With so much misinformation afoot about cities’ plans to adopt or consider the use of eminent domain on underwater mortgage loans, the Review-Journal can be forgiven its mistakes in describing the plan and its consequences in an Aug. 11 editorial. Mistakes they are, however, and as such, they’re in need of correction.
As the national mortgage crisis developed in 2007-08, those of us who began thinking of eminent domain as a cure did so in response to one very basic observation: So-called “portfolio” loans held by banking institutions that have the authority to modify the loans are indeed modified at high rates, but so-called “securitized” loans held by securitization trusts are not.
The reason was simple. Deeply underwater loans default at high rates, with sky-high foreclosure costs for creditors. Creditors able to modify loans, lift them above water and reduce or eliminate default risk accordingly benefit themselves through these modifications as much as they benefit borrowers. It’s a win-win. Hence the bank portfolio loan holders modified — and still modify — at high rates.
The trustees and servicers of securitized loans, by contrast, lack authority to modify loans on the requisite scale — even when doing so would salvage value for millions of investors in securitization trusts. The contracts under which these loans were securitized — known as “pooling and servicing agreements” (PSAs) — were drafted in haste during the bubble years, when many thought home prices could only go up. They accordingly didn’t authorize trustees or servicers to modify loans on a large scale in the event of a market-wide housing price crash.
Because these PSAs, which now function as suicide pacts among bondholders, are contractual in nature, and because bondholders are too numerous and too scattered (literally worldwide) to come together to rewrite them, there is only one way to bring the modification benefits enjoyed by portfolio loans to securitized loans: local government assistance using the power of eminent domain.
Contrary to what the Review-Journal’s editors have been told, eminent domain is not “supposed to be used only when private land is needed for public purposes.” Eminent domain has always been used to buy all forms of property, tangible and intangible alike. What matters is simply that there indeed be a public purpose, and that fair value be paid.
Mass foreclosure-blighted cities such as North Las Vegas, Richmond, Calif., and scores of others have public purpose aplenty to bring loans above water and keep residents in their homes, paying their debts. And fair value can easily be both raised and paid because, again, modifying these deeply underwater loans raises value for the investors, who are accordingly willing to finance the purchases. Again, it’s win-win.
Who, then, would oppose this approach to our cities’ continued foreclosure crises? The answer is straightforward: Certain elements of the securitization industry hate this idea because it exposes the role of their dysfunctional “pump and dump” contract arrangements in causing the crisis and prolonging its aftermath. Accordingly, they have spent literally millions of dollars on disinformation campaigns targeting investors, homeowners and, yes, even newspapers. They also have turned to a friend in the one federal agency they have managed to capture: Edward DeMarco, outgoing head of the Federal Housing Finance Agency (FHFA).
The Review-Journal appears to be impressed by the threats issued by both the securitization industry and Mr. DeMarco to “redline” North Las Vegas, Richmond and other cities that use the eminent domain tool to clean up the mess the industry left in the wake of the bubble it caused. It shouldn’t be. Redlining is illegal under the nation’s fair lending laws, and the industry’s use of its monopoly power over securitized lending to redline would violate the antitrust laws as well. The industry knows this and, accordingly, is bluffing.
The threat issued by Mr. DeMarco is likewise unlawful. It not only offends the fair lending and antitrust laws just noted, but also is far in excess of FHFA’s statutory mandate. For that reason and others, FHFA will not make good on this threat when Mr. DeMarco’s replacement takes office this autumn. Were it to try, it would find itself not only in court, but subject to congressional investigation as well. A news release from Rep. Keith Ellison, D-Minn., calling out FHFA on its threat should leave little doubt on that score.
The Review-Journal and its readers should take another look and not fall for the tactics employed by an industry that seeks to block value-adding modification transactions between creditors and debtors. The eminent domain plan, through which cities enable those transactions, is win-win. It will benefit investors, homeowners and their communities alike. Readers who would like to learn more might begin with the author’s recent New York Fed paper, “Paying Paul and Robbing No One” (http://www.newyorkfed.org/research/current_issues/ci19-5.html).
Robert Hockett, an originator of the eminent domain approach to securitized underwater mortgage debt, is a professor at Cornell Law School and a recent resident consultant at the Federal Reserve Bank of New York and the International Monetary Fund. For the past several years he has helped found and continued to consult for a number of nonprofit and for-profit institutions developing eminent domain plans for underwater loans. He is not financially invested in any such institutions or plans.