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Eminent Domain: Eminently Suitable for Defaulted Loans

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A remarkable result of the housing crash has been the revelation that although local governments retain legal authority over real estate — taxes, title, recordation, foreclosure — 100% of them lack the will or the way to protect constituents from a horrific, slow-motion disaster.

If they won't use their powers constructively, then reduce complexity by having Washington centralize all this — such as title registry. That might even save money and thin the fog.

But Washington has done little that has been quantitatively effective in reducing the enormous costs and collateral damage associated with forcing out owners and throwing properties on the market.

Now comes a new idea: San Bernardino County, California, is considering acquisition by private investors via eminent domain of home-secured loans, to protect homeownership while delivering the market value of the old loans to their owners.

Many vested interests, starting with large banks and other investors who don't want to recognize losses, particularly on second lien loans, object vociferously to getting paid off at market. That's odd if their accounting is honest—but they're entitled to pursue their perceived self-interest. The people of our political subdivisions are likewise entitled to exercise their legal rights.

What legal rights? According to some commentators, this program is unconstitutional. First we are told eminent domain doesn't apply because there is no "public purpose." Ridiculous excuse. Protecting and improving neighborhoods, as with eminent domain for urban renewal, is a well-tested public purpose.

Second we're told that the program breaches the "sanctity of contracts." Indeed it does. After prior misreading of the Fifth and Fourteenth Amendments, state legislative enactments have breached the "sanctity of contracts" to serve a public purpose with support from the Supreme Court since 1937 (West Coast Hotel Co. vs. Parrish). Now we again have what that Court referred to as "unparalleled demands for relief."

I do not argue for the specifics of the San Bernardino plan, but rather for flexible use of eminent domain, which fits specific classes of situations such as: The homeowner can't pay on his current mortgage loans, but he's able and willing to pay on a new mortgage loan with value at least as high as the reduced market value of his present loans.

A concrete example: Suppose the customer's payments under a 30-year government-backed fixed-rate mortgage, plus home equity loan — averaging a 6.5% rate — aren't affordable. He's paying only on the home equity. The total market value of the loans is only 50% of the balance.

Maybe he can make the much smaller payments — approximately half as large — under a new mortgage with no reduction in principal, but interest-only payments for 10 years with initial rate of 3.25%. This isn't a modification. It's a single new mortgage which should receive the same government backing, since it's more affordable.

Between the mortgage servicer settlement, legacy Countrywide, investors and various federal interventions, the refinancing of the old mortgages doesn't get done. So, the borrower, even after being magnanimously accorded the highly-touted advantages of "single point of contact" and "no dual tracking," is likely to lose his home.

Fix this: Cut the fiddling with securities trustees and owners of seconds. If the holders of the existing loan can give the borrower a better deal than the outside investor proposes, let them do so. Otherwise, the investor gets the loans.

Why does this idea upset almost everyone? First, it requires the current owners of the debt to recognize their losses. Maybe up to now their accountants and regulators have helped or allowed them to avoid this.

Second, the servicers who have been paid to mess with these mortgage problems—ineffectually, but profitably — don't want the game moved off their turf.

Then, there are the special pleaders who insist that the right solution always requires reducing principal to or below market value of the home. Reduce the principal every year? Every day? Somehow, it's OK to lose money on your investment or pension account, but never on your home.

Rates have dropped precipitously. Reducing the interest to market — which, under our inherited system, has become virtually a fundamental right of homeowners — is just too complicated without eminent domain because of the multiple consents required. Let's cut the knot, chop up the obsolete papers, and reduce the overhang of vulnerable mortgages. Next go after the mortgages on unforeclosed, abandoned properties that are not being maintained.

Washington isn't motivated to do this. Get out of the way and let governments that are closer to the people and have more direct eminent domain power do it.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.

