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No Wonder Eminent Domain Mortgage Seizures Scare Wall Street

There is a great disturbance in the force.

Wall Street's political operatives — the American Bankers Association, American Securitization Forum, the Securities Industry and Financial Markets Association, and the Financial Services Roundtable — wrote a panicked letter to the Supervisors of San Bernardino County in California to express "strong objection" to a proposal by a startup mortgage company. The letter conveys the unmistakable threat that Wall Street will sic its lawyers on the county and will "likely be reluctant to provide future funding to borrowers in these areas."

The proposal is that the county use eminent domain to buy underwater mortgages, almost half the mortgages in the county. The mortgage company, working with the county, would then negotiate new mortgages with the homeowners that they could afford. If the proposal worked as planned, the county would get relief from the foreclosure crisis, the mortgage company would make a profit, and the idea would spread to other counties and towns.

A legal challenge by Wall Street might be expensive to fight, but the arguments are pretty flimsy.

Eminent domain is commonly used to buy land for projects like roads and schools. Existing law allows the use of eminent domain to buy any kind of property, however, including even intangible property like trade secrets. There is no apparent reason that eminent domain could not be used to purchase mortgages.

The Constitution requires only that the county pay fair market value and that there be a public purpose. Deciding a fair price would not be hard. There are frequent auctions of mortgages with a sufficient number of informed, sophisticated buyers. The auctions are an almost perfect pricing mechanism.  There would be comparable sales to determine almost any mortgage's fair market value. 

Showing a public purpose would not be hard either. A public purpose can be cleaning up contaminated land, renewing a "blighted" neighborhood, or even stimulating economic growth by replacing residential neighborhoods with commercial development.

Wall Street argues that the county's purpose would not be to reduce the foreclosures that are wreaking economic havoc, but to enrich the mortgage company. But law professors, economists, community advocacy groups and politicians with no financial interests at stake have argued for just such an effort to address the foreclosure crisis.  A program by a government agency not motivated by the pursuit of profit would be greatly preferable, but this proposal by the for-profit mortgage company obviously serves a public purpose.

The threat of a boycott is also hollow. A decade ago Wall Street bullied Georgia into gutting a state predatory lending law by refusing to buy Georgia mortgages. Wall Street has not bought mortgages since the collapse of the private securitization market five years ago, however. A threat of a boycott by Fannie Mae and Freddie Mac would be credible, but the threat of a boycott by Wall Street is not.

Wall Street quickly persuaded some mortgage investors, such as pension funds and insurance companies, to oppose the proposal, but investors will do fine – maybe even better than they would otherwise. The program would likely target homeowners with second liens. Mortgage investors own most first mortgages, but the biggest banks own most second mortgages and home equity lines of credit.

About half of delinquent first mortgages also have second liens. Second liens are secured by the value of the home in excess of the amount of the first mortgage. Since the housing bubble burst, there often is no excess. At foreclosure, first mortgage holders are paid in full before second lien-holders are paid anything, and the holders of seconds usually come away empty-handed.  Courts give firsts the same priority over seconds in bankruptcy.

Second liens have a ransom value in voluntary modifications, however. Unless the second lien-holder agrees to something different, the voluntary reduction of principal on a first mortgage is a gift of collateral to the second lien-holder and may still not get the homeowner above water. Second lien-holders sometimes offer to reduce the second by the same percentage that the first is voluntarily reduced, a far cry from the priority in foreclosure and bankruptcy. Mortgage servicers, the companies responsible for negotiating voluntary modifications of first mortgages owned by investors, frequently have a stunning conflict of interest. The four biggest banks - Bank of America, JPMorgan Chase, Citigroup and Wells Fargo - control two-thirds of all mortgage servicing, mostly of mortgages  owned by investors. The same four banks hold $363 billion in second liens, very commonly on the same property as first mortgages they service.

So 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.  

The biggest banks have delayed recognizing losses on seconds for years while paying dividends and lavish executive bonuses. Involuntary sales of seconds at fair market value would end fictitious valuations and require an immediate accounting loss, making dividends and executive bonuses much harder to justify and perhaps even revealing some banks to be insolvent.

The biggest banks have used their political power in Washington to defeat any effort that would effectively reduce foreclosures, such as allowing judicial modification of mortgages in bankruptcy, allowing a federal agency to use eminent domain to buy mortgages, or providing teeth for the chronically ineffective Home Affordable Modification Program, because those efforts would also require the immediate recognition of losses on mortgages.

