Apr202013

The Eminent Domain of mortgages proposal is rearing it’s ugly head again

What was the tagline for Jaws 2? “Just when you thought it was safe to get back into the water”.  Eminent Domain is the seizing of private property at market rates for public use for example roads, schools, and other infrastructure.   Robert Shiller is to my surprise, a proponent of using eminent domain.  How is purchasing a mortgage which is a security agreement between the lender and the borrower qualifies as a public use?  Eminem domain just a backdoor way to force a principal balance write down on a mortgage by using local government’s police power.  The principal reductions completely let’s the borrower off the hook and encourages additional moral hazard type behavior.  Oh, and the new term is now called “targeted mortgage reduction“.  Now there is an second attempt by California local governments to purchase and restructure underwater mortgages to market value of the subject property by using eminent domain.  We need Chief Brody to go out in the water again and take out the eminent domain shark just one more time.

Eminent domain to fix troubled mortgages makes a Calif. comeback

(Reuters) – A controversial proposal to get local government officials to condemn distressed mortgages — in the same way they might condemn a dangerous property — is slowly gaining traction in some California communities, several months after it appeared the idea had been killed.

After months of contentious debate, officials in San Bernardino County, in January killed the idea of seizing troubled home loans in a process known as eminent domain. They rejected the idea after fierce opposition from Wall Street trade associations and investors in mortgage-backed securities.

But since then, San Francisco-based Mortgage Resolution Partners (MRP) has signed advisory agreements with five California towns that permit the financier-backed group to begin negotiating a sharp reduction in the dollar value of distressed loans that are held in securities administered by banks and mortgage servicing firms.

The principal reduction proposal also keeps getting suggested at the federal level by people like Mark Zandi.  Eminent domain of mortgages is just principal reduction but performed at the local level.  However, usually the federal proposals have some sort of bailout for the lender on the reduced portion of the loan so not make the lender too angry.  You can see the evidence of crony capitalism due to the fact that a federally enforced principal reduction will have some bailout to lender at tax payer expense.

MRP’s strategy is to either achieve a voluntary agreement with servicers and banks to reduce the principal owed on loans that are valued at prices higher than the homes are worth, or use the club of eminent domain to forcibly seize the loans and restructure them at a lower price.

MRP, which earns a $4,500 fee for every loan that is restructured, argues the threat of eminent domain gives municipalities, hard-hit by the housing crisis, an opportunity to help cash-strapped homeowners struggling to pay their mortgages.

This is very heavy handed…agree to my terms or I’m going to reduce the principal balance on the mortgage anyways.  This is extortion.

But Wall Street trade groups like the Securities Industry and Financial Markets Association and the Association of Mortgage Investors argue that forcibly condemning home loans and rewriting them is a violation of contractual agreements between a bank and a borrower.

Let’s take this argument outside of the housing industry and use another example from real life.  Can the City of Anaheim eminent domain the contract between the Angles and Albert Pujols?  Should the City be able to eminent domain the contract thereby reducing the compensation to Pujols because the City just feels it’s too high and athletes shouldn’t be compensated that much? See how crazy and intrusive it sounds when you illustrate it with an an example that doesn’t involve housing or the mortgage industry?  The same logic using Albert Pujols’ contract as an example should be applied to housing.

“This type of government intervention is only going to harm the housing market,” said Chris Katopis, executive director of the Association of Mortgage Investors, which represents a group of about two dozen, private bond investors. “This is not a fair and equitable solution.”

Chris Killian, a SIFMA managing director, said the MRP plan forces “investors to lock in a loss on a loan” by reducing the mortgage value, even if the borrower is still making payments.

If the loanowner gets a principal reduction and value of the home increases shouldn’t there be recourse by the lender to recover their loss caused by the eminent domain?  The responsibility should go both ways.  The loanowner gets a principal reduction, however a lien is placed on the house if the borrower sells.  Really, I just prefer if this eminent domain example does not ever happens and the loanowner either applies for  a loan modification, short sale, or foreclosure.

MRP’s most recent advisory agreement was signed on April 2 with the city of Richmond, Calif., according to public records and MRPs marketing materials reviewed by Reuters. Other California communities that have signed similar agreements with Mortgage Resolution Partners are El Monte, La Puente, San Joaquin and Orange Cove.

I doubt the average politician in one of these local cities even vaguely understands the long term consequences of this proposal.  Grant it, I didn’t attend a Ivy League college and didn’t graduate Phi Kappa Beta.  However, the intelligence of these local politicians should be called into question in how damaging of a proposal for the community this really is or maybe they just want to handout goodies to the public so they can get reelected.

