Residential Real Estate Recovery Proposal
By: Stanley L. Klos

The Federal Deficit

PAID

Courtesy of Wall Street

By: Stanley L. Klos

September 17, 2008

As I leafed through the Wall Street Journal on September 17^th, bypassing the numerous stories pronouncing the devolution of Wall Street to its former Buttonwood Tree status, I failed to find any articles reflecting on the 221^st anniversary of the Constitution of 1787.

In the summer of 1786, President of the United States Nathaniel Gorham’s home state of Massachusetts had erupted into rebellion and the nation had no money in its coffers to raise troops to put down Shays' armed insurrection. In November of 1786 the congressional and U.S. Presidential terms expired and the newly elected delegates could not form a quorum to elect a new President and continue the business of the United States. All throughout December and then January 1787 the delegates failed to form a quorum. War reparations and debt were crushing the economy while the Constitution of 1777 (The Articles of Confederation) failed dismally in organizing the thirteen states into an effective federal government. Finally on February 2, 1787 the United States in Congress Assembled formed the constitutional quorum and elected President Arthur St. Clair whose first major legislative act was to pass:

Resolved that in the opinion of Congress it is expedient that on the second Monday in May next a Convention of delegates who shall have been appointed by the several States be held at Philadelphia for the sole and express purpose of revising the Articles of Confederation and reporting to Congress and the several legislatures such alterations and provisions therein as shall when agreed to in Congress and confirmed by the States render the federal Constitution adequate to the exigencies of Government and the preservation of the Union. [i]

The nation was bankrupt in 1787, the currency in a hyper-inflated state and foreign loans were defaulting on all fronts. While the delegates worked in Philadelphia to revise the Constitution of 1777, St. Clair and his congress went to work on creating an operating bill for the Northwest Territory (Ohio, Illinois, Indiana, Michigan, Wisconsin and parts of Minnesota). St. Clair had a buyer for one million acres of land for one million dollars ($73 billion in today’s dollars) that, if a body of federal laws could be formulated to govern this vast territory, the land could be sold placing the confederation government on a temporary positive cash flow footing.

The result of the 1787 United States in Congress Assembled session was the enactment of the Northwest Ordinance and their non-alteration and acceptance of Constitution of 1787 that emerged from Philadelphia. On September 28^th, despite the fact that St. Clair and his Congress had the power to change the proposed second constitution in any way they deemed appropriate - “such alterations and provisions therein as shall when agreed to in Congress,” the work was sent on in its original form to the states for ratification. The 1787 Constitution was ratified, the unicameral United States in Congress Assembled was dissolved in 1789 and the current tri-parte system began to govern the United States of America during a financial crisis that overshadowed any challenges faced today.

So today, I scoured the Wall Street Journal to discover if anyone, on the anniversary date of this great constitution, took the time to ask “What would George and Alexander do in this 21st American financial crisis?” and then report their findings.

I found nothing despite, history being the crystal ball to the future.

Two Solutions:

Since 1991 this author has been advocating two important measures to guarantee the prosperity of the United States of America for future generations of its citizens and his eight children.

First: Hamiltonist measures (see below) [ii] must be formulated by Congress and the President to develop revenue sources that are dedicated solely to retiring the now 9.7 trillion national debt while putting the brakes on deficit spending.

An analysis of the current debt after similar deficit spending in American history yields the following numbers which, I calculated on the September 11, 2008 - $9.7 Trillion figures.

Revolutionary War Debt of $75 Million in 1790 is = ? in 2007

In 2007, $1.00 from 1790 is NOW worth:

Civil War Debt of $2.8 Billion in 1866 is = ? in 2007

In 2007, $1.00 from 1866 is NOW worth*:

World Wars Debt $269 Billion in 1946 is = ? in 2007

In 2007, $1.00 from 1946 is NOW worth:

The debt, therefore, that the nation finds itself in on September 17, 2008 is substantially less when compared to the relative share of 1946 GDP debt.  In other words, if we adopt Hamilton measures NOW the debt can be greatly reduced to the benefit of all including future generations of Americans.

Second: Correct the 1986 Tax Law that placed real estate into a "passive income" category with, primarily, the exception of primary and secondary residences.

