The ITT List
Eminent Domain Plan Amounts to Another Fake Foreclosure Fix
The financial world is abuzz with debate this week over a proposal, currently under consideration by California's San Bernardino County, to use eminent domain to seize underwater mortgages. The proposal, brought to the county by San Francisco-based firm Mortgage Resolution Partners, would see local governments take ownership of mortgages that have been bundled into securities, compensate the firms that hold the mortgage at the home's market value, then write down the balance on the homeowner's loan to more closely reflect that value.
Unsurprisingly, this is being decried by investors in mortgage-backed securities as a breach of private property rights. The American Bankers Association, the Mortgage Bankers Association and 16 other financial groups wrote a letter last month to the San Bernardino Board of Supervisors expressing “strong objection” to the plan and implying that Wall Street may sue if the county goes ahead with a forced restructuring of mortgages.
Another group of commentators, however, seem to believe that a scheme concocted by a group of venture capitalists is the deus ex machina that underwater homeowners have been waiting for. On the New York Times editorial page, Joe Nocera calls the scheme “housing's last chance,” explaining that “it’s principal reduction using a stick instead of a carrot.”
Except that this is not a stick. It's another way for a new group of investors to make money off of the mortgage market, and for cash-strapped cities to potentially get stuck with the bill.
As Yves Smith notes on Naked Capitalism:
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.
According to an article from Press Enterprise, one of the reasons that we know so little is that the plan was initially kept quiet due to a confideniality agreement the firm required the County CEO to sign. Among the most important omissions so far: What kind of fees will MRP be charging? (according to Smith, individuals who've met with MRP say it may be as high as 5.5% for every condemned mortgage, even though the firm will only be acting in an “advisory” capacity) And what happens if homeowners can't refinance into a Federal Housing Authority-backed loan, as the proposal stipulates?
Kathleen Pender of the San Francisco Chronicle summarizes how the plan works as follows:
Suppose a homeowner owes $300,000 on a home now worth $200,000. The city seizes the loan and pays the current mortgage holders $170,000. This price assumes a large number of severely underwater homeowners will ultimately default.
The city, which now owns the loan, writes down the balance to $190,000. Now instead of being underwater, the borrower has $10,000 in equity. He gets a new loan for $190,000, which pays off the $170,000, with $20,000 left over for the city to share with its investors and pay expenses.
Whether $170,000 is a fair price depends on whether the borrower would have defaulted on the loan or continued to pay it.
But only performing mortgages, in which homeowners are still current on their payments, would be seized through the plan. Beyond the concern, which Smith raises, that it may not actually be a legal use of eminent domain to compensate the original investors at a discounted rate for these mortages, one has to wonder who this would really help. Homeowners who are underwater on their mortgages are at a higher risk of defaulting, but they are already supposed to have a chance to refinance through federal programs. The low success rate of these programs, however, is in part explained by the contradictory incentives that exist for mortgage servicers, which generally collect fees for deliquent loans as well as from homes that are sold following foreclosure. In short, foreclosures are often more profitable than modifications for the banks that are responsible for approving them—which leads to the myriad stories of homeowners being erroneously told that they must become delinquent on payments in order to be eligible for HARP, or being given a revolving door of reasons why they don't qualify.
These are the areas where actual sticks—not ones that introduce a middleman who will reap profit without performing any discernable service—could help relieve the crisis. But federal policy has so far done little more than mediate between the competing interests of different groups of banks and investors. If this policy is implemented broadly, as its initiators and proponents apparently hope it will be, it would merely introduce another set of financiers to the mix without adding additional safeguards on how they can attempt to profit from gambling on peoples' homes.
Compare this to Iceland where, after banks defaulted on $85 billion in 2008 and mass protests ensued, the government took a major stake in them and forgave debt exceeding 110% of a home values. In February, Fitch Ratings acknowledged that the country's “unorthodox crisis policy response has succeeded” in creating a stable outlook for the housing market.