The group is also negotiating with officials in North Las Vegas, Nevada a community of 227,000 people that was particularly hard hit by the housing bust. In North Las Vegas, MRP has identified at least 4,700 underwater home loans, mortgages that are for more than the homes are currently worth, that could qualify under its plan.

In 2013, getting out from under your underwater mortgage is no longer a problem, so why is this program even needed? With the recent increase in home values and the incredible bidding wars that are happening for homes, the loanowner should just short sale if they want out or wait for the bubble to reflate.

The revival of eminent domain as a strategy for restructuring distressed mortgages comes as the U.S. housing market is showing signs of revival. But according to CoreLogic there are still an estimated 10.4 million U.S. homeowners who are underwater on their mortgages.

“It’s not a panacea to deal with the broad issue of foreclosure, but it is another tool that could be potentially effective,” said Bill Lindsay, the manager for Richmond, California, a city of 105,000 people.

The loans MRP seeks to restructure are those packaged into securities sold by Wall Street banks before the financial crisis. These private label mortgage securities do not carry a government guarantee of principal repayment, which distinguishes them from mortgage debt issued by government-sponsored mortgage firms Fannie Mae or Freddie Mac.

I hope this will the vulnerable part of this program that will ultimately lead to it’s failure.  Currently, 90% of new originated guaranteed by Fannie Mae, Freddie Mac, or insured by FHA.   If investors refuse to purchase these products then MRP won’t have the funds to purchase the loans and repackage them on the market.  Or if the investors what a much higher return then the current rates of returns for mortgages due to the risk of these repackaged loans, the borrower will realize they will getting a principal reduction however the payment on the newly eminent domain could be higher.

Loans in private label bonds are not eligible for most federal government mortgage modification programs

Last year, private label mortgage bonds returned 21 percent, making it one of the top performing assets for bond investors, according to Amherst Securities Group. The bonds rose in value in response to the Federal Reserve’s decision to buy $40 billion in government-guaranteed mortgage debt each month and an improvement in the performance of some of loans.

Most debt instruments, which includes private label mortgages, increased value last year due to the drop in interest and mortgage rates.  This trend could easily reverse if interest rates start to increase and lowering the value of the debt instrument.  In addition, these private label mortgages most likely required large down payments with strong credit and income requirements.  Finally, it’s not really a 21% rate of return, it’s an unrealized gain which can easily change if mortgages rates move in the wrong direction.

Traditionally, local governments have used eminent domain to condemn blighted properties or seize land for public works projects. Wall Street trade groups have warned communities that using eminent domain to seize mortgages could spark litigation and cause lenders to be wary about writing mortgages in certain towns.

That might also be another weak point of this proposal.  If San Bernardino County tries to implement this program they might find themselves with lenders unwilling to underwrite new loans in the County.  This would have a crushing effect the to the home values in the area.

MRP, in its marketing documents, has said it has investors willing to finance the cost of condemnation so the municipalities do not have to spend any money seizing mortgages. The group has not publicly identified its financial backers.

So, I like to summarize all the negative aspects and weaknesses of this proposal just to illustrate how bad of an idea this is.

  •  This process will encourage underwater loanowners to default and receive a principal reduction
  • With the current market value increasing most of these loanowners could probably sell their house with multiple offers.
  • The eminent domain process is for public use and how is a mortgage (a contract between two private parties is not public use)
  • Current lenders will probably stop lending to borrowers in cities that promote this eminent domain process
  • Investors of the new mortgages will want a higher rate of return ie a higher mortgage rate on the restructure mortgage
  • They were probably be huge legal battles between the current lenders and the cities over this
  • After December 31st any principal write down will be taxed as income.

My hope is that will all these problems I listed above that the program is never implemented.  This is the worse of the worse proposals to come out of the housing bubble. There are already existing methods if you can’t afford your mortgage; loan modifications, short sale, or foreclosure.  There is no need to have a heavy handed approach that is probably illegal and won’t survive the court battles between the existing lenders and cities.

So, why not short sale or foreclose if the in the market place is purchasing practically any structure with a roof and a toilet .  It’s greed by the loanowner, because they want keep their house and have a lower payment and a principal balance to match the market value.  The implementation of this proposal could ruin the very fabric of the housing market and it make home lending very similar to unsecured credit lending.  And if that happens home lending will return to the days of the 5-year balloon payments.  This proposal needs to stopped before it ever gets implemented by a do-gooder city government.