Shelter from the storm

As the Fed contemplates expanding TALF beyond highly rated, newly made loans to riskier or older troubled assets, it should go one step further to address the heart of the credit crisis -- depressed home prices.

TALF, or Term Asset-Backed Securities Loan Facility, is currently aimed at stimulating demand for AAA-rated securitized assets in auto loans, credit card loans, student loans and Small Business Administration-guaranteed small business loans. But to put the financial crisis behind us sooner rather than later, TALF- eligible collateral should include residential mortgage backed securities, or RMBS, that meet appropriate credit criteria and resecuritizations of RMBS originated after 2006.

Such a move would allow buyers of RMBS to get the same return on capital but pay higher prices for assets that are clogging bank balance sheets. If balance sheets improve, banks will be more comfortable originating new mortgages and extending more credit across all sectors. Up until now, most proposed solutions to the housing crisis have focused on supply by limiting foreclosures. Although this may help individuals who are at risk of foreclosure, it does little to remedy the massive supply and demand imbalance in the housing market.

Meanwhile, there have been a number of proposals that could have a chilling effect on the housing market and totally defeat the purpose of TALF. Among the more ill-conceived ideas is the application of "mortgage cram-downs" or reductions in mortgage principal balance without principal payment. The proposed laws contemplate voiding contractual provisions that determine the rights and responsibilities of the parties involved in the securitization trusts. If proposals such as these become law, investors may lose confidence in securitized assets and demand larger premiums, which will only push mortgage rates higher.

Along with including RMBS in TALF, temporary tax incentives will stimulate demand for housing. The White House has proposed a $15,000 tax credit, but larger tax incentives are needed for homes in Florida and California, two states where excess supply is a huge problem. The tax credits should correlate to the amount of the down payment made on the home -- the larger the down payment, the larger the tax credit.

Such tax credits would not only stimulate demand but also help stabilize home prices because larger down payments mean buyers have a greater interest in holding on to their homes even in tough times. To avoid tax abuses, the tax benefit would be spread over a few years, as long as the borrower remains current on his payments. This program could be phased out after the housing market has stabilized and the incentive is no longer needed.

Finally, the government should remove the moral hazard of allowing existing borrowers to stay in homes they could never afford in the first place. For borrowers who were victims, the government should institute a rental program allowing the right to rent the property for one year at a payment of 38% of monthly income. This would keep homes off the market, allow the servicers to collect income and let borrowers stay in the property as tenants. Failure to pay under these terms would result in immediate eviction. If the market stabilizes, the tenants would be given the right of first refusal when the lender decides to sell the property. For speculators and those who misrepresented their financial situation, no help should be provided.

The keys to getting the country out of the housing crisis -- and the financial crisis -- are sound mortgage lending practices, reasonable mortgage rates and time -- time to work through the oversupply of homes. Expanding TALF, providing tax incentives and allowing some underwater home­owners to stay in their homes as renters will go a long way toward accomplishing these goals.

Steven D. Persky is a founder, managing partner and chief executive of Dalton Investments LLC. Todd Sherer is a portfolio manager for Dalton's distressed mortgage strategy.