A controversial new proposal for cities to seize underwater mortgages through eminent domain is unfolding into sharp clashes between mortgage investors and would-be rescuers of depressed housing markets.
At issue are hearings held by a so-called “Homeowners Protection Program Joint Powers Authority” established by California’s San Bernandino County and two of the county’s cities, Fontana and Ontario, which are weighing plans to ease a persistently deep housing crisis in the region, known as the Inland Empire.
Most of the attention, and controversy, surrounds a proposal by the San Francisco-based venture capital group Mortgage Resolution Partners (MRP), which purports to be a private-sector solution to the housing crisis.
MRP’s plan, called CARES (“Community Action to Restore Equity and Stability”), entails the acquisition of “deeply underwater” mortgages at valuations determined by a court. MRP boasts the privately funded initiative means it would come at no cost to cities in San Bernardino or elsewhere; similarly, homeowners pay no fees or higher taxes for the CARES program. Also, by working only with current mortgages, MRP says its program avoids the moral hazard of inducing default in contrast to other loan modification programs.
To some officials in distressed housing markets like San Bernardino’s Inland Empire, MRP’s plan seems to offer a no-cost way to help residents weighed down by mortgage debt, thereby freeing up consumer spending that could lift the region’s economy.
But SIFMA, the Securities Industry and Financial Markets Association, representing investors in mortgage-backed securities, is having none of it. The industry association is warning that eminent domain is not a genuine solution to the Inland Empire’s housing problems.
In a letter submitted Friday to San Bernardino’s Joint Powers Authority (JPA), SIFMA says the MRP plan, if adopted, will drive lenders and mortgage investors away from the region, thus making it harder and costlier for residents to obtain credit.
“If performing mortgage loans are taken from their holders, this will cause significant losses to those holders, and cause those who fund mortgage loans to act very cautiously,” SIFMA said.
SIFMA also cited “legal and constitutional concerns,” and unsubtly suggested the county and JPA can expect to “become entangled in lengthy and expensive litigation with the holders of mortgage loans” –i.e. SIFMA.
Finally, SIFMA frontally attacked MRP, saying: “If San Bernardino were to adopt MRP’s plan … it would position itself as a facilitator of a group of opportunistic investors’ unjust, and likely unconstitutional, efforts to extract profits from a different group of investors.”
The public discussion has become heated. MRP called an idea floated by SIFMA to prevent home loans in cities adopting its plan from being bundled with the cheapest mortgage securities “reprehensible and immoral” and “likely illegal.” SIFMA, meanwhile, is saying that its asset-manager members are managing the pension funds of “teachers and state employees.” Trying to present a more sympathetic face on its side, the securities association says, “When one of these asset managers suffers a loss, it is really borne by those individual investors and savers.” One side offers a private-sector solution to the housing crisis. The cities that would stand to benefit from this solution say an important public purpose is served by keeping underwater homeowners in their homes and lifting a severely depressed local economy. The other side says the plan does nothing to help delinquent homeowners since the city would be seizing only performing loans while forcing losses on mortgage bond investors.
While you’ve got to give MRP credit for their ingenuity, I believe adopting the group’s plan would be an injustice. While to most people, eminent domain may have somewhat of an abstract quality to it, allow me to share a personal experience that I think bears on this issue.
My parents had a small commercial property, their principal asset, that was located in an area that the city and a large property developer wanted to redevelop. Some twelve years ago, my recently widowed mother and I were called to a meeting in the developer’s executive suites. They were all smiles, and expressed sympathy for our recent loss and effected a desire to help my mother with her financial problems by providing a ready offer of cash for her property.
The amount eventually offered (after lots of beating around the bush) was enough to guarantee a penurious retirement. It would be as if investors came to you in early 2009 to discuss a stock portfolio you acquired for, say, $1 million, which fell to $500,000 in the midst of the credit crisis, and they offered you $400,000.
You see, there is a difference between liquid securities like stocks, which if you must, you can sell for their depressed value, and illiquid assets like property. Making a property market into a redevelopment zone shuts out normal buying and selling. That’s why MRP’s offer to buy mortgages at “fair market value” at court-ordered values is misleading.
Once a government exercises eminent domain in a region, no reasonable person would buy, so the market is frozen at values that are lower than the depressed values current before the government’s declaration. It would be as if you could only sell your $500,000 for just $400,000. And if you say no, you fight the government and just hope to be able to hold onto your property.
And therein lies the nub of this issue. Sometimes the individual good must be sacrificed to a greater “public purpose”—public transit in a dangerously congested area, for example. But it is another thing altogether when the city is taking property from Peter and giving it to Paul. That has become common in modern U.S. history, usually under the theory that economic development is an acceptable public purpose. The U.S. Supreme Court in 2005, in a 5-4 decision in Kelo v. City of New London, said this was constitutional. But Susette Kelo’s life was ruined, a community was disrupted and the developers eventually abandoned the project. Many states revised their eminent domain rules as a result. So while some courts will approve this sort of thing, a finding that it is legal does not mean it is moral.
SIFMA is right. Mortgage investors, including, yes, humble government workers invested in pension plans, may lose when defaults cause losses on their mortgage securities, but it is unfair for a city to capriciously enrich MRP’s investors at the expense of Joe Teacher (or even Joe Fat Cat).
My mom endured a long struggle, but we narrowly escaped the city’s redevelopment scheme (others did not); as the real estate market recovered, she sold her property for four times the amount offered by the developers.
While no one wants to experience a financial loss, it is tolerable to lose wealth knowing that children will be educated in a school that could not be located anywhere else, but it is hard to tolerate seeing your wealth be handed over to fat-cat developers. Similarly, it would be unfair to hand over the wealth of mortgage-backed securities investors to the fat cats of MRP.