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Bill Frey's radical ideas for how to fix the housing market

Posted by: Peter Coy on December 11, 2008

Guest blog from BusinessWeek Banking Editor Mara Der Hovanesian:

Bill Frey, an avid investor in mortgage securities, seems to put his money where his mouth is. This summer, he vowed to sue banks over forced mortgage modifications, arguing that they would bilk bondholders like him out of promised income. Indeed, on Dec. 1, he lodged a class action lawsuit against Bank of America for its plans to change the terms on some 400,000 home loans. Frey believes that if these contracts are broken they will forever damage the secondary market for mortgages, which has been the financing engine for funding home purchases in America for decades. See our story on Frey’s lawsuit here.
But that’s not the end of Frey’s radical ideas. He’s been writing Congress about some ways to fix the housing market. He’s certainly not going to win any popularity contests with these suggestions, but the ideas seem to be grounded in common sense. A Dec. 2007 article in the Atlantic broached the subject of eliminating the mortgage-interest deduction. Maybe these other ideas will also gain traction.

Read on for an edited version of Frey’s ideas:

1. Eliminate the 30-year fixed rate loan
Frey says that the 30-year mortgage, a mainstay in home lending, should be eliminated because the time line is far too long and poses far too much risk for investors. Banks and investors must hedge their bets against prepayments (which are rampant in refinance booms for one) and as a result often stretch and take risks or use accounting gimmickry to do so. His solution is to introduce loans with 30-year amortization, but that are renegotiated every five years. These types of loans are common in Canada and other countries.

2. Set underwriting standards for loans that are securitized
Creating a maximum loan-to-value (LTV) underwriting standard for securitizations would raise the quality of loans across the board. This standard LTV, while subjective, should probably be 80%. Loans originated above this threshold should stay on banks’ books. This would force a more careful credit review by originators of such loans.

3. Phase out the home mortgage deduction
A tax subsidy encourages homeowners to take on too much debt, which places the risk on society in general. Better to give favorable tax treatment for the equity in the home, starting with the down payment. This credit would obviously need limits, but the concept of subsidizing equity, as opposed to the debt, would remove some of the systemic risk placed on society by high loan-to-value mortgages. Furthermore, additional periodic principal pay downs could trigger some sort of partial tax credit in the first few years of a loan’s existence. This period has historically been the time in which defaults have occurred.

4. Limit the use of home equity loans
The logical limit for the use of home equity loans would be to forbid their use in the purchase of a home. Instead of using home equity loans as down payments, prospective homeowners would have to actually save and place their savings into a house as a down payment. While this concept may seem logical, it was forgotten over the last several years. Furthermore, post-purchase limits based on home purchase price or current market value should also be in place. Large scale use of homes as piggy banks places the financial system at an unacceptable level of risk.

5. Force Wall Street firms or underwriters of mortgage securities to own a portion of what they sell off to investors
The issuer of mortgage securities should swallow the first 1% of losses on the mortgages it sells as securities. It should be required to hold this position for no less than three years. This would insure that any errors in packaging and underwriting would be taken as a loss by one of the parties that are best able to avoid the bad loan decision.

6. Wall Street issuers of mortgage-backed securities should not indemnify the trustee of the MBS from bondholder lawsuits that result from improper servicing or other servicing errors
Trustees of an MBS securitization are responsible for enforcing the contract rules as a fiduciary of the bondholders. Ironically, they themselves are protected, which is like the fox buying off the guard of the hen house. As a result, there is no one guarding the interests of the bondholders.

7. Homeowners should be penalized in the event of a foreclosure
Laws must prevent borrowers from avoiding personal liability in the event of foreclosure. Such laws would encourage homebuyers that run into trouble to not abandon their homes. Post-foreclosure liabilities are common in England and discourage homeowners from walking away from their obligations. Such liabilities could, of course, be dismissed in the event of bankruptcy. While these changes may sound radical, they are essential to reducing the probability of a systemic housing meltdown and in mitigating that downturn, should this type of housing problem recur in the future.

Reader Comments


December 11, 2008 3:48 PM

Most of the ideas are good, I like item 7 the most - it makes sense.


December 11, 2008 3:53 PM

Neither political party would risk losing the middle-class and poor vote by supporting any of these ideas. Two quick points: Eliminating the 30 year mortgage loan would eliminate the ability for most people in those two demographics from ever buying a home. Eliminating the home mortgage deduction is like raising taxes - we know how that flies - and I would think would again reduce the number of potential homebuyers.

Pedro Fernandez

December 11, 2008 3:55 PM

While I don’t disagree with these ideas, I do have some questions. So what happens to the American dream? Sure, investors would be better protected but consumers would not be so eager to buy homes because of the ramifications and not to mention the seemingly tighter credit restriction. I mean, the essence behind entrepreneurs is risk taking. We take calculated risks; we reap good rewards. We fail to properly calculate our risks (as investors); whose fault is this? Do we just want to fix everything with regulations? If so, what happens to the so called free market capitalism? I think what we will find out from this recession is that we can’t have the cake and eat it too. Rather, we have to share it. Bottom line in every business is that consumers want value, which means cheaper and better products and consequently, we demand cheaper labor, which in turn means more outsourcing, which mean less jobs, which means lower wages in the US and high unemployment, which means we don’t earn enough to buy your $200K home. So, are regulations and restrictions the answer?