In 1992, I personally pleaded with Richard Darman (Bush Sr’s Director of Management and Budget) and other economic advisors that:

… the trend of millions of homeowners utilizing home equity credit lines to pay off short term consumer debt could thrust America into a depression. "Consumers are being enticed into saddling their homes with enormous debts to obtain an interest tax deduction for cars, credit cards, and other consumer goods," Klos explained. "Should congress fail to correct the current tax law, the economy will continue its downward trend," he continues, "the jobless recessive trend will climax when home-owners begin to default on equity mortgages instead of credit card and car payments. Our country could be faced with millions of Americans loosing their homes because of over-extending prompted by aggressive home equity and mortgage lending." Pocono Record, January 25, 1992 “RE/MAX Head Offers Bush a Recovery Plan”

What I formally proposed in 1992 (above), 1994 (U.S. Senate Bid), 2000 (Governor Rendell’s Philadelphia Political Fest Rebels With A Vision Exhibit) and 2004 (GOP Convention President Who? exhibit) was the rejoining of real estate gains and losses to the portfolio equities market. Additionally, I recommended an easing of loan regulations to enable entrepreneurial families to readily acquire and renovate mixed-use owner occupied buildings. Small businesses, I maintained, “… are the financial back bone of America and such measures would enable entrepreneurs to start and/or expand their ventures on bricks and mortar.” I purported that targeting loans to mixed use buildings would result in the raising of entrepreneurial families in the town centers throughout America, improving city quality of life causing reductions in urban sprawl.

National Debt – PAID – Courtesy of Wall Street?

So here we are, as predicted, the single family home mortgages are taking down Wall Street, who greedily loaned money at absurdly low equity levels to anyone that had a deed. No surprises here including my failure to awaken the representatives of the people to the inevitable mortgage crisis and for that I am truly sorry.

The surprise that became apparent on this venerable September 17th date is that the home mortgage crisis created a primary source of government revenue that, technically, has the potential of reducing, in meaningful numbers, the National Debt! The homeowner real estate taxes and mortgage interest tax deductions fostered an economic climate where it made sense to acquire large homes with, in this case, even larger mortgages. Greed on Wall Street in creating instruments to fund this homeowner demand X additional homeowner Greed to utilize their artificially valued laden home equity lines to prematurely realize their American dream was squared by FAS 157 overzealous reckoning in a collapsing real estate market (GW x GH x FAS)² = Disaster. The result was a fire sale of assets by troubled financial institutions so monumental that only the richest country in the world can print enough 'borrowed money" to buy the failing companies.

As I see it, last year's implementation of FAS 157 (mark to market accounting) has created enormous capital shortages by valuing the mortgage loan assets at absurdly low values despite the overwhelming majority of home mortgages performing as contracted with most Americans.

So, to put it in clear real estate terms, here in Clearwater, Florida financial institutions own millions of dollars of home mortgages. With the new FAS 157 mark to market accounting system the inevitable burst of the housing bubble requires the financial institutions to determine the value of these mortgage assets against the current market value of the homes. Homeowner equity has evaporated and despite that most of the loans being paid (strong positive cash-flow) FAS 157 requires the financial institutions to effuse enormous amounts of cash to meet the new mark to market (current market prices of the homes) value ratios.

This, clearly, is not just happening in Clearwater but all throughout the United States and financial giants, such as AIG, are being forced to come up with enormous amounts of capitol to meet FAS 157 accounting procedures despite positive cash flow on the majority of their holdings. The cash isn’t there for AIG, and a host of financial institutions. The result is they are forced to sell performing assets, such as AIG’s airline leasing business, virtually overnight to remain solvent which is an impossibility.

So instead of repealing a poorly timed FAS 157 mark to market accounting system giving time for the federal government to ferret out the facts behind the mortgage backed securities collapse (not even the CEO's are sure what their traders acquired in the troubled companies) and the real estate market to stabilize, the FED is all but forced to step in and purchases AIG for nearly ten cents on a dollar with its trillion plus asset base just after acquiring Freddie Mac, and Fannie Mae. In twenty-four hours, with this one acquisition (if the cash flowing assets are managed properly) the national debt is reduced 600-700 billion dollars and Congress, which has done little to correct the root rot of the mortgage crisis, will most likely provide funds to the treasury insuring socialism replaces capitalism on Wall Street as more financial institutions begin to fail.

So why in this time of great crisis wouldn't the Wall Street Journal reflect on the Constitution of 1787, its times and the post war debt parallels of two economies and ask; What would George and Alexander Do in 2008?

Historic amnesia seems to be the aliment of the Free Press as well as the United States in Congress Assembled.

Black Wednesday, September 17, 2008, is a day that irrevocably changed America. George Washington and Alexander Hamilton, move over, as you met your match with George W. Bush, Robert Paulson, and Christopher Cox. The national debt is about to be paid courtesy of Wall Street as the federal government is the only real buyer for the trillions of "at risk" mortgage equities even at the dime on the dollar prices. It is a bargain, the President has already put a down payment on it (AIG, Freddie Mac, and Fannie Mae) and Congress is surely going to secure loan after loan with the only real collateral they have, the American Taxpayer. Or is it?

The question is will a federal government that has already saddled their children with 9.7 trillion dollars in debt , health care programs that are reaching 25% of GDP (even before the Baby Boomers reach their Golden Years) competently manage trillions of dollars in home mortgages and failed financial institutions? What about the commercial mortgages? Will they acquire them too!

