We're four years into a housing crisis. Nothing has yet worked to
stem the terrible tide of foreclosures.
There are few counties in America in as rough shape as San Bernardino County in California. During the housing bubble, the good times were very good. But then came the bust.
Today, San Bernardino County has one of the highest unemployment rates in the nation: 11.9 percent. Home prices have collapsed. Astonishingly, every second home is underwater, meaning the homeowner owes more on the mortgage than the house is worth. It is well documented that underwater mortgages have a high likelihood of defaulting -- and, eventually, being foreclosed on. It has also been clear for some time that the best way to keep troubled homeowners in their homes is by reducing the principal on their mortgages, thus lowering their debt burden and more closely aligning their mortgage with the actual value of the home.
Which is why Greg Devereaux, the county's chief executive officer, found himself listening intently when the folks from Mortgage Resolution Partners came knocking on his door. They had spent the previous year kicking around an intriguing idea: have localities buy underwater mortgages using their power of eminent domain -- and then write the homeowner a new, reduced mortgage. It's principal reduction using a stick instead of a carrot.
I know. When you first hear this idea, it sounds a little crazy. Eminent domain to take a mortgage? But the more closely you look at it, the more sense it starts to make. It would be a way to break the logjam that keeps mortgages in mortgage-backed bonds -- securitizations -- from being modified. It could prevent foreclosures. And it could finally stabilize housing prices.
The core issue that Mortgage Resolution Partners is trying to solve is what might be called the securitization problem. Bundling mortgages into securities and selling them to investors was, initially, a wonderful idea because it greatly expanded the amount of capital available for homeownership. But the people who wound up owning the mortgages -- investors -- were diffuse, often with conflicting interests, while the mortgages were managed by servicers or trustees who didn't actually own them. And the securitization contracts never anticipated that people might need to modify. So it has been nearly impossible to modify mortgages stuck in securitizations.
It turns out, however, that there is nothing to prevent a government entity from using eminent domain to acquire a mortgage. "Eminent domain has existed for centuries," said Robert Hockett, a law professor at Cornell who has served as an adviser to Mortgage Resolution Partners. "And it is applicable to any kind of property, including a mortgage." What matters, Hockett continued, is two things: Is the entity paying fair value for the property, and is it for a legitimate public purpose?
Can there be any doubt that keeping people in their homes constitutes a legitimate public purpose? "This is a yoke around the American economy," said Steven Gluckstern, an entrepreneur with a varied career in insurance and finance who is the chairman of Mortgage Resolution Partners. "When people are underwater, their behavior changes. They stop spending. There are 12 million homes that are underwater," he added. "Is the answer to really just let them get foreclosed on? Or wait for housing prices to rise?"
According to Gluckstern, the fact that the foreclosure crisis is continuing is precisely why housing prices aren't rising -- despite some of the lowest interest rates in history.
As for fair value, since the home has dropped dramatically in value, the mortgage is worth a lot less than its face value. On Wall Street, in fact, traders are buying securitized mortgage bonds at a steep discount -- reflecting the true value of the mortgages they're buying. Yet the homeowner remains saddled with a mortgage that is unrealistically high. The plan calls for the county to buy mortgages at a steep, but fair, discount to its face value, and then to offer the homeowner a new mortgage that reflects much, though not all, of that discount. (Fees and costs would be paid for by the spread.) The money to buy the mortgages would come from investors; indeed, Mortgage Resolution Partners is in the process of raising money.
The securitization industry is up in arms about this proposal. In late June, after the plan was leaked to Reuters, some 18 organizations, including the Association of Mortgage Investors, wrote a threatening letter to the San Bernardino board of supervisors claiming that the plan would inflict "significant harm" to homeowners in the county.
For his part, Devereaux insists that no final decision has been made. But, he says, "this is the first idea that anyone has approached us with that has the potential to have a real impact on our economy." Other cities are watching closely to see what happens in San Bernardino.
We're four years into a housing crisis. Nothing has yet worked to stem the terrible tide of foreclosures. It's time to give eminent domain a try.
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