Using Eminent Domain to Condemn Underwater MortgagesAug 17, 2012 by Ugh
With millions of homeowners still "under water," some local governments are considering a novel solution: condemning their mortgages through the power of eminent domain.
There are several ways a local government could use eminent domain to write down mortgages, but the basic idea is fairly simple. Much like the condemnation of a piece of land for public use, the town or county would seek court approval to pay a “fair market” value to a lender or investor holding a homeowner’s underwater mortgage. That amount would be substantially less than the unpaid balance. Once the seizure is approved, the local government would then offer to sell the smaller mortgage back to the homeowner, who would refinance the outstanding balance with a new loan.
Not surprisingly, the banks/investors/governments (Fannie/Freddie) that hold the mortgages are none too happy, since this is what they've been trying to avoid all along, and would prove a great many of the banks insolvent, perhaps with collateral consequences (one pointed out is that it's going to be hard for homeowners in those communities to get credit to buy homes in the future; also, Rahm Emanuel is a dick, but I digress).
But...I'm intrigued. This doesn't seem to be any worse than what the Supreme Court blessed in Kelo (to quote wiki's summary: "the Court held that the general benefits a community enjoyed from economic growth qualified private redevelopment plans as a permissible "public use" under the Takings Clause of the Fifth Amendment."). If anything, it's better than Kelo. So there doesn't seem to be a Constitutional problem here as long as they pay the holder of the mortgage FMV for the loan, and it appears the FMV in a great many of these cases is a lot lower than the face value.
I also liked the description in the article that the complex contracts governing the mortgage trusts held by the banks/investors is acting as a "suicide pact" since it prevents modifications that would ultimately be good for the holder. And: the same trust contracts that have impeded investors from writing down loans also leave them with little protection from a local government that offers less than fair value when it seizes mortgages, she wrote. Obviously cities should pay FMV in any event.
The "moral hazard" argument is raised, stating "Cutting the loan balance of a troubled homeowner will only encourages future borrowers to take on debts they can’t pay back...." But that doesn't seem right unless you want to characterize the power of eminent domain as some sort of insurance policy. And there is (supposedly) the lenders as gate keepers to keep this from happening, and how many people are going to take out a mortgage larger than they can afford because they think they can get the state to use its power of eminent domain several years down the road when they can't pay anymore?
I'm sure there are many things wrong with this that I'm not thinking of, but seems pretty interesting.
Update: Turb in comments provides a link that shows the many things wrong with this plan that I didn't think of.
Aug 17, 2012, 03:39:46 Turbulence wrote:
Felix Salmon points out that while in theory eminent domain could solve a bunch of problems here, in practice, the plan that Morgrage Resolution Partners has cooked up is an awful plan that won't fix anything and will probably never get off the ground. Unfortunately, Reuters is incapable of running a blog web site, so you'll have to do with a google cache link:
Aug 17, 2012, 05:05:50 Ugh wrote:
Ah, thanks Turb. I guess I was thinking that the FMV of the loan itself was less than its face value and not just the home (led astray by "That amount would be substantially less than the unpaid balance." in the article) Also, I didn't think of people continuing to pay the mortgage on houses underwater (which was stupid of me).
Aug 17, 2012, 10:41:33 libjpn wrote:
If either of you would like to write a post about this for ObWi, I would love to read it. The recent discussion about money drying up at banks and the reasons for it suggests that lots of folks might have very different views of the solutions. This may be meta, but I'm always amazed at the stories about people walking away from their mortgages.
and the various discussions about morality.
One way that Japan avoids this is that the local tax levied on structures is quite high, so it usually makes better financial sense to tear down the building, so if a similar situation were to arise here, the bank would probably tear down the house rather than leave it standing, though this only goes for places within incorporated areas, so there are a places that are located in unincorporated areas that are still standing.
This goes hand in hand with the Japanese love of new things. Almost every Japanese who buys a used home and the property immediately tears it down and builds a new one. Another foreigner and I both have 'used' houses, in that we bought them and just moved into them and it is regarded as a bit strange.
Also, when I read this discussion, I remembered this about Detroit
Aug 18, 2012, 01:35:20 Ugh wrote:
Thanks LJ, but I think I've said enough silly things on this topic already.
On walking away from mortgages, other than the attachment to the home itself, I'm not sure why "morality" has anything to do with it.
People should look at it this way: The typical nonrecourse mortgage is an option. The bank lends you money, in exchange you promise to pay them back, but you have two methods. First, you can pay them in cash, plus interest. Second, you can give them the house.
Further, the bank struck this deal with you knowing full well about option two. Why is there some moral choice here?
Aug 18, 2012, 01:56:09 Ugh wrote:
That said, I can see how people might feel guilty about living in a home while not paying for it (although my guess is the bank would rather have them do that then just plain move out and leave the home empty during the foreclosure process).
Also, not all mortgages are nonrecourse, although that should make people feel even less guilty about "walking away" since the bank can still come after them for the difference.
Aug 18, 2012, 02:00:24 ccdg wrote:
"People should look at it this way: The typical nonrecourse mortgage is an option. The bank lends you money, in exchange you promise to pay them back, but you have two methods. First, you can pay them in cash, plus interest. Second, you can give them the house."
This simply isn't accurate. The typical mortgage requires you to pay. If you default and the bank forecloses they still have the right to collect the difference in what they get for the house and what you owe. The fact that they raely do it doesn't meanyou haven't ethically screwed them, and your neighbors.
Aug 18, 2012, 02:57:46 Ugh wrote:
If it's a non-recourse loan, it certainly is accurate. And this is part of the reason why banks would require 20% down, so you couldn't just jump ship six months later.
It could be that these days most mortgages are not non-recourse, in which case, yes, the bank can come after you for the difference, as I note in my second comment.
Aug 22, 2012, 00:17:17 ccdg wrote:
Missed your second comment when I wrote mine. Correct of course.