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FHFA Threatens to Kneecap Use of Eminent Domain to Condemn Mortgages

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All this talk of firing Ed DeMarco seems to have led him to decide to live up to his reputation.

Amanda F pointed to a wee notice released by Fannie’s and Freddie’s regulator:

Now let us recall that using eminent domain is a mere fondly-hoped-of cash cow for promoters like Mortgage Resolution Partners, who plan to nick a fee on every performing mortgage condemned (they are targeting ONLY borrowers that are paying on time but deeply underwater). While we think eminent domain could be a tremendously useful tool for getting around servicers who refuse to do modifications of borrowers who are delinquent or under financial stress, we are firmly opposed to the MRP scheme (the big reason is that the price at which they propose to condemn the mortgages is under fair market value and hence tantamount to stealing).

And by starting where investors will come out losers, MRP has set out to galvanize the opposition. When servicers have been sitting on their hands and abusing both borrowers and investors, condemnation is a win-win. But the MRP proposal is an exercise in extraction from investors, who most often place their money with fund managers who can’t be bothered to sue. While they say they will only condemn non Fannie and Freddie mortgages, their huge PR push has led other groups to start pushing eminent domain proposals. The nay-sayers’ slippery slope argument isn’t nuts. Anyone who condemns a first mortgage ought to condemn a related second (which will of course get the banks up in arms). And if you are a local pol, how can you justify condemning private label mortgages when someone in your jurisdiction might be identically situated from an economic standpoint, but doesn’t get a break because he is in a Fannie or Freddie mortgage?

The key bit of the FHFA notice is this:

FHFA has determined that action may be necessary on its part to avoid a risk to safe and sound operations at its regulated entities and to avoid taxpayer expense.

This is code for “If our concerns are validated, we will throw our weight against it.” And the FHFA has a lot of weight. While the SIFMA threat to exclude municipalities that started doing condemnations from the Fannie/Freddie “to be announced” market is a close to meaningless threat (as in it sounds impressive but the economic impact is pretty close to nada), the FHFA could bar Fannie and Freddie refis in the same areas. Since any local official who produced such an outcome would be tarred and feathered, you can expect that if the FHFA adopts this tactic, eminent domain is pretty much dead, barring a change in leadership at the regulator.

Now of course, we can expect any and every friend of servicers to provide submissions to the FHFA saying how terrible using eminent domain on mortgages would be. But cut through the lobbying BS, and there are two valid concerns. One is the one I flagged, that plans now being discussed seriously would condemn money good mortgages at significant losses to investors. Although most of the industry objections to date have focused on the constitutional issues (which I am told are pretty serious in California, one of the test grounds), simply because that’s the first line of defense. To my mind, the pricing, or more accurately, stealing issue is stronger, and the FHFA has legitimate grounds to be concerned. A second issue is that even if performing mortgages were condemned at a true fair market price, it would still increase prepayment risk, which is already hard to model. The undesirable feature of mortgages is that they go away just when bondholders are happiest, when interest rates drop. So MBS have a higher interest rate than fixed maturity bonds of the same credit quality to compensate for this unattractive quality.

There is enough history with prepayments that investors can model it pretty well, and the GSEs have a huge hedging operation to manage the risk. Condemnations of performing mortgages will be a wild card and will undermine the ability to predict the rate of prepayments, leading investors to demand an even higher premium over similar fixed term bonds. And it will similarly massively complicate the GSEs’ portfolio hedging.

I hate to be the bearer of bad tidings, but the FHFA is not wrong to be concerned. And rather than shooting at DeMarco, try shooting instead at the guys who are messing up using up eminent domain as a tool to address the mortgage crisis by coming up with and loudly promoting a plan with serious deficiencies.

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36 comments

  1. JGordon

    Ed Demarco is not only a hero, but also one of the few non-crooks inside the Obama administration. I’m not sure why people are always hating on him.

    Although it does go towards the premise I concocted that the American people prefer lying criminals representing them. If lying, venal criminals weren’t in power already, the American people would just elect a bunch of them in by November. Because that’s the true heart and soul of the American character.

    Using that reasoning I learned to stop caring about what happens, and I’ve been better for it! You all should do the same.

      1. Markar

        The comment you just replied to would hardly be a characterization of or represent the views of Geithner.

