Somewhere, someone must be laughing.
Regular readers may recall about a dozen municipalities, with San Bernardino getting the most press by being one of the earliest to consider it, were looking into using municipal powers of eminent domain to deal with the foreclosure mess. The particular scheme they were considering was beaten back, and as we’ll discuss soon, for very good reasons.
Let me stress that eminent domain could be a very powerful, positive tool to deal with a whole series of problems: foreclosed properties the banks are letting fall apart (accompanying fines would also help), condemning mortgages in the “zombie title” status, where banks have walked away after scaring homeowners into leaving via foreclosure actions that were never completed, or homes just entering foreclosure. Hedge funds would, for instance, be very interested in providing funds to acquire and restructure mortgages of borrowers; this would be a way to cut the principal mod Gordian knot (as in servicers find all sorts of reasons not to do them because it is far more profitable for them to foreclose.
But instead, zombie like, a hare-brained version of this idea refused to die. And keeping it around will encourage both securitization originators and investors to oppose any use of eminent domain, even ones that would be in their interest, out of slippery slope concerns that it will legitimate abusive applications as well.
Now to the particulars. Brockton, MA is looking at both a good idea and a bad idea. From Huffington Post:
In a move that’s pitting grassroots housing activists against Wall Street interests, the City Council of Brockton, Mass., decided this week to commission a study into the feasibility of using eminent domain powers to seize the mortgages of local residents struggling to pay off their loans.
The plan being studied would essentially use municipal government’s prerogative of eminent domain to take possession of foreclosed residential mortgage notes, selling them back to residents, as the City Council resolution put it, “for the purpose of removing blight and restoring family home-ownership within the city.”
The city would also focus on seizing the mortgages of “underwater” homeowners, those who owe more on their homes than their current appraised worth and would greatly benefit from a new loan that resets the value of their property.
The terminology here is remarkably confused, which is a troubling sign the activists are way over their heads. The note is not foreclosed upon. The property is foreclosed upon. The note was extinguished in the foreclosure. The municipality wants control of the property. This is a legitimate use of eminent domain, since vacant properties are often blighted, and lower property values in the neighborhood. The condemnation serves a broader community purpose.
Having said that, a lot of details would need to be sorted out to make a program like this work, and this idea does not look like it has been thought out very well. After a home is foreclosed upon, the displaced homeowner typically rents (unless they are so destitute that they have to move in with relatives or live in their car). Moving into a rental entails costs, that of the actual move, and usually some expenditures associated with settling into a rental (if you have any discretionary cash, there always seems to be a need for an extra light or two, curtains, small tables, etc. So even if the old home was in perfect shape, the homeowner will have to get out of the rental (can he right away? most rental terms are a year). Can the now-renter afford the carrying cost of the vacant property (heat to keep pipes from freezing, property taxes, securing the property so squatters don’t move in and his appliances aren’t stolen? And what if the former owner has moved out of the area? It’s doubtful he’d be able to return.
Vacant properties deteriorate quickly: they get moldy, the copper is stripped if the house in’t watched closely. So the former homeowner also may not want it back; it may be too far gone for him to take it on, financially.
All these considerations mean these properties are not likely to go to the former owners unless the city condemns them after eviction but before the property is sold. The properties that are creating blight now are best thought of as candidates for homesteaders, people who don’t have much money but could invest sweat equity and some funds in fixing up an abandoned home. These programs take thinking and oversight to work well. New York City had a very good homesteading program; I’d assume there are other successful programs Brockton could learn from.
But the second idea, of condemning mortgages where the borrower is paying on time, is both dubious legally and much more a scheme to enrich the promoters than a “social good” program, despite claims otherwise. The Huffington Post piece suggests that the approach here is the similar to the one devised by Mortgage Resolution Partners, a private equity firm (MRP may be the moving force here). MRP’s scheme achieved the seemingly impossible result of getting the sell size and the normally complacent buy side (investors) up in arms and having them successfully beat back the proposal last year.
We wrote a long post dissecting the scheme’s many defects, among them that it lets the promoters earn rich fees while leaving the municipality with lots of risk. But the key ones are pretty simple:
1. Condemning a performing mortgage (when the borrower is paying on time) does not serve the social welfare aims of eminent domain (serving community needs). These borrowers have been paying on time for years. They clearly have the means to pay. Why should investors, like the pension funds of firemen and policemen, be ripped off to help middle class borrowers with underwater mortgages? This is a subsidy to select individuals, not a “help the city” program. That makes it very questionable. Lawyers who do eminent domain litigation (as in they are practitioners and work for municipalities) see this approach as contrary to precedent and also too costly to do for individual mortgages.
2. Everyone seems to miss that what would be “condemned” is the mortgage, and the value of the mortgage is greater than the value of the house. If you are condemning mortgages, you need to pay the fair value of the asset condemned. The most important determinant of the value of a mortgage is the borrower payment record. A mortgage where the borrower has paid on time for five years would not trade at much of a discount in the open market. Yet the MRP scheme depends on condemning these mortgages at a considerable discount, at 85% of the value of the house, which is already less than the mortgage. In other words, for this plan to work economically (because they depend on a FHA refi program for the takeout), the mortgages can’t be condemned under the law, where the long standing requirement is the owner has to be paid fair market value (or in some states, like California, even more). The mortgages must be stolen. The math does not work unless they are condemned at considerably less than fair market value.
I routinely get “shoot the messenger” reactions whenever I describe how well-indended schemes will make matters worse. Here the downside is obvious: the more homeowner advocates keep pumping the terrible and certain-to-rally-opposition approach of condemning performing mortgages, the more it will give the idea of using eminent domain as a tool to clean up other aspects of the foreclosure mess a bad name.