Populist Economist – A Student Debt for Mortgages Swap

In this series, the policies have been focused on federal moves, but this is one that could be enacted by states or even large counties. It involves a debt swap and focuses on a critical issue for Millenials: housing.

Goals:

  1. Improve our cities by making geographically valuable real estate usable once again.
  2. Remove an asset from the Federal government balance sheet that is seeing mass delinquencies.
  3. Inject educated human capital into our cities.
  4. Improve tax collection on currently non-tax producing assets.
  5. Improve personal balance sheets of students.
  6. Make family formation more affordable.

 

USG is the main student loan financier. It has taken over this role since 2008 as private lending has disappeared. Student loans cannot be shed in bankruptcy. Student loans have slightly higher interest rates than the average home loan, but shorter durations (10 or 20 year repayment vs. 15 or 30 year mortgages). Student loans’ collateral is you the borrower’s earning power. Right now, the delinquency rate and default rate on student loans is rising. While student loans are an asset for USG, it is a shaky asset that is seeing erosion as the economy is barely improving.

There is also the problem of low family formation and our nation’s dismal total fertility rate. While college graduate does not equal smart, college graduate does signal valuing education. Low time preference individuals are the type to carefully consider all variables in when to have kids. Altering the balance sheets of these individuals is going to make them more open to having children from an affordability standpoint. If they are not going to have kids, at the minimum, having them as law abiding citizens of a city will raise the overall environment of the area and spur on others as well as raise the general welfare of city residents. This is a Fair Deal policy that is a win-win-win for cities, graduates and the government.

The Plan

Create a housing program that connects municipalities with massive logs of vacant properties, empty lots, unpaid property tax liens, etc. Municipalities often have land banks and other easy to see listings. Our goal should be finding enough contiguous properties to flood the zone with these new residents. It’d be like section 8 vouchers but for college graduates. Cities hold these auctions often. I have been to some. These properties are going to outside investors or local men with the cash in hand to scarf up and suddenly be renting with a 50% cap-ex rate even using the lowest of low income renters.

Applicants to the program must have a job in the metropolitan areas listed. We can set a cap for the amount of student debt outstanding they have at the moment as the regional banks used for this program would have estimates for the value of the rehabbed homes once occupied. A bank in Philadelphia may say they can allow for students with up to 100K in debt while one in Columbus might set the limit as 70K.

A lottery would be performed from the pool of applicants for each city. All lots must be sold. Once selected, an auction can take place for specific lots by the selected individuals. Either way, they are walking away with keys to their property. If an empty lot, the municipality will allow for tiny houses as well as ‘historical code’ construction.

The selected winners have one year of zero payments to any loan (student or mortgage) as they bring the property to code, an agreed to inspection with the bank, buy a tiny house or construct a home.

Using regional banks, USG would sell the student loans to the banks that buy into this program. They would buy the loans at a discount. Any money earned on the auctioning of properties as discussed two paragraphs above would go back to the USG to make up for the haircut they took on the student loan sale. A way to seed this program to account for haircuts would be to assess a one-time 5% tax on all college endowments. These colleges can contribute to help their graduates who they have set up into debt slavery. With the sum of college endowments across America in 2015 at over $500 billion, this would be a $25 billion initial seed fund.

Any differential between individual loans sold and what the property is assessed at the time the mortgage began would be ‘zero day equity’. Most likely this would be minimal. The banks could play with interest rates on these mortgages, but have found a way to get silver medal borrowers out of what would formerly have been bronze medal borrowers.

  • Cities must sacrifice the properties. Then there is a 10 year tax walk up of property taxes. In the event a buyer sells prior to the 10 year mark, the next owner pays full property taxes in year one. No grandfathering (up for negotiation).

–  Cities suddenly suck in younger residents into residential areas that are employed and not ‘simply artists trying to make it’. As most cities have a city income tax or at least county income tax, this anchors taxes of employed individuals in the city.

–  Cities have to come to grips that these areas are non-performing assets, admit defeat and seek new ways to improve their cities. I’ve seen properties go unclaimed at auctions and come up again in the next auction. They also have to see this as a populist program that is not a fire sale to big biz to gentrify for only the rich. Young college graduates of all walks of life would be a far more palatable group entering than rich old white people. This could also be a means to retain college graduates from in their home neighborhoods to keep talent investing in their community.

–  The US federal government would take a loss on these loans if the one-time 5% endowment tax does not cover the entire bid loss on the loans but this is in effect going to happen at some point.

–  Regional banks have a screening for potential first time buyers that is the perfect profile (college graduates), but now without the college debt burden so their overall risk portfolio of the borrower is improved.

–  The equity issue can be solved by any home sold prior to the ten year mark would see the equity above ‘zero day equity’ levels be captured by the bank when the home is sold. Example: A home is assessed at 70K. Loan swap level was 55K. Once home to code, there is 15K of zero day equity. If home sold in year 5 for 85K, the homeowner gets 15K in equity but the additional 15K now that the home is worth more goes to the bank.

–  Borrowers would have a home while retiring old debt. The new collateral is not them but now their home. They are no longer debt slaves. They would have some home equity. They would have a mortgage payment, not a mortgage payment and a student loan payment. On top of this, their 20 year timetable at 6.5% is now say 30 years at 7%. Their monthly cash flow would be improved.

–  It would be easy for the federal government to play with who is selected out of the lottery. We could place priority on residents from those zip codes.

Market this like the Urban Homestead Programs of the mid-20th Century. Market it as a way for Millenials to enjoy the cool, hip urban life without living in a shoebox. For the regional banks, market is as a safer loan portfolio or possibly mortgages they could package in mortgage backed securities that would be easier to sell due to the quirky bonuses of the equity capture in case of an early sale and guaranteed mortgage borrower risk profile. The other positive is the uncertainty with regards to how the federal government is going to one day deal with the student loan problem.

Cities should target the remaining few home owners and slumlords in the targeted areas and alert them to the potential asset value lift-off that is going to come their way as this gets implemented. These overwhelmingly poor and older residents will now have a once in a lifetime chance to sell their home and for a large gain once they switch from being the only house on the block occupied to becoming the worst home on the block.

Individuals get the opportunity to buy a home, and neighborhoods get the time and effort investment of owners, not renters. Currently, many buyers are frozen out of mortgage approval due to their student debt. Some real estate investment firms have a thesis that America is 60/40 owner/rent now but will be 40/60 soon. Why should we allow consolidation of home ownership to be in the hands of a few investment firms to then tie into securitized bonds with the rent yields? Why should we treat these employed college grads like a yield for some large business entity?

This is a real estate deal. President Trump might be the perfect president for pitching this as it is real estate, and it is about Making America Great Again. Any Democrat president looking to help deep blue cities and the college graduate voter bloc that now heavily favors Democrats should jump at this. A key point to this is that this allows for investment and change made by thousands of Americans taking control of their lives and neighborhoods and not just large real estate developers. This is a win-win-win situation with everyone seeing upside with the only sacrifice being cities making dilapidated properties available. The best part about this program is that it is a win for everyone.

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