A new idea is floating around, the thought that underwater borrowers can be salvaged by refinancing their homes at current interest rates. How? By having local government seize mortgages under the concept of eminent domain, a plan which has been proposed in San Bernardino, Calif.
Dig a little further and we have to ask the question of who, exactly, will buy the existing loans — especially if the current lenders do not want to sell or cannot sell.
One answer comes from Mortgage Resolution Partners.
“Private securitization trusts hold approximately $1.1 trillion of loans," says MRP. “We could offer to buy their underwater loans, but their trust agreements do not allow for voluntary sales. Eminent domain allows us to purchase those loans as well as related second mortgage loans if the holders of the seconds are also unable (or unwilling) to sell. Eminent domain is a way to successfully consolidate ownership of a homeowner's mortgage loans in the hands of someone with the economic incentive and freedom to modify or otherwise resolve them."
It's also a way of generating substantial profits. The Wall Street Journal says that “MRP would work with governments to identify and buy loans at 75 percent to 85 percent of current property values, said people in investor meetings. For a home worth $100,000, the program may pay $75,000 despite a principal balance that might be tens of thousands of dollars more.
“The homeowner would apply to refinance into a $97,750 loan through a federal program. That leaves $22,750, plus a lender's profit of $5,000 or more to cover MRP's fee, valuation and legal costs, a reserve for the municipality, and investor profit. MRP has told investors they could see a return of 20 percent to 30 percent, said one investor who met with MRP." (See: Waterfall Bond Pioneers Consider Eminent Domain as Investment, July 24, 2012)
The eminent domain proposal sets off a variety of alarms. Historically, the sole and only purpose of eminent domain has been to acquire private property for public use such taking land to complete a road or build a school. No less important, under the “taking” clause of the Fifth Amendment the property owner must always receive “just compensation.”
However, all the rules changed with the 2005 Kelo decision, a case in which the Supreme Court determined that government could take private property and re-sell it to private parties if there was a “public purpose” such as the generation of higher property taxes. One result under Kelo was that developers might acquire private property from owners who did not want to sell by working through local politicians, perhaps including those who had suitably benefited from campaign contributions.
“The idea that a citizen’s property can be taken by the government solely for private use is extremely misguided, in fact it’s just plain wrong,” said John Allison, the Chairman and Chief Executive Officer of BB&T, one of the nation's largest banks.
“One of the most basic rights of every citizen is to keep what they own. As an institution dedicated to helping our clients achieve economic success and financial security, we won’t help any entity or company that would undermine that mission and threaten the hard-earned American dream of property ownership.”
And yes, you're reading this correctly. An actual banker refused higher profits on the grounds that the public interest would be harmed. Bookmark this page now...
Like homeowners, lenders ought to be free to sell or not sell their property, in this case mortgage notes. Mortgage investors forced to sell today will likely be compelled to sell at a discount, which may or may not exist in the future while those who finance such deals through government intervention will reap enormous profits. In addition, lenders will see more risk in a marketplace where the government can acquire loans by force. The result will be higher rates.
The real solution to the underwater mortgage problem is a general refinancing of all home loans at today's rates. This solves the lender “taking” issue by paying face value for existing loans. It also solves the monthly cost problem faced by millions of owners who could enjoy far lower rates if only they could refinance. Such a national program would not be cheap, but neither is the ongoing foreclosure and short sale crisis which holds down both home values and the entire economy.