Last Saturday, October 6, directors of the California Association of Realtors® (CAR) voted by an overwhelming majority to support "legislation to prohibit the use of eminent domain to seize 'underwater' notes." It is instructive to examine why the Realtors® have chosen to support such legislation. Indeed, it might be instructive for many to examine just what it is that CAR wishes to prohibit.
While the proposal has been in development for at least a couple of years, it only began to receive significant publicity earlier this summer. In short the idea is this:
Local governments could use their power of eminent domain to seize (albeit, to pay fair market value for) underwater mortgages in communities that have been hard hit and are still suffering the effects of the real estate crash. These jurisdictions would then refinance those loans at a significantly lower principal amount – and, presumably, at lower interest rates too – thereby giving the homeowner both the incentive and the ability to stay in the property.
Steven Gluckstern is a co-founder of Mortgage Resolution Partners (MRP), the entity that has been bringing this proposal to various hard-hit California communities as well as to other impacted areas (e.g. Chicago) around the country.
Gluckstern says that local governments would target those underwater mortgages backed by what are called private-label securities. These were less-than-prime loans, not issued by banks and not held by Fannie Mae or Freddie Mac. "Think Countrywide at its prime," Gluckstern says, "These are the loans that the government wouldn't guarantee."
In August, he described a potentially ideal case for the Monterey County Weekly: "A homeowner who bought a home for $400,000 and took out a loan for $300,000 wakes up after the economy imploded to find the home is now only worth about $200,000. This is the homeowner who is trapped. He can't move, he can't refinance, he can't do anything. He's just stuck. He can short-sell the house and move out, but say he still wants to live in Salinas. "Since negative equity is the greatest single predictor of default, it becomes a numbers game, not only for the homeowner, but for the bondholders backing the loan as well." "How long will the homeowner keep paying on their $300,000 loan? Because when they stop paying and you have to foreclose and pay all the costs of foreclosure and then resell it, how much money will you get?"
In Gluckstern's example, he hypothesizes that the fair-market value of the loan would have dropped to about $160,000 - 80% of the value of the property itself. Under the proposal, the local government would pay that amount (using eminent domain) to take possession of the loan.
"The loan is then written down to $195,000 and the homeowner gets refinanced - at no cost - with a new loan for that amount. The bondholder is reimbursed for the fair market value of the old loan, and the new loan is sold into a federally backed pool. The profit – the difference between the new loan and the 80 percent is then divvied up. The profit pays the local government for the cost of the program and it pays back the investors. Mortgage Resolution Partners makes its money by taking a flat fee of $4,500 from the profit to facilitate the transaction."
Could a local government do this? Can eminent domain be exercised in this way? Apparently, yes.
The exercise of eminent domain isn't restricted to real property. There are two major tests to be met:
Does it satisfy a significant public purpose or benefit?
Is there just compensation for the property (real or personal) that is taken?
David Wert, a public information officer for California's San Bernardino County, provided CAR directors with a strongly affirmative answer to the first question. He described the "ripple effect" of homeowners in financial distress and how much it affected the local economy in general. Implementing the MRP proposal for a few thousand people in San Bernardino County would not just be a benefit to them, it would be a benefit to the whole area.
Would there be just compensation to the bondholders for these underwater loans? Of course they wouldn't be compensated at the loans' face value. The loans are generally worth nowhere near that. But it certainly would be possible to determine a fair market price for them; and it's plausible that those numbers could make the program work.
Space constraints required an overly brief description of the proposal here. Interested readers can find more at www.mortgageresolutionpartners.com Next week we'll look at some of the objections.
Published: October 9, 2012
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