"we can continue to pretend that lower rates solve the fundamental mispricing problem in U.S. markets? "

Paul Kedrosky asks a question:

"Housing and Shared Equity

I'd be delighted if someone would explain to me why we aren't talking more seriously about shared equity home mortgages in the U.S. How is it -- especially given the ongoing onslaught of awful housingdata -- that we can continue to pretend that lower rates solve the fundamental mispricing problem in U.S. markets?

Rates don't do it.

Time is part of the solution, as is lower prices, of course, but a path to get from here to there likely includes lower principal on many loans and shared equity with lenders. Where is the discussion?"

First, here's a discussion of SEMs from Lending Tree:

"How SEMs work

When investors buy shares in a company, they expect to see a profit when the business grows. Shared-equity mortgages are based on the same idea: an investor, often a parent, helps a new homeowner by contributing some or all of the down payment needed to qualify for a traditional mortgage. In return, if the house is later sold at a higher price, the investor gets his original stake back, plus an agreed-upon share of the gain. When done properly, a SEM is a win-win arrangement.

Here’s an example: Ursula and James want to buy a $200,000 house, but they have just $10,000 for the down payment. While they could qualify for a mortgage, their interest rate would likely be higher than if they were to put more money down. Plus, if they made a down payment of less than 20 percent ($40,000), they would also incur the added cost of private mortgage insurance.

Ursula’s mother, Laura, suggests another plan. She will lend them $30,000 (15 percent of the home’s value), allowing Ursula and James to make a 20 percent down payment. The couple will not have to pay any interest on this loan as long as they own the home. When they eventually sell -- hopefully for more than they paid -- they will pay Laura 15 percent of the sale price, plus 20 percent of the gain. If they sell in five years and the house appreciates about 6 percent annually, here’s how things would work out:

Purchase price: $200,000
Sale price: $270,000
Net gain: $70,000
Laura’s equity share: $40,500 ($270,000 x 15 percent)
Laura’s 20 percent of gain: $14,000 ($70,000 x 20 percent)

Laura would receive $54,500 when the sale closes, which represents an annual return of more than 12.6 percent on her $30,000 investment. Meanwhile, for the last five years, Ursula and James would have kept their monthly payments as low as possible while still building equity in their home.

What are the risks?
Like any financial arrangement, SEMs carry some risk. If the market drops and the homeowners sell for less than they paid, the investor will lose money.

In our example above, if Ursula and James were to end up having to sell for $180,000, Laura would lose $7,000. This is because her equity share would drop to $27,000 ($180,000 x 15 percent) and she would also absorb $4,000 of the net loss: ($200,000 - $180,000) x 20 percent.

A SEM also carries a cost for the borrowers. If the home shoots way up in value before they sell, the amount they pay back to the investor may be larger than what they saved in the first place. If Ursula and James sold their home for $350,000 after five years, for example, they would owe Laura $82,500 ($350,000 x 15 percent plus 20 percent of the $150,000 gain).

SEMs are private agreements between borrower and investor, and misunderstandings (or dishonest dealings by one party) can be extremely costly. For example, if the investor is named as a co-owner of the property, she is legally responsible for a share of the property taxes, liens or other obligations, and her credit will be damaged if the mortgage goes into default.

In addition, without a contract there is nothing to prevent the borrower from reneging on the deal when the house is finally sold. That’s why it is always a good idea to get legal advice when arranging a SEM, even when it involves close family members."

Now, here's Kedrosky again:

"Nope, am honestly interested in discussion on the subject.

Like you, I don't believe rates are the issue. I believe it's
principal, which means deleveraging, or credit restructuring, or
whatever euphemism you choose. The debate, the way I see it, is
whether it happens through continuing default or some other mechanism."

So, you can see that he means why not use SEMs to stop defaults. In other words, this is a proposal, if I understand him, for loan modifications. The comments on this post are wild, so you might want to read them. Here's Felix Salmon:

"Paul Kedrosky pleads:

I'd be delighted if someone would explain to me why we aren't talking more seriously about shared equity home mortgages in the U.S.

The answer is very simple, I think: the perceived cost to the borrower of a shared equity mortgage is much greater than the perceived benefit to the lender( HOW'S THAT ? ).

The Fannie Mae foundation put out a paper on these mortgages last year, which looked at attitudes towards them:

Survey results suggested also that most renters saw the SEM as a form of bridge finance that they would try hard to pay off in the relatively short term( THIS MAKES SENSE, BUT IT'S TRUE OF MANY MORTGAGES, IN THE SENSE THAT THE LENDER CAN USUALLY BE PAID OFF EARLY. REMEMBER, ALSO, IF THEY USE MONEY TO PAY OFF THE PRINCIPAL ON THE SEM, THEY WON'T BE USING IT TO PAY DOWN INTEREST. HOWEVER, AS STATED ABOVE, THE BORROWER DOES WANT TO AVOID THE HOUSE PAYING OUT MORE THAN THE SEM WAS FOR IN THE FIRST PLACE. ON THE OTHER HAND, THAT'S GOOD FOR THE LENDER. )

At the same time, it's hard to see any bank regulator -- or bank, for that matter -- considering the equity part of these mortgages to be a remotely valuable asset. It has no maturity date( ACTUALLY, IT CAN HAVE ONE ), it's completely illiquid, it can't be called, there's no secondary market in it, and it's fraught with moral hazard: sellers have every incentive to negotiate a low up-front price for their home and receive value from the buyer in other ways( ACTUALLY, I DO SEE WAYS THAT, SINCE IT'S A CONTRACT, A LENDER COULD HAVE A VERY GOOD DEAL ).

I'm reminded of the oil warrants and GDP warrants which were occasionally attached to emerging-market sovereign bonds in the 1990s. They often ended up costing the borrower a lot of money, but investors almost never assigned any value to them until they were very much in the money and paying out.

The most important reason why shared-equity mortgages aren't going to be a big thing, however, is simply that they're too small. They're generally for about 20% of the value of the home -- they're a way of figuring something out at the margin, but not a useful way of (re)structuring an entire loan.

In an ideal world of efficient markets, renters would take some extra money which they have available for mortgage payments, and invest that money in a liquid, securitized tranche of shared-equity mortgages, which would allow their slowly-growing down payment to keep pace with local house prices. But we're now in a world of very inefficient markets, and interest in such products is likely to be zero for the foreseeable future. Which is why they're not going to be part of the solution to the mortgage mess."

I think that the reason that they're not being considered is that lenders, at first, thought that they could get a much better deal from the government, and, now, they believe that the housing market has fallen low enough that they don't seem that desirable, and are marginal. If the lenders saw housing prices continuing to drop significantly, it's hard to see why they wouldn't try such a deal, since it means very little extra money to them ( they already bought the mortgage, and are simply being assigned a portion of it ), and getting hold of a house in a market in which you have to eventually sell it for twenty or thirty percent less than your loan doesn't seem smart, but maybe losing money is. Finally, it might help stabilize housing prices, which you'd think they'd want.