’s Nationwide Homeownership Retention Program for Countrywide Customers. As announced, BofA:

• Will systematically modify troubled mortgages with up to $8.4 billion in interest rate and principal reductions for nearly 400,000 Countrywide …customers nationwide…

Then let’s quickly observe that, for information purposes, the average subprime loan balance was about $158,000 [see Line 1].

We recall that we have a $525 million/month HomePower budget [Line 3]. After a reasonable allowance for overhead and operating expenses [Line 4], we’re left with $420 million/month available for borrower relief [Line 5]. If we then use the ballpark modification cost of $25,000 per mod [Line 6], we can estimate that the Homepower funding will “cover” the costs of 16,800 mods per month [Line 7].

Since subprime mods had been running at a rate of about 30,000/month (see above, Figure 1) HomePower funding would NOT  cover the cost of ALL of the mods.  Just slightly more than half [Line 10].  Not a bad start.

CONCLUSION

With a monthly “run rate” of $1 billion per month, this implies that the annual program will “only” amount to $12 billion per year. This figure sounds - and is - “small”, relative to the:

1. $350 billion already distributed to financial institutions under TARP ; or
2. The roughly $200 billion “hole” (see Figure 4) resulting from the disappearance of equity extraction.

However, we will probably never know anything about the effectiveness of the $350 billion in TARP disbursements, in terms of moderating foreclosures, as described by David Barstow in the 9 Jan New York Times (Treasury’s Oversight of Bailout Is Faulted).

TARP recipients, by design, do not have “to provide any accounting of how they are using taxpayer money”, and the Treasury has taken “no steps to use any of this money to alleviate the foreclosure crisis.”

So it is certainly conceivable that a well-designed and targeted $12 billion program might do more to prevent foreclosures than a much larger program that lacks accountability and “erodes the very confidence Treasury seeks to restore.”

Finally, the “HomePower” lottery program IS much smaller than the $200+ billion that borrowers recently extracted from their homes to buy stuff and pay down consumer debt (see Figure 4). This emphasizes that it will be impossible to duplicate the scale of the equity extraction wave, unless the federal government distributes the equivalent of substantial checks (as suggested in Dissembly Required) to every American household.

Until the government agrees to embark on such a massive and direct spending spree, perhaps they should try to harness the country’s taste for games of chance, and see if this generates enough excitement  - and spending - so that we can gamble the housing recession away.
- - - - - - - - - - - 

I used to work with numbers for a living, but now I may be too odd to even hit the jackpot as I look for a new job or at least my next idea.  Till next time.

REFERENCES
   
I. Artman, Sterling Slivers – No Pace Like Homes, No Place Like Homes, Dissembly Required, 2008.  Special thanks to my Title Consultant for America Gone Mod  – Joshua Artman.

A. Greenspan & J. Kennedy, Federal Reserve Working Paper 2005-41 - Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences, 2005.

S. Hankins, M. Hoekstra, & P.M. Skiba, 2009 AEA Annual Meeting - The Ticket to Easy Street? The Financial Consequences of Winning the Lottery.

E. Oster, Harvard University - Are All Lotteries Regressive? Evidence from the Powerball, 2004.

K. Tillwitz, DBRS - Is More Debt Forgiveness On The Horizon, 5 Jan 2009.