With some 29 percent of borrowers underwater or almost underwater on their home loans, a plan in California to use eminent domain to reduce mortgage principal is attracting a lot of attention. Here’s what the hubbub is about.
What’s the proposal?
The idea is that municipalities use their power of eminent domain to help homeowners who owe more than their house is worth. The municipality would set up a special entity to buy the mortgages—not the homes themselves—and then give the homeowners new, smaller loans that more accurately reflect the market value of the properties. A firm touting the idea, Mortgage Resolution Partners, would find institutional investors to fund the purchase of loans on behalf of cities. MRP would charge a percentage as fees for its work selecting and restructuring the mortgages. The modified terms would apply only for borrowers who are current on their loans and owe more than their homes are worth.
Why can’t the lenders just do this on their own?
Remember mortgage-backed securities, the loans that were bundled and then sliced up into bonds on Wall Street? Since the loans are dispersed through a broad array of securities, it can be tricky to get the investors to reduce the principal on a loan. (I wrote about this tangled web at the investigative newsroom, ProPublica.)
Where did the idea come from?
The idea began receiving attention last month, when San Bernardino County and a few other California municipalities were considering a plan proposed by San Francisco-based MRP. ”Eminent domain is a way to successfully consolidate ownership of a homeowner’s mortgage loans in the hands of someone with the economic incentive and freedom to modify or otherwise resolve them,” MRP says on its website. The proposal had come from research by a Cornell University law professor, Robert Hockett, according to the Press-Enterprise, the newspaper that covers San Bernardino. Hockett was curious about the legal methods municipalities may possess to help reduce the debts of underwater borrowers.
Would courts ever approve such a plan?
Under eminent domain laws, municipalities can force the sale of a property at a fair value if it’s in the public interest. The law is usually used for real estate, such as buying homes that are in the path of a new freeway, but eminent domain has also been used in other intangible purchases, such as buying copyrights or contracts. For example, the City of Oakland once tried to use eminent domain to buy the Raiders football team in a move to prevent it from relocating to Los Angeles. The California Supreme Court found this type of intangible purchase could be allowed under eminent domain, although it ruled against the city for other legal reasons. There’s no doubt plaintiffs will challenge this use of eminent domain; since it’s never been used in such a way, there’s no direct precedent.
What’s the response been so far?
The proposal has stirred quite a national debate. New York Times columnist Joe Nocera praised the effort. ”The more closely you look at it, the more sense it starts to make,” he wrote on July 9, lauding how it cut through the tangle of ownership caused by securitization. In an op-ed for American Banker, Representative Brad Miller (D-N.C.) said the idea could reduce foreclosures and would hurt only big banks by forcing them to recognize losses.
There’s been more opposition, though. The financial industry, including banks and mortgage investors, quickly decried the plan. A letter (PDF) cosigned by 18 industry organizations said the plan has “very serious legal and constitutional issues” and would be “immensely destructive” to mortgage markets by eroding the value of the bonds and undermining the contracts between investors and borrowers. Some generally liberal bloggers also questioned the plan. In a lengthy takedown, Yves Smith, who blogs at Naked Capitalism, said MRP would earn “obscene” fees that “fleece” the municipalities and leave the cities responsible for legal challenges. FireDogLake‘s David Dayen questioned the usefulness of helping only borrowers who remain current on their loans, as did Reuters’s financial blogger Felix Salmon.
Will this idea move ahead in San Bernardino County or elsewhere?
The county and two cities have formed the special entity they’d need to start buying the mortgages, but they haven’t started the program yet. They first need to be comfortable with the legal implications—and MRP would need to find investors agreeable with the legal risks—as the big banks would likely launch a huge legal battle.
Why is this proposal garnering so much attention?
Because the underwater mortgage problem remains huge. Mortgage data released on July 12 by CoreLogic shows that while the number of underwater borrowers has been decreasing, roughly one in four homeowners still owe more than the property is worth—making even long-shot ideas worth a second look.