Opinion

Felix Salmon

Why you can’t use eminent domain to buy performing mortgages

By Felix Salmon
July 9, 2012

Back on June 21, I looked at the plan from Mortgage Resolution Partners to use eminent domain to buy up underwater mortgages. I wasn’t very impressed, and now that the dust has settled a bit, it increasingly looks as though the scheme — at least as currently designed — is going to end up going nowhere.

San Bernadino, which seemed to be very interested in the idea originally, is now backpedalling:

“We see it as intriguing, but it’s definitely not something we’ve decided to do,” says San Bernardino spokesman David Wert. “We just wanted to get all the information and see if it might actually work.”

And most importantly, a grand coalition of powerful interest groups has released a strong broadside saying that MRP’s plan is a really bad one. Check out some of the names here: The American Bankers Association, the American Securitization Forum, the Association of Mortgage Investors, the California Bankers Association, the Community Mortgage Banking Project, the Mortgage Bankers Association, Sifma, the Financial Services Roundtable — it’s an impressive list, and at this point it’s pretty much impossible to find any institution which supports the idea, other than those directly involved.

The letter from the various interest groups does not, in truth, make particularly compelling arguments. For instance:

If eminent domain were used to seize loans, investors in these loans through mortgage-backed securities or their investment portfolio would suffer immediate losses and likely be reluctant to provide future funding to borrowers in these areas.

This is pretty silly stuff: the fact is that nearly all new mortgages in San Bernadino and across the country are being financed by the government, and insofar as there is a little bit of private-sector financing, it’s probably not coming from people who bought subprime CDOs at the height of the bubble.

But really the point of the letter isn’t to make an argument: it’s to make a point. Two points, really. Firstly, there’s the word “unconstitutional”, which appears very high up. That’s code for “we’re going to appeal this thing all the way to the Supreme Court, so you’d better be willing and able to spend an enormous amount on legal fees.”

And secondly, the letter sends a very clear message that CDO investors are not on board with this scheme. And that’s the thing which ultimately will result in its death.

In principle, a plan like this could be put together in a way that investors could get behind. But it wasn’t, and MRP got greedy, and as a result it’s not gaining traction: just this morning, for instance, the LA Times came out against it.

The problem, at heart, is that MRP is looking to buy up only seasoned, performing mortgages: precisely the ones which are worth the most money, and which don’t present much of a systemic danger to the San Bernadino housing market. We’re talking here about loans which were made during the height of the bubble, on homes which have since plunged in value — and yet the homeowners have diligently made all of their payments on time. If I’m a mortgage investor holding a portfolio of mortgage loans, these are the ones I love — they’re the ones which help to offset the fact that so many of my other loans are in default. Yes, it’s true that I will have written down the value of my holdings on the grounds that my mortgages aren’t worth as much, in aggregate, as they were during the bubble. But that doesn’t mean that I’m valuing the performing loans at deeply-discounted rates. Quite the opposite, in fact: many of them are worth more than par, trading at about 106 cents on the dollar, just because the interest rates are high and the underwater status of the loan means that it can’t be refinanced.

MRP, by contrast, wants to pay vastly less than par for these loans. To use Kathleen Pender’s example, where a homeowner owes $300,000 on a house now worth $200,000, MRP might pay $170,000 for the loan. Which works out at just 57 cents on the dollar. That’s a highly-distressed price for a performing asset, and I can definitely see that MRP would have a huge amount of difficulty persuading the court that it was a fair price. After all, the only way you get to such a price is by assuming that there’s an extremely high probability of future default — despite the fact that the homeowner has remained current through the largest financial and housing crisis in living memory.

There’s a very big collective action problem in the distressed-mortgage world, and in principle the use of eminent domain is just what the doctor ordered to sort it all out. But I fear that MRP has done everybody a disservice here by putting forward the worst possible use of eminent domain: basically buying up precisely the mortgages which no one is particularly worried about. What’s desperately needed here is a plan which CDO investors can get behind. Right now, they own many mortgages they’d love to get out of, but instead they’re holding on to them because the way that the CDOs are structured, they basically can’t be sold and have to be serviced instead, at significant expense, even when they’re deeply in default.

