Corporate Governance

Seizing Property to Unseize Property Markets

By Carolyn Moskowitz

In the current issue of The Pomerantz Monitor, Jay Douglas Dean reports on the potential use of eminent domain to free up the stagnant housing market. Millions of home owners are still underwater, defaulting on a massive scale.  As foreclosures sweep across America, they depress real estate values for everyone.
 
Many economists have concluded that the best way out is to get lenders to reduce the principal balance on these mortgages to reflect the actual value of the real estate. The government has tried several times to push such a process along, but with very little success. Not only have lenders been reluctant to swallow losses on these mortgages, in many cases the banks don?t even own the mortgages. Millions of them have been sliced and diced into mortgage-backed securities, which are owned by thousands of investors. Getting them all to agree to modify particular mortgages in their portfolios is impossible. As ?Irrational Exuberance? author Robert Shiller has said, owners of securitized mortgages ?live all over the world and have no way of communicating with each other, let alone coming to an agreement to give homeowners a break.?

One possible way around this problem would be for local governments to employ a novel legal tactic: use their eminent   domain power to acquire these mortgages from the holders, a process that would not require their consent. Governmental entities would have to pay ?fair value? for these underwater mortgages, but in this market fair value would be far less than the outstanding principal balance on them. Once the localities acquire the mortgages, with money provided by private investors, they could refinance them for the homeowners, letting them hold onto their homes while making more reasonable payments.  

According to a July 5 video on the online Wall Street Journal, some county and city officials in California are giving this ?silver bullet? serious consideration. New investors can expect to be repaid by homeowners who are issued new mortgages and who are no longer underwater.

Credit for this idea probably belongs to Cornell Law Professor Robert Hockett.  Joe Nocera of The New York Times recently interviewed professor Hockett, who has served as an adviser to Mortgage Resolution Partners, a company consulting with California municipalities on the issue. Hockett told Nocera that to invoke eminent domain powers, the governmental entity has to show merely that it is paying fair value for the property, and that it is acquiring it for a legitimate public purpose.
 
Keeping people in their homes and salvaging real estate markets could well be construed as a legitimate public purpose. ?This is a yoke around the American economy,? said Steven Gluckstern, the chairman of Mortgage Resolution Partners.
 
The eminent domain solution is already getting pushback from investors in mortgage backed securities who, obviously, don?t want to suffer the losses such transactions would impose on them. A draft of proposed rules circulating among members of the Securities Industry and Financial Markets Association, a trade association of mortgage bond investors, would threaten municipalities that are thinking of using eminent domain to acquire underwater mortgages. The rules would disqualify mortgages from those communities from being packaged into certain types of mortgage backed securities. Gluckstern called this maneuver ?reprehensible and immoral,? and also ?probably illegal.?

Full post as published by PomTalk on August 28, 2012 (boomark / email).