Eminent domain for underwater mortgages could have biggest impact on banks
By Matthew Goldstein
A controversial idea of using the power of eminent domain to seize underwater mortgages may hurt some of the nation’s biggest banks more than investors in mortgage-backed securities.
The reason is the process of condemning a mortgage in which a borrower owes more money than their homes are worth will likely result in a seizure of any home equity loan–or second lien–on that property as well. And that could spell trouble for many U.S. banks, which at the end of the first quarter had $700 billion in second liens on their books, according to SNL Financial.
The trouble is that analysts say many banks have not adequately reserved against losses on those second liens or taken write-downs to reflect the impairment in value on the underlying mortgages. So an outright seizure of those second liens by a local governments could result in unexpected losses for the banks.
Who says? Some of the biggest proponents of the eminent domain plan being promoted by Mortgage Resolution Partners, a San Francisco firm with backing from a group of West Coast financiers.
Robert Hockett, a Cornell University law professor, who is advising MRP, says, ” what we are planning to do, is the second liens would be extinguished once the first loans are taken.” But Hockett, who has been researching the use of eminent domain to fix the nation’s housing woes for some time, said MRP is sensitive to the potential pain this can cause the nation’s banks and is willing to work with them.
The law professor went on to say that some pain is necessary because millions of average Americans are suffering under crushing debts and something needs to be down to jump start the economy. He wrote about the plan in an op-ed for Reuters.
Still, the plan, which I and my colleague Jennifer Ablan wrote about two weeks ago, is also sparking controversy in other quarter as well.
Rick Sharga, a vice president with Carrington Mortgage Holdings, says “logistical implications” using eminent domain to seize and fix underwater loans is “mind-numbing.” Chris Katopis, a executive director of the Association of Mortgage Investors, which represents a group of private bond investors, says the group is concerned that MRP has not reached out to private bond investors about the proposal.
It’s not clear just how far the MRP proposal will go. Even some people sympathetic to the plight of underwater homeowners say they aren’t sure the idea of eminent domain is workable.
But given the sad state of the US economy, it’s a good thing if people start focusing again on the how household debt continues to keep a lid on the economy and hurt families.