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.
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How dumb are municipalities? Are they interested in the monorail I’m selling as well? I’ve sold monorails to Brockway, Ogdenville, and North Haverbrook, and by gum I’ve put them on the map!
Maybe people say “those who can’t, teach.” But really, I think politics is for those “can’t.”
I don’t mean that to be bitter and defeatist. I mean we need to change the type of people who go into politics. We need life-long career politicians with public service backgrounds, and we need experienced real-world types to advise them.
It seems like simple corruption to me, not misguided good intentions. Just ask cui bono, and it’s the slick [monorail] consultants, not the people with performing loans.
Why don’t municipalities collect a “blight tax” in good times to fund a municipal corporation that buys, maintains, and rents blighted homes? And it would be the tip of the spear in taking homes away from banks that are dragging their heels on foreclosing to extract fees and shuck taxes and maintenance.
“I mean we need to change the type of people who go into politics. We need life-long career politicians with public service backgrounds, and we need experienced real-world types to advise them.”
ScottS, that description sounds like what now sits in Congress. Are you sure you want more of that?
I don’t think it does describe Congress. They are typically industry people temporarily in control of the regulatory framework that, in principle, is the check on their private-sector career. Put in charge of keeping people out of the cookie jar, they instead give all the cookies away to their cronies. Then they hop back into the private sector when we “vote the bums out.” That’s not what I consider a career politician with a public service background.
But you’re right — maybe it isn’t the political cycle that’s the problem. The true problem is agency. Could direct democracy be the answer?
I should have been more specific on the “real-world advisers” — I mean e.g. real-world forensic accountants, prosecutors, etc., should advise legislators on legal frameworks for deterring and catching financial fraud. I don’t consider lobbyists or industry executives — typical congressional advisers — to exist in the real world.
Perhaps it would make more sense to condemn the limbo properties and force the putative mortgage owner to prove its title to the note and mortgage? If nothing else, this would clean up the land records which were hopelessly fouled by MERS. It would get the properties out of servicer clutches, eliminate fees and limit the mortgage owner and the bank to fair value market of the property as determined in a local court. Any excess would simply disappear.
As the property owner, the municipality could then deal freely with the former owner. although the owner might have to go through bankrupcy to shake free of residual obligation on the note.
It *would* make sense to use eminent domain on *any* property whose title had been fouled by MERS, simply to quickly eliminate all clouds on the property title.
I believe eminent domain could be used in a way which would set a deadline for anyone claiming property rights to claim compensation for the seizure, so that any bank which failed to notice what was going on could have its rights extinguished without payment.
I believe, due to the historical background of eminent domain, that eminent domain has major advantages over other procedures if you are trying to quiet title. But a legal expert should weigh in.
The property would then be returned to the person living in it, which is clearly in the public interest.
City Life/Vida Urbana, the group that is organizing the campaign, does have some decent legal backup. And I would agree that there is strong tradition of municipal activism in Massachusetts, which includes a good number of market incursions, such as muni owned electric distribution.
While there certainly is the potential for this plan to fail, I would encourage these groups to continue their study. I don’t trust Huffpo to do close enough reporting to determine the actual legal process being proposed – whereas I do know and trust some of the actors involved to make sound decisions, and work to mitigate bad consequences of poor decisions (unlike their opposition).
Why would the principle of fair market value dictate that the mortgage that’s being condemned be valued on the basis of the mortgage holder’s payment record? The whole problem of the housing bubble had to do with obviously overvalued properties due to a market overheated by extravagant and deceptive lending practices.
This we know. Been there, done that. So we also know that fair market value CANNOT be what the mortgage holder is paying. It might be half that by any realistic assessment. If we know that a given homeowner is “under water,” we also know the real value of the property. Use that.
And if laws don’t allow it, change the laws. That’s what democracy is for.
