As additional solutions are cooked up to deal with the historic foreclosure crisis, one possibility hit on by many observers is the idea of having municipalities use eminent domain laws to take over mortgages and then refinance them for borrowers at market value. This would save hundreds of thousands of dollars for borrowers and reduce the risk of foreclosure, while freeing up funds for the revitalization of local economies. Banks would be forced to take the losses, and with the housing market reset, the economy can grow again.
That’s the idea behind approving responses to one such plan, in California. Joe Nocera called it “housing’s last chance.” And today, Rep. Brad Miller offers his endorsement of the concept, which is structurally similar to one he proposed a couple years ago, for a modern-day Home Owners Loan Corporation:
Eminent domain is commonly used to buy land for projects like roads and schools. Existing law allows the use of eminent domain to buy any kind of property, however, including even intangible property like trade secrets. There is no apparent reason that eminent domain could not be used to purchase mortgages.
The Constitution requires only that the county pay fair market value and that there be a public purpose. Deciding a fair price would not be hard. There are frequent auctions of mortgages with a sufficient number of informed, sophisticated buyers. The auctions are an almost perfect pricing mechanism. There would be comparable sales to determine almost any mortgage’s fair market value.
Showing a public purpose would not be hard either. A public purpose can be cleaning up contaminated land, renewing a “blighted” neighborhood, or even stimulating economic growth by replacing residential neighborhoods with commercial development.
In concept, you can see the appeal of such an idea. In particular, however, we have to look at the deal on the table. The county of San Bernardino, the nation’s largest, is considering a plan from a for-profit company called Mortgage Resolution Partners, where the county performs the eminent domain to buy the mortgage, but then MRP negotiates the new mortgage.
Analysts like Felix Salmon and Yves Smith see a lot of problems with MRP’s proposal. First of all, under the scheme, MRP appears to get a massive windfall in exchange for managing this taking and refinancing. They put up some of the capital, but this only works for them if they initially buy the mortgage at a massively reduced rate. It begs the question of why the middleman is necessary. Furthermore, the deal only covers performing loans, current underwater mortgages, that are private-label securitizations and not held by the GSEs. That seems to narrow the impact significantly. Furthermore, current underwater borrowers have a decent chance to get their own refinance, with the tweaks in the recent rules. MRP just doesn’t seem to add much value here and yet they’ll reap a huge reward.
Yves writes that the municipality would be at risk as well:
One of the big problems with this plan, which seems to have been overlooked so far, is that any municipality who goes down this path is likely to be the designated bagholder. Mind you, that isn’t based just on the general tendency of municipalities to be easy prey for clever bankers, but also based on the few, but nevertheless troubling, operational details that have been made public.
The proposal has the municipal authority (the idea is that various localities will join one umbrella authority, presumably per state) borrowing funds from “investors” (key terms not specified) to condemn mortgages. MRP’s own website makes clear that they intend to target only performing mortgages. Yet various accounts also say consistently that MRP thinks it can condemn the mortgages at a discount to face value, and refi them at a profit. This premise is fundamental to the entire scheme working; it’s how the municipalities can afford to pay the considerable operational costs as well as MRP’s fees. And it amounts to theft.
One of the requirements of eminent domain is that the property owner be paid fair market value. For a performing mortgage, it’s awfully hard to argue that that is less than 100 cents on the dollar (in fact, as Felix Salmon points out, it’s actually more these days since interest rates have fallen). MRP argues that they ought to be less since 18% of homes that were performing but underwater in 2010 became delinquent in 2011 (aside, I wonder how many of these were people who defaulted because servicers told them they needed to be delinquent to qualify for HAMP). First, that figure should be lower for the remaining mortgages (presumably, the weakest borrowers default, so the ones who are left are presumably sounder). Second, that logic cannot extend to specific mortgages, since it is specific mortgages that are being condemned. Would you accept an offer less than the blue book value of your car simply because someone said you had a 5% odds of being in a car wreck in the next year? No, but this is the argument that is being made.
Yves adds that municipalities would be on the hook on the constitutional lawsuits, which are sure to pop up, considering that the entire banking industry threatened the county with action if this went through. And then there’s the age-old question of how second liens (like a home equity line of credit) would get treated in this exchange. Rep. Miller seems to think they would be extinguished once this came before a judge, but that’s not totally clear to me.
Nick Timiraos has more on this as well. To add another wrinkle, the city of San Bernardino, the largest population center in the county, just filed for bankruptcy. This puts the county in a pretty vulnerable position, where they may just accept whatever grounds some fly-by-night company puts in front of them if it means the prospect of economic growth. But we just don’t have enough data on precisely what MRP wants to do here to make a judgment that this is a win-win for everyone and not just the company.