The exact inside workings of the “Financial Crisis” I am not fully aware of. Options, sub-prime mortgage alternatives, derivatives and the other likely investment vehicles from the news media seem to be staggering.
I have not heard any specific “free-market” alternatives issued to solve the problem.
Here is my solution based upon the free market:
* Have investors draw money out from their IRA, Roth IRA and pension plans for a sub-prime mortgage investment.
* For maximum risk reduction limit the sub-prime mortgage exposure to 10-20% of the total portfolio value. (It would be more prudent to limit the exposure to 10% or even 5%.
* The limitation of the investment allowed would be a maximum of $20,000. This would allow enough of an investment by an individual who does not have that much in but wants to take a higher risk because of the low amount in the account.
* A new mutual fund industry could exist or in some fashion or like Fannie Mae or Freddie Mac.
* For reduction of risk exposure assumes the value of the investment will fail. Structure the dividend or interest income return so the value of the account will remain even with no return. This is the same technique which is used with high risk investments but with the other portion of the portfolio being in guaranteed no-risk government bonds. The interest from the bonds would over say ten years yield a return on investment equal to the loss of the account. This would affectively zero out any loss from the account but obviously would not return any investment return as well. The observance of BETA management should be strictly accounted for. Examples of rounding out a portfolio through Collar Investing as outlined by Thomas J. Schwab of Summit Portfolio Investing, LLC http://www.summitportfolioadvisors.com may be a good strong way to reduce risk and be aggressive at the same time to help in reducing risk associated with aggressive portfolio management and also lowering the risk aspects generally associated with high risk investment portfolios in other portions of the investment portfolio.
* To offset this potential risk factor the U.S. Government would give an up-front 10% tax credit.
* The tax credit if the investment was inside of an IRA or Roth-IRA or Pension Plan would be able to be taken off on the individuals personal income tax return for 2007 or 2008. The reason for the 2007 is to stimulate activities from an amended return (I do realize that the IRS is loaded down with over 1MM amended returns at the present time from the Economic Stimulus Payments as well at this time.) Or a separate 1040-IRA could be filed at the rate of 15% by the government. The trustees would submit a separate form for the pension holders. An election would be submitted to the sponsoring company if the 2007 was elected. Otherwise the normal course would be for a 2008 tax return for the credit amount.
* If after five years the investment failed then the government would come up with another 10% tax credit or when the investment was sold. The credit would go to the IRA/Pension in this case instead.
* At withdrawal the increase in value of the account would be considered as part of the basis and no income tax would be due on early withdrawal.
* If early withdrawal did happen then no 10% penalty would be accessed against the portion of the interest gain. This would be allowed if the IRA/Pension amounts were kept separate either from an accounting standpoint by the Pension trustee or the IRA trustee. An individual could keep the information separate by opening a separate IRA or Roth-IRA account. If the later is done then the IRS would pay the first five years of the IRA account fees through a tax credit.
* Use of the funds when withdrawn could be used for home construction of solar cell panels on a home. If additional funds were needed beyond the basis and interest income of the invested sub-prime mortgage funds then these funds could be withdrawn without a 10% penalty and the with additional funds would be taxed at the capital gains rate rather than the ordinary rate for the cost of the domicile primary residence solar cell panel investment only.
* The objective here is to leave out the government or at least as much as possible. Tax credits would act as a social manipulation and stimulus.
* This style of stimulation would also leave funds with the United States government to stimulate other sources of alternative energy. An example of this would be the funds could be used to create a 20 X 20 miles solar cell farm in the Arizona or New Mexico desert. Maybe even an algae farm of equal size for the creation of an alternative source of biofuel created from algae. Is there a river close by.
* The available source of Pension, IRA and Roth/IRA funds would not distract from returns on investment but rather a stimulus of ownership would be crucial in resolving world markets. A solution without the possibility of the government going broke would stabilize world markets. This also could stimulate employers to release additional funds to a pension plan because of the enthusiasm of the employees. A restriction of investment through employers pensions could be made if the pension is less than 100% funded. This would be true if the funds were from a defined benefit plan for the tax credit of course.
* Additional funding sources could be from Annuities. A restriction of the March 2007 date may need to be imposed to not allow investment of funds just to get a personal income tax credit.
* Ease of the withdrawal requirements from these types of investments would need to be put in place also. Withdrawal of funds after April 1 of the 70 1/2 birthday would not be calculated for the RMD (Required Minimum Distribution) until after the maturity or the refinancing of the underlying mortgage. Two options would be needed for this calculation by the trustee. Either after all mortgage backed sub-prime mortgages would have to be liquidated (this test may need to be age sensitive) or with a minimum of 5% per year for the withdrawal. Assuming a 20 payout. The other alternative would have to allow a February 15th calculation by the trustee and a withdrawal of additional funds by March 30th for the request. If funds would need to be re-deposited in a 60 day window from April 15th should be allowed. No late fees or penalties for the requirement. Thus older taxpayers would need until June 15th to file their income tax returns.
* States may need to comply and modify their income tax filing seasons and requirements. Most states for state income tax returns take the numbers from the federal returns for purposes of pensions and IRAs. The 10% penalty is usually a percentage of the federal amount. California takes an additional 2.5% of the penalty as an example. Capital gains treatment of pension or IRA withdrawals would need to be changed in the state laws to conform with federal treatment. Federal laws could be adjusted to change the reporting of the capital gains portion under Schedule D rather than the Form 1040 page 1 section. This may be difficult for a federal requirement but the asset would have to be held for one year anyways.
* Again, from the mortgage side of this mess I can see a huge problem but I do not see as much of a down side with this type of a plan as I do with the one-owner concept of the federal government. Administration of existing mortgages would remain a constant. The citizens and world markets may be able to participate in this style or structure of investment. IRA or Roth/IRAs may be considered for foreign investors. If funds were input into a Roth/IRA format and kept separate then a no tax credit would be available for the foreign investor but a maximum of $125,000 could be invested. This would be in essence a foreign cushion and if they are over 59 1/2 at the time of the withdrawal no income tax would be do. An additional withdrawal of the interest and Roth/IRA would have to be allowed due to the restrictions on withdrawal at the border of $125,000 at the present time due to estate tax purposes. Relief of the withdrawal of $10,000 of reporting would have to be waived for transfers of funds out or into the country as well. The 10,000 restriction is in place to detect movement of terrorist funds. An individual to trustee or bank to trustee account should meet this requirement and the receiving trustee would make the appropriate declarations.
* Amounts above the 10% and not inside of an IRA or Roth/IRA up to 20% of ones investment portfolio could be invested in these sub-prime mortgage back securities and the tax treatment would be that of an insurance policy. The maximum amount would could be included would be $10,000,000. The estate tax treatment would be tax free and the gift tax per year would be tax free for the interest income portion.
Let’s knaw on something like the above and keep the government solvent. Many individuals bearing the risk spreads the risk and lowers the individual percentage of loss. We have had numerous large company merge due to large collective amounts being in one place. The last thing we need is for the largest organization to go under. A 5% or 10% loss over ten years by many is less than one large organization which we all depend upon going under. The safer investments from the many will come out even with risks spread and no equity lost or gained over time. The loss by one which depends upon all of us contributing for its stability would be catistrophic for all.
Keith Ljunghammar, EA