Monday, September 08, 2008

Shared Ownership

In my last post I ranted about the mortgage mess. Ranting is easy. Coming up with a solution to the mess is harder. People want solutions. Here goes a post on a possible long term solution.

My solution is a radical thing that starts by re-assessing mortgages altogether.

A mortgage is a thing where you borrow money to buy a home and pay interest on the loan. The interest rate is set by the global money market. This rate is manipulated by centralized banks such as the Federal Reserve, Fannie Mae and Freddie Mac.

The loans are made by banks seeking a guaranteed income from their investment. From a macro view, this system is untenable. You have groups trying to get an assured income on trillions of dollars in investments.

Libertarians often rant against this structure calling it "rent-seeking."

The paradigm has borrowers bearing the entire risk of homeownership. This type of system seems to work when prices are rising. Unfortunately, there is no such thing as a perfect market where prices run up forever. When the market slows down or dips, the last people in the market get hurt big time.

Imagine a person borrowed $100k in 2006 to buy a $100k house. They worked hard and paid $20k of their loan. In the mean time, the house dropped in value to $80k. Their bank statement would show they had $20k equity on a loan, while in reality they have zero real equity in their home. If they are forced to sell, the homeowner can kiss their money goodbye.

A more equitable way to go about housing is to develop a system of shared ownership. In a system of shared ownership, multiple groups would have a stake in a house. Imagine the same house where the home buyers had an arrangement of shared ownership. Imagine that, at the purchase of the house, the homeowners had a shared ownership arrangement where the value of the house was split into 100 shares. During the years, they bought back 20 of the shares for $20. When the home buyers were force to sell in a down market, they would have a real 20% equity in the home and would get $16k when the house sells at $80k.

I should note that homeowners and the bank would share in both the risks and rewards of homes. The shared ownership notes would trade on a market and would rise and fall with investor's expectations of the market.

It would take a long dissertation to explain how contracts and the mathematics around shared ownership would work. People are very good at writing contracts.

The public debate should focus on the distinction between sharing ownership and mortgaging ownership.

I contend that sharing ownership builds community, while the mortgage process encourages a gambler's approach to housing and ultimately forces people into subservience to the banking community.
NOTE (9/11/2008): I decided that Shared Risk Financing is a better name for what I described in this post, than shared ownership.

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