The fair market value of the property is not in question. It is the value of the mortgage, the financial instrument, that is in question, since that is what is actually being condemned and that is what must be compensated. The fair market value of the house may have fallen, but if the borrower has continued to make payments all the same, then the value of his/her financial obligation is the same now as it was before the bubble collapsed.
And, as is pointed out in the post, it may well end up being pension funds, not banks, that take the hit when performing mortgages are suddenly devalued and pre-paid due to eminent domain take-over. Sadly, the banksters have worked things so that retirement funds and other investors are on the hook for bad mortgages, not they themselves. As a consequence, trying to undue the damage to borrowers can easily end up hurting retirees who, often as not, are the very same people. Go figure.
The “law” is the Fifth Amendment, which calls for just compensation to be paid when property is taken by government for public purpose. You think you can “change the law”? Please.
A mortgage which (a) is non-recourse, and (b) is backed by a house which is worth substantially less than the outstanding principal on the mortgage, is most certainly not worth face value; anyone doing a proper underwriting would notice that the borrower has strong incentives to default.
Accordingly such a mortgage could be seized for fair market value (which is what the takings clause guarantees) rather than for face value.
This would only apply to seriously underwater non-recourse mortgages, of course.
If the homeowner is not in default, then you have an eminent domain proceeding that interefers with a legitimate contract.
Should the government step in and interfere with a legitimate contract even though it appears that one of the parties made a bad bargain? I think this is a real slippery slope.
If the homeowner is in default and has been foreclosed upon, not only should eminent domain be persued, but perhaps even better for the local government would be suits for a public nuisance. A suit here would not require the local government to come up with the value of the property to put pressure on the foreclosing lenders. Under the right circumstances, public nuisance suits can be quite punitive. This would either force lenders to clean up the property or sell it at a significant discount to avoid a large damage judgment.
I just bought a foreclosed property as an investment. Price was great. Financing was terrible -25% down- plus I was forced to escrow for all of the repairs the appraiser said were needed which turned out to be another 12% of the price. With closing costs, it turned out I had to put up 37% of the total cost in cash.
So even for investors it is tough because most of the properties are in serious need of repairs.
But how is a homeowner going to be able to get a mortgage on these properties if his/her lender is going to require repairs to the house when the foreclosing lender won’t make them? The new lender has a right to have good marketable collateral so I can see why it wants repairs before making a loan.
When a stupid idea refuses to die, I always ask Cui Bono…
I routinely get “shoot the messenger” reactions whenever I describe how well-indended schemes will make matters worse. -Yves
No good deed goes unpunished, but nevertheless, have you made these concerns known to the city council of Brockton? They are all excellent points and would serve the council well to consider carefully. If they are enlightened enough to look into this in the first place, they might also be judicious enough to see the value in your critique.
It’s hard though, unsolicited advice is usually headed for the circular, along with some resentment, regardless of merit.
It would be good if someone from Brockton brought this post to their attention.
Perhaps minus the title (which one could blame the messenger for).
Yves:
“The law locks up the man or woman
Who steals the goose from off the common
But leaves the greater villain loose
Who steals the common from the goose.”
“Stirling Newberry @SSNewberry
I no longer ask who steals from the public on the street, I ask who stole the street from under the public.
Retweeted by Yves Smith”
The original (above) goes back 300 plus years, relating to the Enclosure Movement, an older form of the privatization of public goods. This stuff has been with us for a long time. Refer also to the Norman Kleptocracy of the 11th Century.
this is a slippery slope …… abused by wall street or abused by local cronies ????
Misconceived and mistaken schemes like this just are a reflection of how desperate people and their communities are becoming. Listen up there Barry buddy!
I didn’t know NYC has a homestead program. I would love to hear more about that.
WhileI appreciate these solutions are far from ideal at least solutions are being looked for in US. Sadly in UK nothing is or has happened to help those in similar situations. I wrote this to add my voice to those who are championing change. http://lifeafterdebts.blogspot.co.uk/2013/01/philosopher-lawyer-and-political.html