So let’s see an eminent-domain plan which is designed to buy up defaulted properties, rather than ones which are current on their mortgages. Let’s see a plan which buys properties themselves, rather than just the liens on those properties. And most importantly, let’s see a plan which is constructed by the owners of CDOs, rather than by a bunch of outside financiers looking for a huge profit opportunity. In principle, there’s a way to do this right. It just isn’t the MRP way.

Comments
7 comments so far | RSS Comments RSS

I had thought it sounded like a decent idea, partly because I thought he was talking about non-performing loans. Even there, I’d feel better about eminent domain “bailing in” holdouts after a tender offer for 2/3 (or so) of the CDO is accepted voluntarily. If you’re trying to solve a collective action problem and avoid holdout problems, there’s a case for that; if you’re trying to get investors to give up assets for less than they’re worth, with or without any collective action problems, this isn’t a country where government officials should make that happen for you.

Posted by dWj | Report as abusive
 

In non-recourse California, the market will start to clear when more of those performers realize that they are sending good money after bad and declare bankruptcy. Their stream of payments should be going to a market-priced house. Unfortunately the 20% down payment required by some would be a problem.

Posted by walt9316 | Report as abusive
 

Some answers to questions
asked by an independent investigator from Oyster consulting
answered by George Hartzman
on his Wells Fargo Whistleblower filing

http://hartzman.blogspot.com/2012/07/som e-answers-to-questions-asked-by.html

Felix, I can’t quite understand why this isn’t being reported.

I could use some help.

I can’t say more than please.

I feel like I am screaming inside of a sound proof shell.

Posted by Hartzman | Report as abusive
 

I am not sure it is needed for those properties. Short sales and foreclosures are, or can be, swift and probably as efficient as eminent domain, and if they want to sit on nonperforming assets, that is their business. As people rarely stay put more than seven years and most mortgages are paid off within twelve, it will clear itself over time. Occupants of performing loans will seek an opportunity for exit, (bankruptcy, job loss, death, divorce, transfer, etc.) so the lender will face a loss eventually but that would be spaced over time and could be in the distant future. Eminent domain might work if they were immediately auctioned off, allowing the lender to refinance their own property, but few would want the certainty of a loss now in place of a possibly smaller one in the future, but unless you want to force recognition of the the loss now, I don’t see what eminent domain has to offer.

Posted by MyLord | Report as abusive
 

First, it’s San Bernardino, two “r’s”
Second, it leaves out agency back mortgages. In San Berdo county, that’s gotta be at least 3/4 of all mortgages… and that’s how you know that this thing is/was never gonna happen. It’s pure political theater. A way for the politicos to look like they care about the little guy, and also extract campaign money (or just plain cash) from “donors.”

Posted by Bernanke | Report as abusive
 

Like 80% of underwater mortgages are fully current and performing – and those are carried on lenders’ books at full face-value AIUI. Writing all of them down to FMV of the securing property would erase like $1.0Tril from lenders’ balance sheets. Any program that creates an incentive for borrowers to go delinquent and/or otherwise compels a write-down of all underwater loans before that financial hole is filled has got “calamity” baked into it. Those who pay on underwater debt do so out of a sense of duty and/or to preserve their credit ratings – dangerous at this time to do anything that disturbs that.

This whole matter reminds me of the attitude of several former mistersses – they loved the task of selecting the color and accessories of the next sports car I was looking to buy, and had not a care in the world about how to pay for it – that was my problem.

Posted by MrRFox | Report as abusive
 

Dear Felix, you clearly do not understand the secondary mortgage market and as such should not even be commenting on it. The link you gave to 106 price on MBS containing underwater performing mortgages is referencing AGENCY debt, NOT private label securitizations. As such, the government fully guarantees every single loan in the pool, regardless of whether it continues to make payments or not. This is NOT the same as the non-agency market! Non-agency underwater performing loans do not trade anywhere near 106!

Posted by Jerome77 | Report as abusive
 

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