But Wall Street's power in Washington may be as useless in defeating a proposal in San Bernardino County as strategic nuclear weapons are in fighting an insurgency. No wonder Wall Street is panicked.

Brad Miller is a Democratic Congressman from North Carolina.


(17) Comments



Comments (17)
Instead of financial bailout for banks, the fed and congress must plan a partial bailout for homeowners , so that it can help common citizens and shore up housing market which in turn can help other sectors to shore up from recession. The one who always benefit from fed reforms are the bigwigs with a lot of wealth.
Posted by Johnson009 | Tuesday, October 09 2012 at 12:49AM ET
Eminent domain can be used to force the false claimants to notes/property to prove their claims. Upon seizure of the real estate, the local govt can put its IOU in trust for the proven note holder. Upon proof shown of ownership the claimant can be paid. If no true owner can prove up the claim--state law would require the IOUs to escheat to the states. Its a good way to deal with uncertain title.
Posted by OLDER&WISER | Thursday, July 19 2012 at 3:15PM ET
@Eugene5000: If mortgages are not property, how is it that they are bought and sold? I agree that this is a terrible idea, but mortgages are definitely property with an intrinsic value.

This would all be unnecessary, of course, if rather than panicking in 2008, the Fed and Congress had worked together to creator a bailout for homeowners. This would've shored up the housing market while simultaneously allowing banks the time to write down their losses. Instead, what happened is Wall St. went right back to business-as-usual and millions of homeowners got foreclosed on and lost their homes. Proving once again that our country is run by the very wealthy for the benefit of the very wealthy.
Posted by day2knight | Monday, July 16 2012 at 10:51AM ET
San Bernadino just filed for Bankruptcy. Looks like they are trying to cover up their finacial negligence by using legalized theft.
Posted by ejhickey | Friday, July 13 2012 at 12:35AM ET
Brad Miller is stark raving mad. The obvious problem with the eminent domain approach for acquiring mortgages is that a mortgage is in no way "property". Eminent Domain doesn't even apply.

Miller's article draws a ludicrous comparison between mortgages and intangible/intellectual property. The word "use" in the Fifth Amendment applies rationally to the latter, but not the former:

- A mortgage is not "used" in any reasonable sense of that word. The government may acquire real property and build a bridge on it - that is "use". The government can't "use" a mortgage in anything approaching the same sense as the word applies to tangible property. Even in routine financial dealings, one company doesn't "buy" a mortgage in the same sense that one "buys" a banana - buying a mortgage is merely a reassignment of the right to collect on the loan and to foreclose on the underlying backing property.

- Intangible property such as a patent does fit the "use" notion, but the US government doesn't buy patents. Miller states "Existing law allows the use of eminent domain to buy any kind of property, however, including even intangible property like trade secrets", a reference to "Ruckelshaus v. Monsanto". Again, even in this grayest of gray areas, those trade secrets (data about pesticides) were intended to be "used", unlike the mortgages.

The city of San Bernardino's problems can only be solved by:

1) Reversing the last 50 years of housing madness/subsidies.
2) First mortgage holders reneging on their loans - aka, "jingle mail".
3) Not paying their employees so damn much. Unionized government employees in California make twice the comparable wages in flyover island.
Posted by Eugene5000 | Thursday, July 12 2012 at 4:50PM ET
The implications of something like this are huge. First it can destroy investor money for fear of them investing in mortgages in the United States. But even more important that ruining the economy is our individual freedom. To give this kind of power to government is unprecedented in the land of the Free. If they can do this with homes to help the economy what will stop government from doing it with any other asset they believe will, for instance, help them to reduce the budget deficit. Wise up folks!!!!!! Yo can be angry at big Banks and Financial institutions and demand that legal action is taken for the crimes committed or that laws be changed to make officers of corporations responsible when the so obviously step over the line, but to create a government at any level with this kind of power is asking for the end of what the Founders of our Constitution had in mind. This would make us a Socialist/Communist type Nation where the people really had no power at all and government could get away with anything it wanted in the name of making things fair for all.
Posted by robrose | Thursday, July 12 2012 at 3:21PM ET
There is an old Supreme Court case; Bigelow v. RKO Radio Pictures, Inc. 317 US 251 (1946) which states that: "The most elementary conceptions of justice and public policy require that the wrongdoer shall bear the risk of the uncertainty which his own wrong has created."

