Saturday, August 11, 2012
There has been some discussion over the past couple of months over an innovative proposal to have governments use the eminent domain power to take ownership of underwater mortgages, to decrease the risk of default and then refinance the obligations, all to promote the common good. Here are some links to give you a sense of the major points of this debate.
The launch of this idea comes from a proposal by Law Professor Robert C. Hockett (Cornell) in his piece It Takes a Village: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Value Preservation, and Local Economic Recovery. The abstract:
Respected real estate analysts now forecast that the U.S. is poised to experience a renewed round of home mortgage foreclosures over the coming 6 years. Up to 11 million underwater mortgages will be affected. Neither our families, our neighborhoods, nor our state and national economies can bear a resumption of crisis on this order of magnitude.
I argue that ongoing and self-worsening slump in the primary and secondary mortgage markets is rooted in a host of recursive collective action challenges structurally akin to those that brought on the real estate bubble and bust themselves. Collective action problems of this sort require duly authorized collective agents for their solution. At present, the optimally situated such agents for purposes of mortgage market clearing are municipal governments exercising their traditional eminent domain authority.
I sketch a plan pursuant to which municipalities, in partnership with investors, can condemn underwater mortgage notes, pay mortgagees fair market value for the same, and systematically write down principal. Because in so doing they will be doing what parties themselves would do voluntarily were they not challenged by structural impediments to collective action, municipalities acting on this plan will be rendering all better off. They will also be leading the urgently necessary project of eliminating debt overhang nationwide and thereby at last ending our ongoing debt deflation.
Professor Hockett's idea was then promoted in the media by, among others, Prof. Robert J. Shiller (Yale--Economics & Finance), in the New York Times Piece Reviving Real Estate Requires Collective Action. As the title indicates, Schiller theorizes the mortgage crisis as in part a collective action problem that can be addressed by Hockett's proposal to use eminent domain to seize underwater mortgages.
But eminent domain law needn’t be restricted to real estate. It could be applied to mortgages as well. Governments could seize underwater mortgages, paying investors fair market value for them. This is common sense too. The true fair market value for these mortgages is arguably far below their face value, given the likelihood of default, with its attendant costs.
Professor Hockett argues that a government, whether federal, state or local, can start doing just this right now, using large databases of information about mortgage pools and homeowner credit scores. After a market analysis, it seizes the mortgages. Then it can pay them off at fair value, or a little over that, with money from new investors, issuing new mortgages with smaller balances to the homeowners.
Yesterday in The Atlantic Cities, Amanda Erickson published an excellent overview story about the proposal, Can Eminent Domain Solve our Mortgage Woes?. Of note to us are the comments by the eminent eminent domain expert (that's not a typo) Prof. Thomas Merrill (Columbia).
It's a clever idea. But is it legal? "It's very unusual," says Thomas W. Merrill, a law professor at Columbia University who specializes in property law. But, he notes, "this doesn't mean it's unconstitutional."
Before the landmark 2005 Kelo vs. New London decision, Merrill says, there's little doubt that the courts have upheld this kind of law. "Before Kelo, courts took a hands-off approach," Merrill says. In the 1984 case Hawaii Housing Authority vs. Midkiff, the Supreme Court ruled that the Hawaiian legislature could take a property controlled by landlords and sell it back to leasees. "Condemning a landlord's interest in property to transfer to a tenant is not too different," Merrill says.
But Kelo changed that. In that case, the Supreme Court ruled that cities could use eminent domain to transfer land from one private owner to another, and that doing so for economic development purposes constitutes a public use. "At this point, I guess you'd have to say all bets are off in terms of what is and isn't eminent domain," Merrill says.
And finally for now, Prof. Richard Epstein is critical of the idea. From More Nonsense on the Home Mortgage Front: Don't Let Municipal Governments Condemn Mortgages at Bargain Rates:
The idea has already been rightly panned by the Wall Street Journal. But the entire proposal needs still further consideration. First off, Hockett and his group insist that there is a huge collective action problem that prevents the rationalization of mortgage matters. And there is. It is called local government regulations that have blocked the foreclosure measures set out above. Handle those and the externalities to which they refer disappear. No longer do we have owners neglecting property or clogging the courts with endless motions.
Again, this post is just to give you some links to look at the arguments. From my perspective, these are some fascinating arguments that illuminate not only the mortgage crisis but also the general debate over eminent domain.