In this article, I shall present the engineering solution to the sub-prime crisis in America, which is having a negative effect throughout the world. I shall begin by describing the origin of the problem. Then I shall proceed with the analysis of its nature. Based on its nature, I will present the solution with all the necessary explanations on variations of scenarios. Let us begin.
Origin of the problem.
The problem begins when banks and other lending institutions in USA lent money to people who would not have qualified for loans to buy properties, thus the term “sub-prime”. They did that in order to charge higher interest. Higher interest means higher profit, which will inevitable lead to higher income to the CEO. As for the sub-prime borrowers, they got to own their houses for the first time. So, everybody was happy.
How about the risks? It must not have been obvious in the beginning. The loans are backed by properties. If the borrowers fail to pay the installments, the banks can seize their properties and recoup their money. Property prices were quite stable at that time. Not only that, the sub-prime loans had increased demands for properties. As a result, property prices had increased. So, the risk of borrowers failing to pay their installments plus property prices dropping appeared to be a remote possibility.
How did this affect the whole world? When the banks run out of cash to lend, they securitized their sub-prime loans to sell them to investors worldwide for a few percentage of the loan amount in commission. In return, they got new injections of cash, which enabled them to lend more.
The problem came when the seemingly impossible scenario happened. Borrowers cannot pay their installments and property prices fall. This has become a global problem as many institutional and retail investors have invested into these sub-prime loans. The rest is history. Companies had gone bankrupt and many Americans are facing the prospect of being evicted from their homes. Welcome to the biggest recession in history.
Nature of the problem.
Despite the huge impact on the whole world and millions of lives affected by it, I am going give you an analysis that may seem out of place. In my opinion, the problem is entirely virtual and not physical.
Let me explain further. If a house is burnt to ashes, there are physical losses. The furniture, food and clothes in the house had been reduced to ashes. Their value is gone forever. This is a real physical loss. However, in the sub-prime crisis there is no real physical loss. Many houses are worth lesser than what they used to but the physical houses are still there. Not a single brick is lost. This is what I mean by saying that the sub-prime crisis is entirely virtual and not physical.
My solution is derived by this fact.
Solution to sub-prime crisis.
Based on the true nature of this crisis, I shall now present my engineering solution as follow:
Allow the banks to repossess the houses. Do not prevent nor delay them. Let nature runs its course.
In case somebody accuses me of being insensitive, not compassionate and not knowing what I am saying, let me explain the rationale. What will happen when the bank repossess your house and evict you? It has to sell it for whatever price it can get to get back their money. Will the banks be successful in getting back their money?
Consider this. The United States of America is facing an oversupply of houses right now. If there is a massive repossessing of houses and auctions of these houses, there will be a huge increase in the supply of houses. The result will be a drastic drop in property prices. Those who had been evicted from their houses can buy back their houses at a fraction of the present price. The problem would have been solved.
Of course, I do not pretend to know about the law. Does the law allow those who are evicted to buy back their own houses? Can the banks repeat the repossessions if the evictees buy back their houses?
In this case, let us assume the worst case scenario. Let us assume that those who are evicted cannot buy any houses. In this scenario, two seemingly contradictory events have happened in the same space and time. On one side we have a lot of empty houses and on the other we have a lot of people with no houses.
What will happen then? Foreigners like myself will come to the rescue. I will buy those houses at dirt cheap prices and rent them back to the Americans at dirt cheap rents. If I buy a house at US$100, I do not mind renting it at US$1 per month. My condition will be the tenants are to take full responsibility in all the maintenance. In one year I will have US$12. This is equivalent of an annual yield of 12%. So even if the property prices never rise, I am still making good profits. I am sure a lot of foreigners will share my sentiments.
As a result, those who had been evicted from their houses can continue to live in their original houses with low rents. They may have lost ownership of their houses but at least they do not have to sleep at the streets. The problem is solved.
How about the investors and lenders?
My response is, be a sport. You took the risk for the sake of higher returns. The risks turn against you. You lost the bet. When you invest in bonds or any loan instrument, you are basically placing a bet that the underlying borrowers can afford to pay you back the principle amount plus interest. If they fail, you lost your bet.
Let this be a lesson learned in investing and trusting in the so-called financial expert. Pick yourself up and move on.
In conclusion, the solution is very simple. This is what engineering is all about, simplicity. However the bottom line is, it works.