Eminent domain for underwater mortgages could have biggest impact on banks

June 19, 2012

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.

 

7 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Matt, this is the first I’ve heard about this, and I looked through the other articles as well. I don’t think this will survive legal tests.

Eminent domain is used to acquire assets for the common good, not to extinguish liabilities for individuals and firms for non-common profit. The banks will beat this in court, and the regulators will support them.

PS — I own no banking shares at present; don’t expect to for a long time…

Posted by DavidMerkel | Report as abusive

david, yeah it’s an unusual proposal and we have lots of questions about it. still, it’s intriguing. read hockett’s oped for the legal grounding on it.

The crucial point here, David, is that the plan *does* make use of eminent domain to acquire assets (at fair market value) for the common good. To see why, please look at the full Memorandum outlining the plan and both its financial and legal justifications: http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=2038029. The municipalities that are employing our plan will be devastated by mass homelessness, deteriorating housing stock and revenue base, and unprecedented blight if their underwater mortgage crisis is not addressed *very soon.* And our plan is the only way to do that.

Posted by RobertHockett | Report as abusive

I did read it. Part of my difficulty is that I disagree with the New London case. But aside from that, eminent domain typically used because the land/buildings in question must be destroyed/altered to serve a greater good. It is the assets that must be altered, and not their financing. Particularly if the asset returns to the original owner with the only substantive change is a lower mortgage balance (and likely lower rate), the mortgage investor, should he have enough of a concentrated interest (not assured) to pursue legal action, could allege a “taking.”

Eminent domain means the original owner loses some value of his property. If that doesn’t happen, I don’t see how one can use eminent domain.

Now, I’m not a lawyer; this feels weird…

Posted by DavidMerkel | Report as abusive

David –

Eminent domain does not necessarily mean the original owner loses some value. It simply means that the owner is compelled into the conveyance. The compensation may or may not reflect “full value.” In fact, there are countless stories wherein an owner of property becomes subject to a taking that ultimately proves to be a financial windfall.

That being said, like you, I think this approach, while laudable for its innovation, will ultimately prove unworkable. Allowing private capital to piggyback the public purpose franchise of municipal governments is proving to be politically difficult – ask a Chicago resident how they feel in retrospect about the new parking regime!

Posted by pholstein | Report as abusive

Well, its finally happened, cities have found a way to use eminent domain to rob banks.

Posted by DonTabor | Report as abusive

So, they have a problem because Banks might have to take some responsibility for the financial mess we’re in now. Moreover, if memory serves me right, Banks did have a huge opportunity to resolve this catastrophe under the Making Home Affordable program’s Home Loan Modification program, which come to find out, Bank of America reportedly made screwing homeowners by refusing to modify most requests for loan modification and giving bonuses to the employees to got such loans into foreclosure irrespective of whether they were entitled to modifications of their loans. Not that the bank would not have lost a dime when modifying a loan, but that foreclosure promised a larger dividend to the bank that would a loan modification. So now, what was it that anyone found objectionable to the use of eminent domain to resolve this problem?

Posted by albinoism1 | Report as abusive