With all the fraud coming forth by these "too big to fail" banks, there should be no question that they should have to bear the burden of what their fraud has created.
Posted by Renoira | Thursday, July 12 2012 at 11:55AM ET
Spoken like a true politician who has no understanding of economics and no concern for the sanctity of contracts or individual rights. By all means, government should impose its "solution" into this area as well. Is it any wonder our country is in the fiscal mess in which we are?
Posted by JHoff | Thursday, July 12 2012 at 11:02AM ET
Add your comments here.
Posted by JHoff | Thursday, July 12 2012 at 10:50AM ET
I was on a bank board for 12 years and we would never have treated our borrowers as shabbily as this current crop of bill collectors. We would gladly modify a loan to keep from foreclosing. I want that borrower in there working for me - I don't want his house and the attendant expenses and risks.

Better to lower the rate or modify to whatever the borrower can afford and lose some interest (especially when your cost of money is 0) than to foreclose and lose great gobs of principal. It is gov't subsidies and bailouts fueling this crisis - without them any sensible person would modify the loan instead of playing games, losing paperwork, and stonewalling.
Posted by CEBVA | Thursday, July 12 2012 at 8:05AM ET
Not sure if I quite understand the process correctly.
1) New mortgage company buys existing mortgages (not the property?) under eminent domain.
2) Mortgage company then negotiates new mortgages with the homeowner.
3) Since mortgage preference is based on recording date, doesn't this make old second mortgage the new first mortgage, and the new company's mortgage in second place??
Foreclosure eliminates the second mortgage because the holder (presumably) doesn't bid enough for the house to maintain/payoff the second loan. But without foreclosure, just because the original first mortgage changes hands doesn't cause the second mortgage to become invalid. What am I missing?
If eminent domain is used to take the property, then the county becomes the owner, and is obligated to sell the property to the highest bidder, not the former owner. And what happens when the former owner wants to pay less than the mortgage company bought the mortgage for? Seems like someone is glossing over quite a few risks here.
Posted by esluva79 | Wednesday, July 11 2012 at 4:44PM ET
This is such a typical bad idea from a government guy. They so obviously have no clue as to how this how happened to begin with, nor what needs to be done to fix it. Why anyone feels that we should bail out homeowners that have overextended themselves in order to fix what they perceived as an insurmountable crisis is absurd. The government entities from city to federal only desire is to have property values rise to where they were during the ramp up in prices, so they will have more tax money to spend. What they can't seem to get through their heads, is that we can't short cut the process the market, by creating phony market floors or ceilings simply so the consumers feel good about about life.
Posted by edm | Wednesday, July 11 2012 at 4:41PM ET
What if the 2nd. lien is current and the 2nd. lien has ZERO equity!Should the lien holder give the borrower a substantial modification or even give the borrower a discounted pay off as the value on the books, if marked to market, should be ZERO! The question is have banks marked to market the 2nd mortgage that has ZERO equity or kept the value as is,as the borrower has always been current and has not as yet strategically defaulted as the bank may not have been cooperative in negotiating a "fair" settlement to all parties?
Posted by Barry Epstein Mortgage Warehouse Network LLC | Wednesday, July 11 2012 at 1:21PM ET
radical inovative ideas always follow a vacuum if it persists long enough. It's not about capitalism or anti-capitalism, or government intervention, at the core. It's about inequities that have existed far too long. Those individuals in the banking industry at the top know what it takes to put an end to the vacuum that exists. But refuse to put those steps in place because it runs counter to what they believe is their first responsibility, and that is to benefit their officers and stockholders, which mostly is true. But when grave mistakes are made, and the problem won't go away, the priority must shift with equity and boldness to include a the one without whom none of this would work, and that's the sheep (the borrower). San Bernardino County is threatening to strike a mighty blow. Is anyone listening?
Posted by jmartin1 | Wednesday, July 11 2012 at 12:33PM ET
The statists have to love this. No matter how logical it may sound, if this moves forward, government is removing risk from the borrower and also voiding a contract (without due process) to boot. This is totally anti-capitalism.
Posted by | Wednesday, July 11 2012 at 12:04PM ET
Cities and counties have abused eminent domain powers across the country, with Supreme Court blessing, so this move can be expected in the new era of government appropriation of what we thought was private property, on the heels of the auto industry bailout, bank bailout, etc.

The end result is further contraction of an already ailing mortgage finance market and decline in property values. But policy wonks never anticipate these unintended (but always forseen by rational minds) consequences.
Posted by Johnpvb | Wednesday, July 11 2012 at 11:51AM ET
Since our federal government is $16 trillion "underwater" perhaps we should use eminent domain to garnish all of your federal pay, retirement benefits and healthcare??
Posted by SEG NSFP | Wednesday, July 11 2012 at 11:34AM ET
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