December 11, 2008 4:21 PM

I wouldn't go for this at all. Everything was running fine until Wall Street got involved! If you remember in the "old days" the banks would service the loans. Now they package them up, get them rated, and sell them. Make the banks keep them. Why do investors have to buy them? It is all a big game that Wall Street lost. On top of that they bet on those losses. The whole system has turned into nothing but a casino. Credit Default Swaps are just another name for a bet. That's why the $335 billion wasted on Wall Street has done nothing. The article tries to put the blame on the consumer and putting restrictions on the consumer when in reality it was the banking and insurance industries that gave the money away like it was water. A person walking up to a bank with no credit, no money and still being able to buy a house is wrong. If the banks and Wall Street were too stupid to realize that then that is their problem. Put the Glass Steagal Act back in place. Get insurance out of the banking and investment business. Have the SEC enforce the laws and quit changing the laws to benefit the rich. Break apart the banks that are too big to fail.

James Sykes

December 11, 2008 4:29 PM

Somewhat harsh as it puts more responsibility on two parties that currently do not have much. That being the homeowner and underwriter. Perhaps the bank could be as discrete as they were before they got caught up in the housing madness.


December 11, 2008 4:54 PM

Basically it's a realistic chain of accountability. It sounds completely reasonable and well thought out. Kudos Mr. Frey and good luck with your lawsuit.

Darren L.

December 11, 2008 5:15 PM

It is truly striking how sensible, yet anachronistic, these "radical" changes are in light of the current situation.

--Discourage overspending/over-leverage
--Don't expect reward without risk

Far out.


December 11, 2008 5:16 PM

Too late Bill. the horse is out of the Barn!


December 11, 2008 6:21 PM

The problem with some of his logic is that it doesn't take into account the run up in housing costs in the last few years. Like college costs, these increases have outpaced inflation, making it nearly impossible for an average worker with stagnant wages to 'save up' for a home.


December 11, 2008 7:25 PM

Sounds like rich guy who's not quite rich enough to have balls as big as the rest of his buddies in the business.


December 11, 2008 7:26 PM

Sounds like a rich guy who's not quite rich enough to have balls as big as the rest of his buddies in the business.


December 11, 2008 8:09 PM

This won't work in America. These ideas all have one component in common, responsibility. We don't do that here.


December 11, 2008 9:07 PM

Boo. I guess Bill would rather have people walk away from their houses and cause his holding to become toxic, rather than take a smaller but known loss. 1. Who would buy a house in todays market without the security of a 30 year, fixed rate loan? As for prepayment, it is better than not getting repaid, plus most of the interest is paid early in the loan anyway. 3. Considering that banks literally counterfeit money and the cards are stacked against the consumer, you should have an interest deduction. You used to be able to write off all interest, but the government changed it to only mortgage interest to get more money. 7. If homeowners are penalized for negative equity in foreclosure, than the banks should have to give the homeowner their share when foreclosing on a house that is not underwater. The other bullets are OK.


December 11, 2008 9:44 PM

Finally! Someone with some common sense to this mess. Why things like this weren't in place already is beyond me. Oh, wait. I know. Greed and lack of accountability.


December 11, 2008 11:20 PM

Three simple things will solve all the problems: (a) fixed interest rates for the vast majority of loans; (b) only full-documentation loans; (c) at least 5% equity or down payment from the buyer for a primary residence purchase. The first two things will ensure that buyers who can afford the payments when they first buy the house will (more often than not) continue to afford it in the long term.


December 11, 2008 11:49 PM

Rantings of a madman. Not sure why this rates front page coverage; just because he's rich and his ideas are "radical?" He's like Bush; he wants commerce to be a dictatorship, so long as he's the dictator. He doesn't want loan modifications because they interfere with his contractual rights, but he wants to stop banks from offering 30-year loans? What a joke. Did you read the article about his lawsuit? Instead of modifications, he wants taxpayers to buy the bad debt he's invested in.


December 12, 2008 12:21 AM

Common sense? Congress would never go for that!


December 12, 2008 12:42 AM

I agree with Frey's suggestions. The politicians are doing everything they know to try to keep home prices from falling. They don't understand that the housing market, and thus the economy, will not recover until it sees bottom. There is nothing anybody can do to stop home prices from falling back to its historic trend. The longer it takes for home prices to reach bottom, the deeper the recession will be.


December 12, 2008 1:10 AM

I agree with most of the comments; especially eliminating the mortgage interest deduction as well as national underwriting standards. How about something really radical - Whatever debt amounts a person is relieved of due to bankruptcy as well as medicare expenditures becomes part of the estate taxation process. That way, if a bankruptcy helps a person when they are young and later in life become wealthy; shouldn't society receive some of that person's success. This would also apply to whatever the Feds pay for in terms of Medicare expenditures for you. Of course, a small estate that's under the estate taxation minimum's wouldn't be affected.

Lynn Robb

December 12, 2008 8:04 AM

Each of these seven suggestions benefits only one half of the housing market equasion--the lender. Before you can lend there has to be a buyer, and if Mr. Frey's policies are adapted the pool of potential buyers will have shrunk exponentially.

There is, however, another constituency which will benefit inordinately from the proposed changes and that is owners of rental property. As fewer and fewer people can afford the required downpayments or choose not to buy because of inhospitable terms or tax treatment of loans, we will become, like Europe, a nation of renters.

If you think the chasm between the middle and upper classes is wide now, just wait ten years under Frey's scenario. While I certainally don't advocate imprudent lending standards, I do believe we as a nation need to provide some incentive to homeowners.


December 12, 2008 11:45 AM

GO TO THIS SITE... this is amazing


December 12, 2008 3:46 PM

But this would be too responsible. Where's the freedom to do what you want (without regard to the impact on anyone else) on the spur of the moment? =}

John E. Lyons

December 14, 2008 11:09 AM

Mr. Frey's ideas have NO chance of being implemented! They are too well grounded in "common sense" to ever be adopted. The only effect they would have is to restore order to the securitization market.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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