If these socialistic measures must take root it is imperative an exit strategy be devised to restore capitalism.  Additionally, if by some miracle the government manages these assets properly while adopting a true residential real estate recovery act, the profits will pour in.  Such profits MUST be utilized to retire the National Debt.

Residential Real Estate Act Proposal:
 

First: Move residential real estate gains and losses, (one to 4 family units) into both the ordinary and portfolio tax categories for properties that are acquired in the next 24 months by anyone (individuals, partnerships, corporations etc…). 

Result: Investors and investment entities will start buying residential real estate in a soft market as artificial value (prices higher then the cost of the land plus cost to build) has already dissipated as one can’t build many houses at their current asking prices let alone figure in the value of the land. 

Second:  Any residential real estate acquired in the two year period would remain in this new deducible income tax state for the life of property ownership by the investor or investment entity.    

Result: Investors and investment entities will hold the real estate (limited flipping) as the non-expiring tax deductions make long term ownership very attractive.

Third: once the two year period has expired investment real estate gains and losses is permanently shifted into the portfolio tax category.

Result: A balance market will begin to emerge as investors and investment entities acquire residential real estate at what I believe will be unprecedented levels (two years might be too long).  

Fourth:  Primary and secondary residence mortgage interest should only be deductable for loans up to 80% of the original value of the home’s acquisition value.

Result: This will retain the incentive for citizens to acquire homes while thwarting borrowing on home equity beyond the original 80% balance.

Fifth:  Tax Credits in the amount of 20% should be enacted for entrepreneurial families to purchase mixed-use buildings to expand their businesses and raise their families.

Result: This measure will result in families relocating out of the suburbs into cities and Main Street America.

 

Sixth:  Repeal FASB 157 mark to market accounting and relax regulations to provide time for financial institutions to liquidate assets to meet cash requirements.

Result: The repeal of mark to market accounting will provide financial institutions with an accounting system favorable to a declining real estate market.  Last year's implementation of FAS 157 (mark to market accounting) has created enormous capital shortages by valuing the mortgage loan assets at absurdly low values despite the overwhelming majority of home mortgages performing as contracted with most Americans.  

Seventh:  While the real estate market stabilizes have accounting firms audit the trouble institutions to determine just how many mortgages are delinquent and assess each loan utilizing a simple qualifying formula such as: Total gross income monthly x .4 minus all monthly payments for loans, credit cards, etc giving the auditor a realistic number for total mortgage payment that consumer qualified for.

Result: The permanent move of real estate into the portfolio category will result in healthy capital investments in equities (stocks, bonds, commodities etc…) and real estate.

Eighth:  Rate each mortgage based on this formula (A B C etc...) to get a clear picture of how large a "case of the shorts" each financial institution has in addition to the loans that have already defaulted.

Result: Once the numbers are in (especially Fannie Mae, Freddie Mac and AIG) then Congress can devise reasonable programs to help ailing homeowners first and financial institutions 2nd.  

Stanley L. Klos

[i] Journals of the United States in Congress Assembled, February 21, 1787

[ii] After the failure of the Constitution of 1777’s Confederation in 1788 a new government was formed and President George Washington appointed Alexander Hamilton as his Secretary of the Treasury. Secretary Hamilton inherited a bankrupt nation. In 1790, he published his "Reports on Public Credit," a plan to for the federal government to assume domestic and foreign debt, pay off federal war bonds, and create a national mechanism for collecting taxes.

Republicans, James Madison and Thomas Jefferson vehemently opposed Hamilton's plan. The Virginians saw it as unfair to their state to assume the debt of other States. Opposition arose from other fiscally sound States as well. To break the deadlock, Hamilton negotiated a land and debt agreement with Jefferson. Simply, Hamilton proposed that if the southern states would vote in favor of his plan and in return he would through his support behind the Republicans proposal to move the nation's capital from New York to Maryland and Virginia along the Potomac River.

Hamilton also in these negotiations sought to secure the establishment of a federal bank and mint. Against long odds, he brokered the agreement and placed the nascent United States on fiscally solid ground with the capitol in Washington DC.

The federal government debt was converted into interest bearing bonds which would mature after an assigned period of time. A sinking fund of revenue from the post office was earmarked for the payment of the principal of the debt.

Hamilton’s plan contained three basic provisions:

• As mandated by the 1787 constitution, the foreign debt and interest would be paid in full according to the terms initially agreed to.
• The principal of the domestic debt would be paid at 4 percent interest on long-term and 6 percent on short-term bonds to current bearers.
• State debts would be assumed by the federal government with interest payments deferred until 1792.
•  

Federal stocks would then be permitted to circulate as money, thus making capital more plentiful and readily available. Large reserves of capital would encourage commerce, as well as agriculture and manufactures. The availability of cash and its rapid circulation would lower interest rates, making it "easier and cheaper" for individuals and smaller businesses to secure loans for their enterprises.

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Part I

September 17, 1787 - Black Wednesday
 

Part II

September 17, 1787 - Black Wednesday

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