    1. Mafer

      I´m not completely sold on your premise yet, but the majority of Americans I meet seem to be “low information voters.”

    2. R Foreman

      We developed a system where only lying venal criminals can take office. We found that it results in maximum death, social destruction, and rape of natural resources for those outside our country, while formerly conquered peoples remain strangely pacified. The system we call democratic oligarchy by divine right of b2-aircraftcarrier-laserbombdrone-rfidchip.

      1. JGordon

        Morris Berman has the idea that all the greedy capitalist pillagers saw a Big Oppurtunity when The New World first opened up, and so streamed into America to set up shop here.

        They created a culture that was based on nothing more than greed, pillaging, and economic growth, and now that we’ve just about chewed through all the resources this planet has to offer, not only is the economic system collapsing, but our American culture is as well.

        Anyway, that’s beside the point. The point is that Americans were greedy bastards from the beginning, according to Morris Berman, and my idea is that all the lying crooks we have representing us are just a natural consequence of that. In fact, the American people are themselves lying crooks, and have always been so, so it’s only natural that we elect them into office every 2 and 4 years.

        1. R Foreman

          My personal view is that our system was founded on sound fundamentals, but along the way we had some very corrupt people make a very concerted and persistent effort to infiltrate and pervert our government. A system like ours cannot be changed quickly, so this took place over a long time, a hundred and fifty or more years.

          It should seem obvious that the government, the public, paying off someone’s private losses, should not be allowed, yet that is seen as the norm now. It serves to show how far we’ve gone off the edge.

          I’ve enjoyed Professor Michael Hudson’s discussions of the history of money and lending, since it provides some context for what we’re experiencing now. In retrospect we can see that banking as a business model, had it’s origins as a counterfeiting operation, since they were circulating currency outside the auspice of government.

    3. LucyLulu

      I agree that DeMarco is acting out of principle. He sees his mission as one of protecting the taxpayer’s pocketbook, and has adhered religiously to that mission. I respect him for that, even if I don’t always agree with his policies, and see his focus as too narrow. He IS an honest actor. We’d be well-served to have more like him. He is nothing like Geithner. Heck, DeMarco has brought the most well-researched and evidenced suit against the banks, having (the authority to) file subpoenas and go in and do on-site audits of their loans.

      1. Mattie

        DeMarco also has a mandate to help keep folk in their homes. On this, his response has consistently aligned with the “use them to foam the runway” for everyone else on the other side of the sacred underlying contracts.

        Sacred? We know – we have known since 2004, when the FBI pointed it out to us, that there is material evidence of lender-originated fraud at the heart of those “sacred” deals not deals.

        Why does everyone so conveniently forget the issue of rampant appraisal juicing and loan ap lying [too often by hungry loan officers hungry for commissions]?

        How many of the 11M underwater bubble-days borrowers were victims of this sort of abuse, rather than perps of the wrong-doing?

        If you can’t answer this question, then you should keep quiet about the rights accruing to non-borrower parties to the deals not deals.

        Next ask yourself what recourse do the millions of such victim borrowers have? Answer: none; too late and nobody cared about them anyway. Besides, they had too much value as runway foam.

        Finally, ask yourself – how do these schmucks get out of this hole, now that we’ve eliminated bankruptcy relief potential?

        I got it… Let’s let them refinance into new notes at lower rates [more foam to delay the inevitable]. The new notes will carry, for the first time, an explicit federal guaranty which – thanks to DeMarco’s new rulemaking concerning federal debt collection – renders the new debt, like federally-guaranteed student loans, utterly unforgivable.

        Even Adam Levitan struggles w to this problem, given the unwillingness of either Congress or regulators to do the right thing by these folks, is it any wonder that the idea of eminent domain might capture the attention of desperate imaginations?

    4. LadyLiberty

      I completely agree with you someone has to look out for the taxpayer and obama/holder sure aren’t doing that.