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Comments (13)
Andrew - It must be nice to live in your world.
Posted by dakre98 | Tuesday, July 24 2012 at 2:13PM ET
So I have a borrower with a $10(M) Million Net Worth and a $1M home loan on a house now worth $500K and under this senario the bank gets to eat $500K and restructure the debt without being able to pursue our borrower for the $500K loss? Our down payment on future home loans will now be in the 35% to 50% range. This ought to stimulate the economy.
Posted by ibat26231501 | Tuesday, July 24 2012 at 2:19PM ET
So I have a borrower with a $10(M) Million Net Worth and a $1M home loan on a house now worth $500K and under this senario the bank gets to eat $500K and restructure the debt without being able to pursue our borrower for the $500K loss? Our down payment on future home loans will now be in the 35% to 50% range. This ought to stimulate the economy.
Posted by ibat26231501 | Tuesday, July 24 2012 at 2:19PM ET
Andrew you are living in a dream world. Your concept would basically stop securitization of Mortgages in America. It would stop Investment in Mortgages in America. How in will this help our economy?
Posted by robrose | Tuesday, July 24 2012 at 2:30PM ET
Every math professor I had in college was irrational and I had 6 of them. The one I had in multi-variable calculus had to be institutionalized mid-way through the course. Mr Kahr may be a good mathematician but he is essentially a socialist. He touts every socialist agenda from minimum wage to government seizure of assets. He is somewhat inconsistent when in one breath he wants the federal government to intervene. When they don't, he wants the power to be in the hands of local government that he just castigated. Like most elitists, he believes government control is the answer. From what I have seen of credit card issuers, he certainly is whistling a new tune these days.
Posted by John C | Tuesday, July 24 2012 at 2:34PM ET
Kahn's approach dangerously expands the power of the government to steamroll over private capital, with terrible consequences to the financial markets. What next, just outright negation of all private propoerty rights in the name of public purpose? Watch what happends when the mortgage market crashes around your head! We only had a taste of that in 2008 compared to what will happen in Kahn's "utopia."
Posted by Johnpvb | Tuesday, July 24 2012 at 2:37PM ET
What happens in five years when the value of the home (current market) goes up and the borrower sells the home? Does the borrower in your world get to keep the windfall, or would you propose that the mortgage holder share in the appreciation? My guess is either you would let the homeowner keep the lottery winnings or you simply haven't thought through it that far.
Posted by Loaner | Tuesday, July 24 2012 at 3:07PM ET
Your "flexible use of eminent domain" is a pipe dream. The San Bernadino plan will only target those loans that are being paid on time, as that is the only way to entice the investors to refinance them. If you target those who are actually behind in their payments (and arguably most in need) there will be no investment capital available to fund that refinance. Nice try, but that's not how the world works.
Posted by BidOnRealty | Tuesday, July 24 2012 at 4:13PM ET
Saw an iteration of this in Louisiana in the 1980's. It went like this --
Economy goes in the dump, Bank has a large portfolio of First Mortgage Residentil Real Estate loans. To try and manage their losses, they begin working with customers who are 90 days past due by reworking their loans at lower rates and by forgiving some of the principal. Not a bad plan until the other 91% of borrowers find out and come in to demand that their loans be reworked because values have fallen on their property also. To be in the program debt had to be 90 days past due - guess what many who had adequate cash flow immediately stopped paying. This is exactly what you will get with this pie in the sky plan.
To show how ridiculous this is - WHy not do the opposite - As Real Estate values increase let the investors increase the amount of their notes by 50% of he gain - see how that sells. Borrowers and investors made a deal - Value goes down borrower loses and probably investor if they cannot pay -- value goes up borrower gets all the upside. If the plan in the article is adopted - good luck to those financing loans in those municipal markets in the future.
Posted by Watchdog1 | Tuesday, July 24 2012 at 4:46PM ET
Where there is a vacuum, an idea will come forth to fill it. The housing crisis has lasted far too long and conflicting interests and political power is at the center of the problem.
Don't think for one moment that the Lenders and the Servicers don't know how to end this crisis. They just need to agree to do the right thing. What's the right thing? Start with do unto others as you would have them do unto you. In the meantime deal with San Bernardino. This is just the first blow.
Posted by jmartin1 | Tuesday, July 24 2012 at 6:05PM ET
I think it's a great idea! In Kelo v. New London (2005), a five-justice majority of the (conservative) Supreme Court held that a municipality could use eminent domain to seize property in an area that it had designated as "distressed" to facilitate a redevelopment project. This obviously qualifies. The straw man argument that this would be used to benefit multimillionaires home-owners is pure bull.

The idea that it's somehow "socialist" is also pure bull. What's socialist is the central planners in the Bush and Obama administrations not requiring the banks to mark-to-market like every other business in America: The brain-child of the extreme radical left wing Marxist-Leninist Hank Paulson to serve the interests of his welfare-queen banker friends at Goldman Sachs.

Don't let the extreme left-wing radical welfare queen bankers get away with it! Force them to mark to market and clean up the urban blight they've visited upon our communities through massive crony-capitalist / Marxists Leninist fraud!
Posted by TomBrown | Friday, July 27 2012 at 7:49PM ET
Extreme radical left-wing Marxist-Leninist central planners, such as Hank Paulson, Alan Greenspan, Ben Bernanke, and Tim Geithner came up with a way to coddle the elitist welfare-queen crony "capitalist" bankers who run America's state-sponsored "bank" utilities (with their tax-payer subsidized FDIC, $9 Trillion in bailout loans, and access to the Fed "discount window"). It was unthinkable for these elitists to suffer losses because the last thing they want to be exposed to is actual capitalism, so they called on their central planner friends to use tax-payer money to re-inflate the housing bubble and also to allow them to continue the fraud of using face values on their worthless mortgages on their balance sheets. Of course the central planning elite Marxists that the welfare queen fraudsters paid for with bribes did the bidding of their masters, and attempted to re-inflate the bubble to artificially high prices... but so far their efforts have not worked, so they are allowed to continue creating the fraudulent balance sheets which protects the crony welfare queens from having to write down losses and thus sacrifice their fraudulent bonuses.

I see this eminent domain tactic as a way to re-introduce reality onto the balance sheets of the welfare queen bank fraudsters.
Posted by TomBrown | Friday, July 27 2012 at 7:59PM ET
Those who whine and complain about how terrible the welfare-queen bank managers will be treated by this plan should keep in mind what our colonial forefathers did when the British tried to seize prime farmland though bogus loans:

British sharpies would come over and make loans to-farmers: they wanted to get into their own hands the rich farmlands of upstate New York. They would make loans to farmers that would be more than they could repay, and at that time you could ask for repayment of the debt whenever you wanted. So the British creditors would ask for payment before the crop was in.

So the colony passed the fraudulent conveyance law. And that law said that if a lender makes a loan to a debtor that cannot be repaid in the reasonable course of business, the loan is declared null and and canceled.

That's how our forefather patriots defended themselves from predatory British lenders back in the day... and that law is still on the books!
Posted by TomBrown | Friday, July 27 2012 at 8:08PM ET
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