The reason I initially contacted Rep. Brad Miller today was to discuss an issue that has come into vogue this week as a potential solution to the housing crisis. San Bernardino County is considering a partnership with Mortgage Resolution Partners on a scheme that would condemn underwater mortgages through the process of eminent domain, and then refinance those mortgages with the borrower. If it works, this would save the individual borrowers tens of thousands, if not hundreds of thousands, of dollars and remove the vulnerability of being underwater; provide an economic stimulus to struggling municipalities; and provide MRP with a tidy profit on the new mortgage, after buying the old mortgage at a large discount through eminent domain. Abigail Field has a very good explainer of this idea.
Rep. Miller entered the debate this week with a column in American Banker, endorsing the concept of using eminent domain as a way to arrest the foreclosure crisis and revitalize local economies. He was immediately pounced upon by several writers, including Felix Salmon, for the differences between his ideal proposal and the realities of the proposal from MRP, some of which I detailed earlier in the week.
So I asked Miller to set the record straight. Miller supports the basic contours of an eminent domain-based process. The condemning authority, i.e. the municipality, would have to pay fair market value for the property, which is what the mortgage would cost under ordinary market conditions. Obviously, if the mortgage is underwater, those conditions would suggest a large discount. However, MRP is only going after performing mortgages, where the borrower is already current. This does help the borrower, because they cannot typically refinance if they are deeply underwater and take advantage of new low rates, while they remain vulnerable to a catastrophic event or financial shock while saddled with an underwater mortgage. But it raises the question of whether MRP can get that fair market value price at enough of a discount to make the whole thing work. In addition, MRP would only seek condemnation of mortgages owned by investors (private label security or PLS loans), rather than those owned by Fannie Mae or Freddie Mac.
“The criticisms of the specifics of the MRP proposal are pretty well-founded,” Miller told me. He wrote an article hypothesizing this type of scheme over two years ago in the New Republic where he outlined an eminent domain deal without a private company’s involvement. “Treasury could have done this with TARP funds and existing statutory authority. FHFA (the overseer of Fannie Mae and Freddie Mac) could still do this. If using federal eminent domain powers became a problem, they could approach local government, the federal entity could front them the money.”
In other words, while Miller supports the idea of using eminent domain at the local level to facilitate a reset of the housing market, that doesn’t mean he was endorsing the specific approach outlined by MRP. As he understands it, there are other entities coming up with similar proposals that sound like they could work better. One has proposed foreclosing on homes, not mortgages, in non-recourse states (states that don’t allow the mortgage holder to go after the borrower for make-up costs in a foreclosure or short sale). “It’s possible that the condemning authority could condemn the home, extinguish all the mortgages on it, and then return back to homeowner with new mortgages,” Miller said. “In recourse states it would not work well at all, because homeowner would still owe any debt. If the purpose is to help homeowners reduce their debt, that doesn’t do the job.” [cont’d.]
Another benefit of condemning the home rather than the mortgage is that it would deal with the second lien problem, which has confounded the industry to date. Many underwater homes – perhaps half – have second liens, like a home equity line of credit, attached to them. Most of the second lien holders are banks. If the first lien is delinquent, that second lien is worthless, and yet the banks still value them at par on their books. The investors would like to see the seconds extinguished, but the servicers – who they pay to work on their behalf – often have massive conflicts of interest because they are affiliated with the holder of the second lien.
Miller hoped that the MRP proposal would extinguish the second liens and break this Gordian knot; but that’s not the case, as Felix Salmon points out. In fact, by dealing only with the first lien and refinancing it to put it in a better position to be paid, the MRP proposal would ENHANCE the value of the second liens, giving a windfall to big banks.
This is why Miller would prefer to see delinquent mortgages targeted rather than performing loans. “Performing mortgages not the most likely to foreclose,” Miller said. “Another group working on the same idea would target delinquent mortgages or mortgages in foreclosure. Those would be greatly discounted. If the purpose is reducing foreclosures, that probably makes more sense.” This was the assumption he made in his initial New Republic article, that the underwater, delinquent mortgages would be available at a deep discount. And in a foreclosure situation, the second liens would get wiped out entirely, so there would be the opportunity to get a deep discount on them as fair market value.
Miller believes that the logistics of the proposal, if calibrated correctly, would work out. The Constitution requires a public purpose for eminent domain, and just compensation. The public purpose would be obvious in the midst of a foreclosure crisis, and the just compensation would be worked out through the fair market value process. Miller acknowledged that “it would require a fairly substantial effort to value mortgages and negotiate with homeowners and handle the legal process,” but municipalities are actually well-positioned to do this. They have legal staffs that handle eminent domain cases all the time. “There would be no way to build straight roads unless government could use eminent domain power.”
Mortgage investors have turned against the MRP proposal, wary that they would get hurt by any deal. And Miller believes they have a point. “Part of the discomfort by investors is that they would have to count on servicers to protect their interests,” he said. “They’re understandably skeptical of that.”
More than anything, the eminent domain debate offers an opportunity to actually talk about how to fix a broken housing market and a seemingly endless foreclosure crisis. Contrary to the bright-side analysts, there is still an enormous problem with foreclosures, and perhaps millions in the queue. “The housing market will recover, but how much permanent damage will result,” Miller questioned. “The quicker we deal with problem, the less damage there will be.”