Dr. Housing's New Frankenstein "Eminent Domain"
Remember the tale of Dr Frankenstein who stitched together parts of various dead people in order to create new life? His handiwork created a living monster.
Is anyone else besides me reminded of this story while reading the latest attempt to breathe life into the housing market?
A proposal out of California ( San Bernardino County) to use Eminent Domain laws as justification to seize current mortgages from original bond holders, reduce the principal, and hand them over to new investors all in the name of keeping people in their underwater homes is the latest in a long line of well meaning, but ultimately , ill-conceived “homeowner assistance” acts.
In this case, the seizures and principal reductions won't be applied to delinquent homeowners, rather to homeowners who are making their loan payments on time but are underwater on their mortgages. Venture capital firm Mortgage Resolution Partners would seize the loan from bond holders, with legal approval from the county in a whole new interpretation of Eminent Domain laws.
These loans would then be reduced in principal, and newly re-issued and held by the seizers. The original lien holder would be paid off based upon “fair market value,” to be determined by the city and its venture capital partner. So, the original bond holders lose money, the venture capital firm (in theory) makes money, and the homeowner gets a new loan with reduced principal.
Eminent Domain laws give power to the state to appropriate property for public use. To interpret these laws in order to justify seizing private investments from one entity, and hand it over to another, is to create a wholly new legal creature.
Mary Shelley's tale of a mad scientist manipulating life is more than just a scary story. The tale is also a caution against unintended consequences that may result from extreme overreaching, regardless of the original good intent.
This plan from Mortgage Resolution Partners, who stand to make money on this deal, would allow the government to step in and redo contracts between the private sector and consumers. Keep in mind that these homeowners are making their payments, none are delinquent, and the original lender is continuing to collect the amount due according to the original contract. If the government is allowed to use their power to interfere and seize the loan, then that could cast doubt over the future of contracts and lending in this country.
If I was a lender and knew that a county could seize my contracted loan for Eminent Domain use, then I would have to protect my investment and consider higher risk pricing for counties that used this legal act. A legal argument for the use of Eminent Domain in this case must make the assumption that these loans are underwater and likely to eventually default, and therefore the original investor is receiving fair market value in any payout.
Imagine if every county in the United States decided to apply the law of Eminent Domain in order to seize the capital excess of a financial bubble, and then reduce debt for those who are current on their mortgage payments. We are looking at hundreds of billions of dollars worth of mortgage debt that would need to be seized by the government and redone.
Meanwhile, as original bond holders saw capital losses, the Venture Capital Firm working in conjunction with the cities, would see (theoretically) gains. And, those lucky homeowners who were part of the action would have debt forgiven, whereas all future homeowners in those areas would likely be subject to higher loan interest rates to compensate for the future potential losses.
One can imagine the possible cascade of consequences from this for the county. If this did result in higher interest rates for the area, then housing prices would inevitably fall. And what about future business? Would business want to move into an area where their employees would be paying perhaps up to 3% higher interest rates on home loans?
Every single lending institution even Freddie and Fannie would have to add the prospect of a mortgage seizure under the laws of Eminent Domain if a home's value drops below what is owed. Certainly, pricing this risk into the costs of a loan would make sense. How could we ask lenders not to be wary of that risk, when government could come in, seize your loan, and give you only what they deem fair value of your debt?
If this passes In San Bernardino county, Chairmen of Venture Capital firm Mr. Gluckstern has said,
“…if it works, every mayor of every city is going to want to do this.”
If this works, this would create a crony capital monster, whose victims will be future homeowners trying to get loans, bond holders left holding the deflated bags, and taxpayers footing the bill for legal fees to defend the government's position. This seems to run counter to our principals as a free market country, whose laws protect private property and private contracts. This is the worst example of a long line of “solutions” to help the housing market, none of which have allowed natural market forces to come to bear.
I should state that I don't think this will pass. But if California, a state which is already in woeful economic shape, enacts this then the rest of the America will get a free look at a bad idea. We don't need another “creative” intervention in the housing market. The struggles in the real estate market, if left to play out naturally, will eventually result in a healthy , normal market. To embrace the idea that homeowners or borrowers can look to the government when they get into debt over their heads is insane. But if this does pass, what next? Don't be surprised if California next uses Eminent Domain to seize student loan debt.
Our good intentioned Dr. Frankenstein is collecting his body parts and planning the creation of his monster. Do we stop him now and get him into grief counseling to accept death -- or close our eyes and let all of society suffer the inevitable consequences?
Logan Mohtashami is a senior loan officer at his family owned mortgage company AMC Lending Group, which has been providing mortgage services for California residents since 1988.
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