Southern Capital Services

Letter to Congressman Bonner

Dear Congressman Bonner:

Thank you for taking the time to meet with us.  As investment professionals deeply affected by the current crisis, we’d like to offer solutions rather than complaints.  With that in mind, here is our proposal for a politically palatable deployment of the TARP funds:

1. The Government should not buy “toxic” mortgages. 
a) The public does not like the idea and feels that their tax dollars are at risk.
b) The government has no demonstrated ability to manage a portfolio of troubled mortgages or the real estate that would be acquired through foreclosure.  Nobody wants to imagine the Federal Government evicting some poor family for not making their mortgage payment.
2. The Government should instead inject capital directly into the troubled financial companies through purchasing of preferred stock (this capability is already provided for under TARP). 
a) The preferred stock purchase agreement between the company and the Government should also carry a provision that the Government would have a first call on all the assets of the company, similar to an IRS lien, until the company buys back the preferred stock. 
b) The preferred stock should pay 2% above the Government’s cost of 1-year money in the first year.  The second year it should rise to 3% above the government’s cost of 1-year money and continue to rise an additional 1% above the 1-year cost of money each year until the company buys back the preferred stock. 
c) There should be a restriction on management salaries and no bonuses until the preferred stock was bought back.
d) The Government bonds sold to raise the money for TARP should be directly linked to the preferred stock so that when the government is paid back, those funds can only be used to retire the bonds that were sold to raise the money for TARP.  This would keep the money from being spent on anything else.

In summary, the attractiveness of this approach is that the Government does not get into the management of troubled mortgages and possible real estate ownership through foreclosure.  The taxpayers would be protected by the first lien on company assets and would enjoy the preferred dividends at a rate of 2% over the cost of money in Year One and rising.  This program would be time-limited and self-liquidating because the companies would have incentive to retire these preferred stocks as quickly as possible because:  1) they would want to get out from under the lien, 2) the cost of the preferred dividends continually escalates, and 3) management would want to get out of the salary restrictions and moratorium on bonuses.  This program would be in place to serve its purpose but then would go away on its own and the taxpayers’ risk would be extremely limited.

Sincerely,

Terry E. Nager, President
Southern Capital Services, Inc.

An Open Letter to Treasury Secretary Paulson

Dear Secretary Paulson:

We need an effective remedy for the subprime lending mess and we need it now!  This is not the time for debating the causes or for accusatory rhetoric – there will be ample time after the crisis passes.  However a plan of attack must be put forth along with the guidelines for implementation.

1) There should be no interference with the sanctity of the existing mortgage contracts.
2) The US taxpayer should not be put at substantial risk in order to bail out unqualified borrowers or reckless lenders.
3) The government must not be the administrator of the work-out remedy because of additional cost and lesser efficiency.

The Proposed Remedy:

1) Enlist the participation of the mortgage lending and real estate industry to agree to implement and administer the proposed plan with minimal cost.  They should willingly agree since they are the ones who will most immediately benefit.
2) The companies that service the mortgages would need to canvas all of their sub-prime mortgage recipients (as well as all of those who were given adjustable rate mortgages in the last few years) to determine which ones are struggling and in need of assistance.  Then they would arrange meetings with those who met the following criteria:
A) The house or condominium must be their primary residence.
B) The borrower must be making the current initial or “teaser” rate payments and give evidence that he/she would likely be able to continue to do so but could not pay the higher reset amounts.
C) The borrower would be required to sign a statement that the information being provided was true and that it would be fraudulent to knowingly attest to false information.
3) The mortgage servicing agent would determine the eligible candidates and they would be offered 2 year government loans that could be renewed every 2 years (assuming the borrower continued to meet the eligibility requirements) up to a maximum of 10 years.  The loan proceeds would be paid out monthly in the amount that the reset payment exceeds the original monthly payment. This LOAN WOULD BE SECURED BY A FEDERAL LIEN (similar to a lien that the IRS could levy for delinquent taxes) which would have first call on the collateral (the home) and would carry AN INTEREST RATE THAT IS 2% ABOVE THE US GOVERNMENT’S 2 YEAR COST OF BORROWING MONEY.  It is imperative that the American taxpayers be protected from loss by having the loans be highly collateralized and a decent rate of return.  After all the American people do not owe a bailout to anyone and should be protected and rewarded for doing so.
4) The borrower would also be required under legal penalty to keep the house or condominium in good repair in order to protect the taxpayer’s collateral.  If the homeowner was financially unable to do so he/she would be required to contact the mortgage servicing agent to arrange for additional government loans with the same terms to make sure that the collateral remains in good condition.
5) After each 2 year period, the loan situation would be re-evaluated and extended if the borrower continues to meet the criteria.  However, in any event the already granted loans would continue for the balance of the 10 years (reset each 2 years in accord with US 2 year government borrowing costs). If the house or condominium was sold or refinanced, the federal lien plus interest would be paid first.

The Anticipated Benefits:

1) Eliminate the likelihood of a recession. The real estate and mortgage lending industries would revive.
2) The value of the sub-prime financial instruments would likely soar upon announcement of the plan because most of the non-performing loans would suddenly have US government backing for the monthly payments.  Their credit ratings would be high and liquidity would return to the frozen credit market.
3) The real estate market should revive with the prospect of numerous foreclosures not coming to pass. Without the increased inventory of the foreclosures and along with the greatly reduced housing starts, real estate prices should stabilize and then begin a recovery.
4) Many people who would have been evicted will be able to stay in their homes.
5) The US taxpayer will be able to come to the rescue without incurring significant risk of losing money and at the same time receive some return on investment.
6) The value of the US dollar should be strengthened because the benefit to the economy would probably enable the Federal Reserve to be more moderate in their interest rate reductions.
7) The need for the so-called stimulus package that is currently being considered in Congress would vanish.  That would be a good thing because it would add to the budget deficit and probably not be a very effective antidote for the economic downturn.

Terry Nager is the founder and President of Southern Capital Services, a Registered Investment Advisor, since 1982.

What is a Charitable Trust and How Can it Help Me?

By Eric Nager

It’s always the season of giving, but what if you could support a worthy cause and potentially realize three different types of tax savings? Happily, the laws of our land allow you to do just that through establishing a charitable trust.  A charitable trust is a legal instrument that allows you to set aside a gift, realize tax savings on that gift, and receive a current income from that gift for life.

Such a trust works best with an appreciated asset, such as property.  As an example, let’s suppose an individual has an unimproved, appreciated piece of land that is generating no current income.  He hesitates to sell it because the capital gains taxes would be high.  So he decides to set up a charitable trust naming a qualified charity as the beneficiary.  The land is deeded to the trust and the trust sells the property.  The donor then realizes the following benefits: 
1. He gets a current year tax deduction for a portion of the gift.
2. He avoids all capital gains taxes when the property is sold.
3. He avoids potential estate taxes on the property since it is now out of his estate.
4. He gets a lifetime annual income for himself and his spouse established at a minimum of 5% of the value of the gift.
5. He has the satisfaction of knowing that he is helping the charitable organization continue its important mission through wise stewardship of funds.

Upon the decease of the donor and his spouse, the remainder goes to the named charity.  Such a trust can also be set up whereby the current income goes to the charity and the remainder to a family heir.  Either way, all parties benefit from such an arrangement which shows that it’s possible to give and receive at the same time!

To explore whether such an instrument is a good fit for you, you should consult with your accounting and estate planning legal professionals.