Eminent Domain Is Bad Ploy for Underwater Mortgages

Illustration by Dylan C. Lathrop Close

Illustration by Dylan C. Lathrop

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Illustration by Dylan C. Lathrop

Officials in San Bernardino County, California, believe they have figured out a clever way to solve the county’s, and possibly the nation’s, housing problems.

Detailed by a Cornell University professor, and pitched by influential San Francisco investors who stand to make a fortune from it, this new idea is based on one of the oldest concepts: the taking of other people’s property.

County officials, joined by the cities of Ontario and Fontana, are considering using an expansive interpretation of eminent domain -- typically used to acquire real property to build public works -- to seize the mortgages, not the real property, of those homeowners who owe more than their homes are worth.

The funds would be provided by private investors, who would pay the holders of the mortgages “fair market value” and then write new ones for the homeowners based on much lower principal amounts, reflecting the new depressed values of the homes. The firm behind this complex plan, Mortgage Resolution Partners, may be in the running to acquire vast numbers of mortgages at discounted rates. Local officials would have, theoretically, solved their local housing problems. Homeowners would stay in their homes and have much lower mortgages.

Advocates tout it as a win-win solution, but the holders of the mortgages must give up their assets and accept whatever value the governmental authority assigns to their notes.

Wholesale Price

The “fair market value” probably wouldn’t be based on an expected sales price of the home, but on a wholesale value that would be at least 20 percent lower than that, said Mark Dowling, the chief executive officer of the Inland Valleys Association of Realtors. (The value would probably be based on the fair market value of the mortgage -- the home price minus many transaction costs -- and thus far lower than the fair market value of the home itself.)

In such a deal, the mortgages’ owners -- bondholders, banks, individuals -- would be hard-pressed to challenge the valuation. Granted, the current owners -- bondholders, for example -- may not be able to collect the full amount owed to them, but they should be free to pursue repayment without being forced to accept a sum lower than what they might have expected to receive.

Wall Street’s largest lobbying group, the Securities Industry and Financial Markets Association, has weighed in against the idea, citing constitutional issues, Bloomberg Businessweek reported.

This complex plan should have been nothing more than a thought experiment in a college economics class except that Mortgage Resolution Partners took the idea to the San Bernardino County Board of Supervisors, which this month unanimously voted to create a “joint-powers authority” to pursue the plan.

Officials say the authority was formed only to explore this idea, but as the Inland Valleys Association of Realtors pointed out in a letter to the county board of supervisors: “Currently, the JPA agreement does not require partner members to approve any JPA programs. Instead, the board is only required to seek approval for its budget from the participating local governments if those governments are asked to contribute funds.”

So the county has spawned a new governmental agency, with few limits on its power and little direction from elected officials. The county will have no oversight of it unless that agency comes to the taxpayers for money -- unlikely, given that investors will pay for this project.

Abandoned Subdivisions

San Bernardino County was hit hard by the foreclosure crisis. Larger in land area than nine states and with a population of 2 million, the county starts about 40 miles east of Los Angeles and ends at the Nevada border.

During the real-estate boom, people looking to buy homes headed inland because it was far more affordable than coastal regions. When the housing bubble popped, the area was left with abandoned and half-built subdivisions. In many places, prices fell by two-thirds or more from the market peak.

The county’s foreclosure rate is one in 179 houses, which is 3 1/2 times the national average, according to published reports. But the eminent-domain idea deals with only 20 percent of the county’s estimated 150,000 underwater households. To avoid tangling with the federal government through Fannie Mae and Freddie Mac, or with politically influential banks, the plan targets only the holders of those bundled, privately held securitized mortgages. This is about acquiring properties on the cheap rather than addressing the main problem.

There would surely be unintended consequences. Grabbing private mortgages could lead to a widespread reluctance by private firms to lend money in the county -- or at least an increase in the cost of lending in that area. That would be a particular problem given that an obstacle to a revived housing market, especially in low-income, high-unemployment areas, is the inability of homebuyers to qualify for mortgages.

As Gideon Kanner, professor emeritus at Loyola Law School, argues, “If you make a reduction in loan balance available, whether by eminent domain or otherwise, these people will be provided with a powerful incentive to stop making payments on their mortgages, hoping to get bailed out by the government.”

The deal could, then, have the opposite result of what is promised.

However it shakes out, the plan would create perverse incentives. Mainly, it seems like a way for big players to muscle out the smaller investors who now are competing for short sales and foreclosures. (I may qualify as one of them, because I own an investment property in San Bernardino County.)

There is increased evidence that the market is fixing itself. Foreclosure rates are down almost 43 percent in California and almost 60 percent in Nevada since the peak of the market, according to CoreLogic (CLGX), the mortgage data company. Although the number of foreclosures was up in San Bernardino County in May over the previous month, it has been little changed since last year, and prices have risen 5.7 percent there in 2012.

Housing Revival

The Orange County Register reported on a feeding frenzy of buyers for foreclosures in nearby Orange County. That wealthy coastal area is a far cry from pollution-choked San Bernardino. But Southern California coastal trends always move inland. Even Arizona, ground zero for the foreclosure crisis, is undergoing a homebuilding revival, as a recent article in Bloomberg News detailed. Many investors have been raising money to buy up foreclosed single-family properties to turn them into rentals, while awaiting a stronger housing market.

Rather than advancing a public good, the main beneficiary of this idea would be those private interests most adept at manipulating the government. Policy makers should reject this abuse of property rights and allow the housing market to do what it already is doing -- recover on its own.

(Steven Greenhut is vice president of journalism at the Franklin Center for Government and Public Integrity. The opinions expressed are his own.)

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To contact the writer of this article: Steven Greenhut in Sacramento at steven.greenhut@franklincenterhq.org.

To contact the editor responsible for this article: Katy Roberts at kroberts29@bloomberg.net.

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