      Financial Fraud Conviction Scorecard:

      Bush: 1300+, Clinton: 1000+, Obama: 0.0 (+/-)

      http://dailybail.com/home/convicted-bush-1300-clinton-1000-obama-00.html

      Fannie Mae and Freddie Mac report profitable quarters, still owe taxpayers $146.5 billion

      http://dailycaller.com/2012/08/08/fannie-mae-and-freddie-mac-report-profitable-quarters-still-owe-taxpayers-146-5-billion/

  2. jake chase

    Let’s see: you are against condemnation of mortgages that are performing although deeply under water and regard this as ‘stealing’ from MBS investors. I am not so certain. It can be argued that those investors are merely stealing from homeowners who are too obsessed with staying in their homes to behave like good economic actors and default on obligations it makes no sense for them to fulfill. And all this concern for the MBS ‘investors’ (usurers) is largely misplaced. They were equal particpants along with the originators and servicers in creating this mortgage mess, and their motivations were precisely the same (greed, grabbing a return without risk, capitalizing upon a gullible public, etc.

    And if the entire securitization market evaporates as a result of this scheme the effect on housing prices might just get the real economy going again. It may be time we stopped concocting reasons to justify the protection of redundant capital.

    1. skippy

      “It may be time we stopped concocting reasons to justify the protection of *redundant capital*.” jake.

      Jake that’s just so un-flowery.

      Try neoliberal *Capital Honey Pot*… all the little bees bring their pollen too you, and the neoliberal magic (selling risk to others) makes honey out of it. Yes, yes some of little bees get a small portion of the honey, but, none of the Royal Jelly (value)… of course.

      Skippy… actually *fictitious price expectations* that becomes more redundant the further you extend time out, is more like it. I can actually hear the screams of – wheres my 20+% – whats this 7ish% shite. Wait till the advisers start gently telling them its preservation time and good luck with that!

    2. F. Beard

      It can be argued that those investors are merely stealing from homeowners who are too obsessed with staying in their homes to behave like good economic actors and default on obligations it makes no sense for them to fulfill. jake chase

      You have a point.

      Since “bank loans create deposits” then the banks are counterfeiters. Thus the debt they create is morally invalid. Thus the MBS buyers are buying stolen goods.

    3. Mcmike

      The entire mortgage industry is built on the phenomena that individuals will try to keep their promises far longer than companies will.

      In fact, bankruptcy for corporations has become a right of passage – deliberately employed and cheered from the sidelines as a smart strategy for explicitly breaking promises they no longer wish to keep.

    4. LucyLulu

      No. If I understand correctly, it’s only stealing if the properties are taken at less than fair market value. Perhaps state laws vary but when I’ve seen eminent domain used, it was required that fair market value be paid for any properties seized and it seems that should be a non-negotiable requirement.

      Outside of that, DeMarco does have final say by using the agencies’ financing as his bargaining chip. If he withholds their financing from a community, any deal is dead. Just as predatory financing legislation was immediately rewritten in Georgia back in 2003 when the ratings agencies refused to rate any GA loans for securitizations.

    5. Yves Smith Post author

      You need to grow up.

      People who buy AAA paper are not greedy. AAA paper is supposed to be a no brainer, super safe investment for widows and orphans. And if you read ECONNED or this blog with any consistency, you’d know that the toxic phase of subprime resulted from the introduction of CDS on ABS securities, which allowed for the creation of synthetic and heavily synthetic CDOs. Those drove demand to the worst subprime. And the investors in that were the banks themselves for bonus gaming purposes, or stuffees, like Landesbanken, the dumbest guys in the room.

      You also need to get clear on who “investors” are. The guys with big enough holdings to go after this are FUND MANAGERS. They are just hired guns, no skin in the game, they can’t be bothered. The end investors have a really hard time even figuring out who the other investors in a particular bond are to take action.

      And finally, this is stealing. The MRP proposal REQUIRES the mortgages be condemned at below market price. I’ve discussed that in prior posts. How would you like it if someone condemned your car, with a Blue Book value of $15,000, for $7,500? Same idea.

      1. F. Beard

        AAA paper is supposed to be a no brainer, super safe investment for widows and orphans. Yves Smith

        If widows and orphans need money, the Federal government should just give it to them. And since “bank loans create deposits” then the banks are counterfeiters and the debt they sell is morally invalid even if it is sold to “widows and orphans.”

        But be that as it is, I am not in favor of principal mark downs since it is likely to hurt innocents. Instead we need a universal and equal bailout of the entire population, including non-debtors, so the debts can be paid plus a ban on further counterfeiting.

