The nine lives of the eminent domain for mortgages debate

November 21, 2013

By Matthew Goldstein and Jennifer Ablan

Law professor Bob Hockett, widely credited with popularizing the idea of using eminent domain to restructure underwater mortgages, says he continues to be approached by yield-hungry angel investors looking for a way to help out struggling homeowners and make money at the same time.

He said an increasing number of wealthy investors on “both coasts” regularly reach out to him to get more information about how eminent domain would work and get a better read on “the prospects of municipalities adopting one or another variance of the plan.”

Hockett also is continuing to advise local officials in a variety of cities including some in New Jersey and New York (Irvington, N.J. and Yonkers, N.Y. for instance) on how they might use eminent domain to condemn, seize and restructure deeply underwater mortgages for homeowners determined to keep-up with their high monthly mortgage payments.

Local officials continue to consider the idea of eminent domain even after it ultimately was rejected in San Bernardino County, Calif., North Las Vegas and banks and bond investors sued Richmond, Calif., the municipality that is furthest along the path to condemning underwater mortgages. The lawsuit against Richmond was dismissed by a federal judge as being premature because the California city merely has said it is considering eminent domain but has yet to actually condemn any home loans.

The lawsuits, however, were something of a warning shot to local officials in Richmond and elsewhere that Wall Street will fight like tooth and nail against the plan that would effectively give municipalities the powers to rewrite mortgages and in the process reduce the value of the bonds the loans were packaged into it.

Hockett spoke to us at the Reuters Global Investment Outlook Summit, where not surprisingly, a number of money managers who invest in mortgage securities either panned the idea or dismissed it as an intriguing intellectual subject that makes for good headlines but not much else. Said Metacapital’s Deepak Narula: “I think it is one of the worst ideas ever. It’s fun to write about but nothing will happen.”

Still, the fact that investors and local officials across the U.S. are talking about an idea as controversial as eminent domain to provide debt relief to cash-strapped homeowners, nearly 1 ½ years after we first wrote about it in San Bernardino County, is an indication of just how lackluster the U.S. economic recovery continues to be.

To be sure, the number of underwater mortgages—home loans greater than the value of the underlying home—is coming down with the increase in home prices in some of the nation’s hardest hit markets like Las Vegas, Phoenix, and southern California. But the number of underwater mortgages, estimated at 10.7 million, remains high and in some communities where a large number of subprime loans were sold, the percentage of underwater mortgages is particularly significant. (For a good look at the counties across the US with the highest percentage of underwater mortgages see this heatmap prepared by RealtyTrac).

For homeowners stuck in an underwater mortgage it limits their ability to sell their homes so they can either downsize to a smaller home, rent an apartment or move to another city or state where jobs may be more plentiful. And being stuck in an overly expensive home mortgage squeezes the available disposable income of borrowers, another drag on the economy.

So the chatter goes on and the odds are inevitable that one community will finally take the jump and actually seize some mortgages. That move will spark an immediate lawsuit from Wall Street banks and bond investors and most predict that matter will then take years to decide and wind its way up to the Supreme Court.

Hockett takes issue with the conventional wisdom that using eminent domain to seize mortgages is potentially unconstitutional and will be a matter ultimately decided by the Supreme Court. But he suggests there is another outcome for all of this and that is if mortgages packaged into residential mortgage backed securities are treated the same way as commercial loans stuffed into commercial mortgage backed securities. He said it’s not uncommon for loans in CMBS to be restructured by the parties without threats of litigation.

Hockett said if Wall Street took the same approach to restructuring severely underwater home loans, especially in a time of crisis, as it does with commercial loans the talk of eminent domain wouldn’t even be necessary.

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