The world is at the beginning of a global economic crisis. Yes, the beginning. We have just seen the tip of an iceberg on the horizon, and have yet to see the entirety of its power.
Markets are in freefall around the globe in the midst of a crisis of confidence, the result of a poorly managed international lending scheme. With our banking systems failing, the public has little faith in deposit accounts, the institutions themselves and the governments regulating them.
Bailouts, such as the Paulson Plan take too long, though the one being implemented by Britain and Italy (and now the U.S.) are considerably faster to implement. (Note: The Epicurus Institute wrote the original plan for that model – see “Invest in America” under Economics).
At the core of this crisis is a simple fundamental – the valuation of property. The simple cure to this is to establish the baseline valuation of the property by a formula considering the original debt and current debt outstanding on that property. At the end of the day, the properties must be worth at the very least what is owed on the property, but more likely, the value should be what was borrowed, originally.
Property, whether residential or commercial, is worth what someone’s willing to pay and to risk in its purchase. Because banks over-leveraged their loan portfolios, the presumption in financial markets is that property is worth considerably less. Not true. Some appraisals suggest that property is worth less than it cost to build the property. How could that be? In fact, it cannot. Only hysteria and fear cause such devaluation, not reality.
The LIBOR rate is also out of control, creating a problem for interbank lending, where banks realize they cannot afford to pay a higher rate for interbank lending. That rate, reflective of risk in lending is simply inflated on fears of the security of banks.
Because banks simply manage loans today, on behalf of mortgage investors, bankers fear the repercussions of renegotiating the loans. Nevertheless, the banks must do so, without delay. As they fail to renegotiate, they cause the loans to fail as people default.
Renegotiation should simply be a matter of sitting down with a borrower and calculating a sum they can afford and establishing their personal baseline. Once banks know that figure, bankers should offer that borrower forty, fifty and even seventy-five year loan programs at a fixed rate of 5.25%. Banks should not take the liberty of renegotiating the original appraised value, but should be willing to rebook the loans on behalf of investors, at the value of outstanding debt.
This process would set the value. All appraisal methodologies would be ineffective if they factor in current sales as sales are at all time lows. Hence, a new appraisal methodology must be created which assumes the value of outstanding debt and original loan amounts.
There are many cases of people borrowing way above their means, and in such cases, the banks have little choice but to foreclose, however, this is not millions, but only thousands of borrowers.
Fixing this mess would result in homeowners staying in their homes; banks reducing their foreclosure rates; bankruptcies being reduced and balance sheets at the banks being stabilized. Government investment in the banks to cover the cost of actual, not presumed losses would provide banks with enough cash to fix any losses on their books.
Once banks are lending again, confidence in the markets could be improved, however, the investor community continues to fear the ability of banks to make secure, safe loans in future.
The solution there is to establish national centralized regulatory checks and balances. Keeping in mind that regulators usually catch bad lending after, not before closing, and that banks are expected to police themselves, the process works better if a central analytical authority verifies the bank’s compliance with regulations before loans are closed.
With regulators involved in the verification process, any anomalies can be caught before the loans are closed.
Frequent readers of this website know we’ve also endorsed business plan evaluations for commercial lending, where banks use an independent third-party evaluator to analyze business plans to determine the ability of the borrower to execute the business model successfully.
While many are calling for more regulation, what is needed is up-to-date regulation and better ability to regulate in a timely manner. The volume of regulation is not the issue.
In this global meltdown, it may be necessary for some governments, including the United States to nationalize banks, as a last resort. Certainly many banks, including well-known names will become memories, whether by failure or merger/acquisition.
Failure to resolve this crisis will create political unrest and revolutionary upheaval. Is the stability and security of the world worth the risk of fixing this solution through tough measures, even ones that go against the ideology of political parties?