  3. Conscience of a Conservative

    The States are wrong in trying to apply eminent domain. Seems more clever than smart and not at all in keeping with what seems the likely intent of the original practice. Demarco is doing the right thing in attacking it. That being said, the attack eminent domain represents on a healthy market in mortgage debt is not all that different than modifying fannie serviced loans that are in investor portfolios.

    1. F. Beard

      “healthy market in mortgage debt”?

      “You shall not charge interest to your countrymen: interest on money, food, or anything that may be loaned at interest. You may charge interest to a foreigner, but to your countrymen you shall not charge interest, so that the Lord your God may bless you in all that you undertake in the land which you are about to enter to possess. Deuteronomy 23:19-20 New American Standard Bible (NASB)

    2. EricT

      I don’t agree. Municipalities will use eminent domain to put a Wal Mart in town, for economic reasons. Why can’t a town use eminent domain for the actual benefit of the community. There was a case that occured in Conneticut that went to the Supreme Court, involving the use of eminent domain to put a Wal Mart in. The homeowners lost, Wal Mart won and everyone is just a little poorer.

    1. Conscience of a Conservative

      Yes the mortgage market is not healthy, as a result of governmenment interference with contract law and excessive manipulation of interest rates by the Fed.

      1. F. Beard

        as a result of governmenment interference with contract law CoC

        Your precious counterfeiting cartel could not even exist to any large degree WITHOUT government privileges such as deposit insurance, a legal tender lender of last resort, Federal borrowing, etc.

        and excessive manipulation of interest rates by the Fed. CoC

        Then some manipulation of interest rates is good, in your opinion?

  4. McWatt

    There is no way that Eminent Domain should be used for anything other than building roads and creating schools and parks. I have spent the last 16 years
    fighting Eminent Domain abuse in a state where it is illegal to use it for any purpose other than previously stated, and it still gets abused!!!! In our state the 1% got their apartment building projects subsidized with Eminent Domain taken land gifts and free parking garages and out right cash gifts and most times all three!!!!

    Please, everyone, do not take the Eminent Domain rabbit out of the hat, it only spells doom for the rest of us.

    1. EricT

      Perhaps if eminent domain is used to benefit the 99%, the powers that be might just rein in the use of it.

    2. monday1929

      You should name the State/locality involved and the names of the (possibly) guilty parties. Let us Name Names.

  5. monday1929

    I have not a whit of interest in this topic, but I believe Yves states both that modeling prepayment is difficult and that it is not difficult, unless there are quotation marks missing?

    1. Yves Smith Post author

      To clarify: technically difficult, but they’ve been at it long enough that they can now do an OK job.

      1. monday1929

        Thank you. I believe the word, “modeling”, will soon be as discredited as the occupation “Money Center Banker” is.
        Or, “efficient market theory”.

  6. Aquifer

    As in the pursuit of understanding i am seldom reluctant to reveal my own ignorance re a subject – I will ask what is the connection between Mortgage Resolution Partners and municipalities that want to use eminent domain? (Must have missed that somewhere …) Are these guys (MRP) hired by them to do the paper work? Are these the guys that determine “fair market value” and so can cheat on that score? What is a good honest way municipalities can determine FMV so that your concerns, Yves, are met?

    I have mixed emotions about the use of ED (ha,ha – wonder if there is a connection ..) for this purpose – but where gov’t officials will not step in in any other manner to save folks, it seems desperate times call for desperate measures, though this may come back to bite …

    It has just occurred to me (better late than never) that this may another sign of a major fault line developing, or at least being made manifest – between the issues of ED for crummy mortgages, home rule to stop fracking, appointed vs elected admin. of municipalities – more and more battles are indeed clearly shaping up as between “Big Gov’t” and “local gov’t.”, with the interesting wrinkle that “States Rights” now appears to be an argument in the “Big Government” column. Wonder if this wouldn’t be a good subject for somebody to explore a bit more and write a good piece on?

  7. Hannibal

    We can only hope (the Federal) US Marshalls have their list and start arresting top down the scumbag mafia money masters.

  8. leapfrog

    What about the glaring fact that most of the mortgage-backed “securities” were nothing-backed? That should come into play somewhere along the line, but its being ignored. How does that figure into the equation? Thanks.

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