Eminent Domain and the Mortgage Market: Relief or Disaster?
California has a reputation for some innovative ideas. Well, the news coming from San Bernardino, is a real shocker for the mortgage industry. Is it relevant to you? While, most experts don’t believe the eminent domain powers will be used in the housing and mortgage market, the consequences of it happening are so big, they can’t just be ignored. (It is kind of like buying a lottery ticket, and then not checking the results. Sure, the odds are slim, but what if…?)
The eminent domain topic is confusing, legalistic and political. To help you navigate through the eminent domain and mortgage market issues learn about:
- Eminent Domain: What’s the fuss?
- Eminent Domain: Relief?
- Eminent Domain: Disaster?
- Eminent Domain: Don’t hold your breath
Eminent Domain: What’s the Fuss?
The housing market meltdown is no stranger to many American states and communities. On one hand, many borrowers are struggling to make their mortgage payments. On the other hand, since their homes are worth less than their mortgages, they cannot just sell their property and pay back the loan, even if that means losing money.
Some of the hardest hit communities have seen prices fall by 50% (or more). Vacant homes and foreclosures lower home values and hurt the local community. For the individual struggling to make ends meet, it makes it almost impossible to sell their property. For the local municipality it means less tax revenues and a lower quality of life for its citizens.
Borrowers, lenders and the government are all looking for solutions and there are no easy ones. Well, a new firm, called MRP (Mortgage Resolution Partners) has come up with a business proposal that goes like this:
- The local authority takes over an asset (in this case a mortgage) and sells it to a private investor group for its fair market price.
- The current lenders (or investors) are compensated because the proceeds of the sale are transferred to them to pay off the loan, or more accurately, pay off part of the loan. (They do take a loss on the sale).
- The borrower gets to stay in his house and refinance a lower mortgage balance and presumably lower mortgage payment.
- The municipality gets a more stable housing community and larger tax basis.
For this to happen, MRP has introduced the idea that the local government (county or city) use their constitutional right of eminent domain. Basically, the government can take a property from a private individual, give them fair market compensation, and use the property for the public good (public purpose). A classic example is taking over land to build a highway or clean up contaminated land.
Without going into details, we can all see that the proposal is full of problems including:
- Legal ones: Is it constitutional?
- Financial ones: Who should pay the price for the housing prices?
- Political ones: Is it a populist move or a strike against big business in favor of the poor?
Eminent Domain in the Mortgage Market: Relief?
Based on the information put out by the MRP and its backers, their plan will bring great relief to the communities and homeowners through stable housing prices and more affordable mortgages. However, their program needs to be put in perspective. They are not calling for a nationwide program, rather an implementation in only the hardest hit areas. Eminent domain requires a public purpose, and their proposal serves this by creating a more stable housing environment..
Who Gets the Relief?
Basically, the eminent domain proposal is a principal reduction plan, forced upon the lenders by the government. The real issue is who will benefit and who will pay the price.
The MRP proposal (today called CARES, Community Action to Restore Equity and Stability) includes:
- Community involvement by showing that a public purpose exists to offer a refinance.
- Borrowers must be current on their mortgage and very underwater. The refinance is a voluntary program.
- Loans owned by private investors (non-Fannie Mae and Freddie Mac loans) through Private Mortgage Backed Securities, which limit the ability of the lender/servicer to negotiate a principal reduction.
- Refinancing through private money.
The MRP program greatly reduces the number of eligible borrowers, as Fannie and Freddie own most loans. It means that the program will be very limited in scope, financially, although a big precedent in terms of lending. The price to be paid, a loss by the investors, is bearable, when compared with the benefit the community gains as well as the individual borrower. According to an article published in the Web site AmericanBanker.com, Brad Miller, a Democratic Congressman from North Carolina, claims
"… the real losers from the program would be the biggest banks, the holders of second liens, not investors in first mortgages. And even for the biggest banks, eminent domain would not cause losses but reveal losses."
Principal reduction is not a popular word with lenders. After all, they entered into a legal contract with the borrower, which requires the borrower to pay back the whole loan plus interest. We all know that there are predatory lenders who offer expensive loans to borrowers who are in poor bargaining positions due to lack of information or financial resources. The job of the regulator is to protect borrowers from predatory lenders and unfair business activities.
Principal reductions are rare. (In fact, the FHFA director is strongly against the use of principal reductions). The HAMP program allows for principal reduction on non-Fannie Mae and Freddie Mac owned loans. However, participating banks avoid principal reductions and instead use refinancing, modifications, short sales and foreclosure options. Current Relief Programs: The National Mortgage Settlement and California Protection Laws are two examples whereby the government has stepped in to rectify unfair practices by mortgage servicers. In addition, the Obama Administration has instituted many programs for borrowers in trouble, through the Making Home Affordable Act. This includes the HARP refinance, the HAMP modification, and the HAFA (short sell) program.
Eminent Domain: Disaster?
You guessed it. The major industry players are against the proposal. The whole idea goes against the idea of the free market and lending. Their opposition is grounded on a moral, legal, and financial basis.
Legal: The opponents claim that using eminent domain on mortgage loans is unconstitutional. While there are legal arguments for both sides, and any discussion could take years in the courthouse, there are precedents for using eminent domain even on non-tangible goods. The public purpose is a broad term, and both sides will argue their case. One problem for the program is determining the value of an ongoing contractual relationship. A mortgage loan is not worth just the house value, but includes a promissory note to pay off an installment loan.
Moral: Letting a borrower get out of their contractual agreement is not moral. It sets a bad precedent for other borrowers. Principal reduction is not a right. Borrowers have rights that protect them, including bankruptcy laws, non-recourse and anti-deficiency laws, and laws governing wage garnishments. (Strangely enough, California has non-recourse and anti-deficiency laws, protecting the borrower in the case of purchase mortgages on their primary residency. This includes even second mortgage purchase loans).Is it right that eminent domain is used to take away the mortgage from the investor, but leaves the house in the hands of the borrower?
Financial: The current investors are interested in seeing an improved housing market. However, that is a function of a healthy job market, and supply and demand. The government should not unilaterally take over private property and transfer wealth. In fact, private investors, who are buying out mortgages at a reduced price, are sponsoring the program. If the investors want to sell their loans, then they always have that option and the marketplace will determine the going rate. If the investors feel that they have sufficient security and rights to obtain more money, then they should be allowed to pursue their legal options. If not, then they can foreclose and pursue the deficiency balance or write-off their losses.
Political: The owners of MRP have political clout, and one was a major fundraiser for Obama. They are using this clout to purchase an asset for a discounted price.
Eminent Domain and the Underwater Borrower: Don't Hold Your Breath
If you are an underwater borrower, don’t hold your breath waiting for the eminent domain approach to solve your problems for these reasons:
- The program has to be adopted by local governments.
- Once adopted, there will be a prolonged legal battle.
- It only applies to mortgage loans owned by private mortgage-backed security investors.
Your FHA, VA, Fannie Mae, Freddie Mac and Ginnie Mae owned loans are not included in the current proposal. Even your bank-owned loans are not included. If you are seeking relief, then look into one of the MHA programs, or speak with your current servicer to work out a loan modification. The more of a hardship, the better chances you can work out a deal with your lender.