Eminent Domain To Solve Housing Crisis?

An interesting proposal was leaked into the news this week, about the prospect of using eminent domain as tool to solve the housing crisis. 

As reported by Reuters:

“A mortgage firm backed by a number of prominent West Coast financiers is pushing local politicians in California and a handful of other states hardest hit by the housing crisis to use eminent domain to restructure mortgages that borrowers owe more money on than their homes are actually worth. Under the ambitious proposal, Mortgage Resolution Partners would work with local governments to find institutional investors willing to provide tens of billions of dollars to finance the condemnation process to avoid using taxpayer dollars to acquire millions of distressed mortgages.

A local government entity takes title to the loans and pays the original mortgage owner the fair value with the money provided by institutional investors.

Mortgage Resolution Partners works to restructure the loans, enabling stressed homeowners to reduce their monthly mortgage payments. The restructured loans could then be sold to hedge funds, pension funds and other institutional investors with the proceeds paying back the outside financiers.”

It’s important to point out that your home would NOT be taken away from you if the property were underwater.  The mortgage would be transferred to the investor and ideally the loan would be restructured to something affordable for the homeowner.  In theory, it’s not entirely different than if your mortgage were sold to a servicer – as has been the case for millions loans.

The question becomes, how would eminent domain fit into the equation?  By definition, eminent domain is:

“An action of the state to seize a citizen's private property, expropriate property, or seize a citizen's rights in property with due monetary compensation, but without the owner's consent. The property is taken either for government use or by delegation to third parties who will devote it to public or civic use or, in some cases, economic development.”

To me, the words “rights in property” (as opposed to “actual property”, since it’s the mortgage we’re talking about, not the actual house) and “economic development” are what give this idea its legs.

So, what would actually happen?  The investor pays the current mortgage company fair market value for the home and re-works the mortgage based on the current price they just paid for.  The investor then begins collecting payments, plus interest and the city gets a fee for the title transfer, with one less vacant property to deal with.

The mortgage company would seem to gain the least from this, but they might not necessarily be getting a “bad” deal.  If someone owes them $400k and the current fair market value is $250k, then yes, they would stand to lose $150k.  But would they really have stood a good chance of collecting that additional $150k via foreclosure?  In most instances, it’s not likely.  Between the cost of the foreclosure process, upkeep of the home, etc., and the likelihood that the borrower wouldn’t have $150k on hand to collect, the $250k one time payment would probably gain them far more.

The question I have is, what happens to the deficiency?  If the government requires the mortgage company to waive their right to pursue for the deficiency (per the example above, the $150k) as a condition of receiving the investor’s payoff, then I think this is a very clever idea.  Even if they allow them to pursue for a fraction of the deficiency – say, 10% - it could still be a good deal for the borrower as well.

All that said, I would assume lenders who currently own the loans will fight this through the courts, tying the process up for years.  Simply put, banks don’t like taking losses, even if common sense tells them their current way of dealing with foreclosures is costing them more.

I’ll be interesting to see how this progresses as more details become available.  To read the full article from Reuters, click here.