How is this possible?
TARP Background
On October 3, 2008, the Bush administration Congress passed the Troubled Assets Relief Program (TARP) as a response to the economic crisis. TARP was funded with $700 billion to work as a "revolving purchase facility", meaning that the government would either purchase assets and sell them or hold the assets to collect off of them. At first, this meant that the government would use the funds to purchase preferred stock off of lenders to help stabilize the securities market. This plan was met with much scrutiny, as trust in the lenders to use these monies in scrutiny was highly debated.
Over the following months, TARP was amended to allow the funds to be used to support loan modifications for distressed homeowners and any program deemed necessary by the government to avert the financial crisis (i.e., the United Auto Workers).
However, throughout these changes in the months following the initiation of TARP, no monies were being earmarked for those homeowners who were upside down (had negative equity) on their mortgages and were struggling to keep their payments current.
On February 10, 2009, the new Secretary of Treasury, Timothy Geithner, outlined his plan to allow TARP funds to be used to help fund private investors to purchase toxic assets from lenders.
Finally, on March 23, 2009, the Public-Private Investment Program (P-PIP) was put in place to buy those toxic assets from lenders' balance sheets. This program works as a collaborative effort between the public and private sectors to fund the purchase of the negative equity loans (toxic assets) from lenders. If a private lender is willing to purchase the loan from the lender at a reduced price, then the government will fund up to 85% of that write-off to compensate the lender.
Economist and Nobel Prize winner, Paul Krugman acted as a mentor and liaison in developing this amendment to aid in the purpose of TARP, touting the financial gains from such programming. This change in TARP facilitated the ability of all homeowners (delinquent or on time) to secure new mortgages at a reduced price.
Program Background
In October 2008, a group of private investors realized that the purpose of TARP, to be a revolving purchase facility to stabilize the economic crisis, should be used to help the homeowners affected by inflated property values. The purpose of the program was directly in line with the purpose of the group: relieve lenders of toxic assets.
At that time, they began working on developmental efforts to put together a program to help "underwater" property owners: those with negative equity. The group wedged a $4 billion hedge fund to purchase such assets from lenders to then secure the owners with new mortgages at market value.
During the course of this development, the federal legislation regarding the TARP funds acclimated to such programs (as outlined above) to aid private investors interested in helping those homeowners. Through this partnership of private industry and government programming, the investor group was able to further supplement their Principal Reduction Program with government funds to enable those homeowners to be relieved of negative equity.
How the program works today
Through the developmental process of the investors' program and the complimentary adjustments in TARP, the investor group was able to facilitate a program that has allowed initial portfolios of loans with the major lenders to close in the months following, and starting in, July 2009.
The process begins with bundling loans from lenders into "buckets" to present to the individual lenders. The investors come to the lenders with multiple millions of dollars worth of loans and offer to clear the lenders' books of such under performing or nonperforming loans with the understanding of the lenders that they will be recompensed their discounted price up to 85% by the government TARP funds through reclamation.
So, for example, if there is a loan in that bundle that is valued at $300,000, and the property is only worth $200,000 (making walking away from the property quite desirable), the investor group would be willing to pay the $200,000 to the lender, and the government funds would cover up to $85,000 of the discounted loan. The lender would then have $285,000 of a $300,000 loan, allowing the lender to:
- write off the remainder of the loan (approximately $15,000)
- be compensated at a much higher level than a short sale or foreclosure (where most of these loans end up either from inability to pay or choice of homeowners to no longer invest in negative equity assets)
- open their books to new, performing loans.
Once the investors have purchased these servicing rights to the loans at the discounted price, they are able to secure the homeowner with a new mortgage loan at a principal amount reflecting the current market value on the property.
Incentives to the parties involved
Lenders are benefited by:
- Being recompensed at near full value of under performing/nonperforming loans
- Benefiting from bulk purchasing of loans to relieve books at massive levels
- Opening books for new, high-normal performing loans.
Investors are benefited by:
- Owning servicing rights to an ever-increasing number of mortgage loans
- Being compensated from the servicing fees associated with those new loans
- Discounting associated fees with such loans to collect off of the investment in aiding troubled asset homeowners.
The government is benefited by:
- Making private investors carry the majority of the cost on most toxic assets, saving government funding for further incentives with aiding in the financial crisis
- Directly impacting the effects of the sub-prime mortgage epidemic
- Stabilizing home prices in response to the current mortgage crisis
- In turn, aiding in strengthening the financial climate in the United States by eliminating toxic assets that are hindering lending by the major banks and private investors.
Property owners are benefited by:
- Eliminating negative equity on their properties (both homestead and investment)
- Accruing financial stability in an unstable financial climate
- Acquiring financial ownership in properties.
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