Tuesday, June 12, 2012

Hockett on Using Eminent Domain to Beat the Housing Crunch

HockettRobert Hockett (Cornell) has posted It Takes a Village: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Value Preservation, and Local Economic Recovery on SSRN.  Here's 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.

Steve Clowney


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This is a great idea ironically using Kelo v New London. One question is how would an eminent domain argument prevail over an 'obligation of contracts' challenge? Secondly, I would expect cash-strapped municipalities would not have the cash to purchase mortgages or pay extra legal expenses for the court proceedings. Could they issue bonds in advance with the resulting raised funds dedicated for the purchases and fees?

Posted by: Tye Van Buren | Jun 21, 2012 8:52:48 AM

I understand the potential legal argument (though I have no doubt that the premise will be tested). However, there are a number of assumptions that leave the world of legal theory and extend into economics and risk/reward - as well as how the participants will respond to this situation. For instance, consumers routinely maintain debts that are above the fair market value of the goods they own. The only cost to defaulting on those debts (say, a bedroom set), is damage to their credit. Credit has a real, measurable market value that means someone who is slightly underwater will live with their situation and make payments.

Additionally, this scheme creates a strange set of incentives. The broader argument would say that individual losses on investments such as housing should be spread out across the "system," causing everyone to pay a little more for our credit risk in the future because we're also paying for the risk that assets may decrease in value. Meanwhile, the benefits of rising asset value belong to the individual who owns the asset.

Based on this model, individuals should strive to have as little equity in their homes as possible because any equity is immediately lost - in the case of a downturn while any debt is eligible to be forgiven.

Posted by: Peter | Jun 22, 2012 3:30:48 PM

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