Great news: Cities to apply Kelo to … mortgages

posted at 11:46 am on July 6, 2012 by Ed Morrissey

If one wanted to craft a strategy to make the home-mortgage market even less stable, increase already-unsustainable public debt, and erode private property rights even further than we have already seen, it would be hard to top a new idea from California, of all places.  Two cities have fashioned a plan to use eminent domain not to seize real estate, but to seize the mortgages on them.  Call this … Kelo meets Hugo Chavez:

Eminent domain allows a government to forcibly acquire property that is then reused in a way considered good for the public—new housing, roads, shopping centers and the like. Owners of the properties are entitled to compensation, which is usually determined by a court.

But instead of tearing down property, California’s San Bernardino County and two of its largest cities, Ontario and Fontana, want to put eminent domain to a highly unorthodox use to keep people in their homes.

The municipalities, about 45 minutes east of Los Angeles, would acquire underwater mortgages from investors and cut the loan principal to match the current property value. Then, they would resell the reduced mortgages to new investors. …

For a home with an existing $300,000 mortgage that now has a market value of $150,000, Mortgage Resolution Partners might argue the loan is worth only $120,000. If a judge agreed, the program’s private financiers would fund the city’s seizure of the loan, paying the current loan investors that reduced amount. Then, they could offer to help the homeowner refinance into a new $145,000 30-year mortgage backed by the Federal Housing Administration, which has a program allowing borrowers to have as little as 2.25% in equity. That would leave $25,000 in profit, minus the origination costs, to be divided between the city, Mortgage Resolution Partners and its investors.

Where to start on this nonsense, given to us courtesy of David Souter?  The Kelo decision gave a legal option of using eminent domain not for public use, such as roads or utility rights-of-way, but to transfer property to other private ownership.  One can imagine that a Supreme Court that had no problem establishing that precedent would suddenly get persnickety about the definition of property subject to eminent domain, not unless the court in question would like to take a second chance at getting that decision corrected and the precedent undone.

If cities began doing this, it will create a number of problems, especially in mortgage markets, which are still unstable thanks to the 2008 housing bubble crash created by government interventions over a decade in the market.  It will disincentivize future investors, who will rightly wonder just how safe their investments will be while cities have the prerogative of simply deciding how much of their investment they should be allowed to keep.  As it works now, investors take known risks on loan securities, but this will add a huge amount of uncertainty to the investment market, and it will drive capital out at a time when mortgage lenders need more capital to get into the market.  That will force lenders to raise bond yields, which will mean higher mortgage rates for borrowers, especially for those who present more risk.

Furthermore, it will hand a carte blanche to local politicians looking to curry favor with residents — and we can expect them to use it as often as they think they can get away with it.  Nothing sells like populism, and nothing in populism sells better than “sticking it to the banks,” even when the “banks” really means lots of investors, large and small, who bought mortgage-based securities for retirement funds and the like.  On top of that, the process heightens the moral hazard of government intervention, which then encourages people to take irrational and damaging risks by expecting private gain with public loss.

In short, this is the kind of policy that is not just misguided, but positively disastrous, even when the government in question is on solid financial footing — which is hardly an apt description of government in California at any level.  What happens when no one wants to buy the mortgages seized by these cities because of the instability and risks involved?  The taxpayers will be on the hook for the principal, even at the artificially-imposed new level, and when the homeowners default on those mortgages, the cities will have to maintain the properties at taxpayer expense.

American government should use eminent domain only on real property, and only for actual and explicit public use, and pay market price as compensation.  This is a violation of private property rights on every level, and a symptom of a government transforming from the traditional American model to something much more authoritarian — and incompetent.


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Hey, this is awesome… nobody should ever be underwater on a loan.

I just bought a new car for $50,000 last week; but now it’s only worth $30,000. Take that loan and resell it to me for $30,000 government officials.

… WOOHOO profit time!

Oh, and guys; I need a second car for my family… can I get anyone to offer me a $50,000 loan for that car too? No? Why not?

What do you mean I’ll never get a loan on a new car again?

gekkobear on July 6, 2012 at 4:12 PM

It’s easy when you only read a third of one sentence.

Steve Eggleston on July 6, 2012 at 2:07 PM

Then I suggest you read the whole thing. You have no business attempting to lecture anyone on reading comprehension.

Dante on July 6, 2012 at 4:20 PM

blink on July 6, 2012 at 4:14 PM

You must admit the standard set in Kelo is very low. In fact, all you have to provide is a plan that shows how the city would be benefit. You don’t have to show your ability to fund, build, operate, or otherwise make the first dollar on the seized property.

All that is required in Kelo is to show your plan can produce more tax revenue than the property does as it sits.

BobMbx on July 6, 2012 at 4:22 PM

Then I suggest you read the whole thing. You have no business attempting to lecture anyone on reading comprehension.

Dante on July 6, 2012 at 4:20 PM

Let’s do so:

American government should use eminent domain only on real property

Once again, HotAir comes down on the side opposed to liberty.

Dante on July 6, 2012 at 11:53 AM

Now, let’s review the entire sentence, with the portion which you chose to not quote so you could make your asinine point bolded:

American government should use eminent domain only on real property, and only for actual and explicit public use, and pay market price as compensation.

I could have included the succeeding sentence that finished destroying your point before you made it, but since you don’t know how to read more than 10 words at a time, it’s pointless to point it out to you. On second thought, I think I will just so you have no excuses:

This is a violation of private property rights on every level, and a symptom of a government transforming from the traditional American model to something much more authoritarian — and incompetent.

Steve Eggleston on July 6, 2012 at 4:36 PM

So, the banks or investors are not being forced to suffer a loss that they have not already suffered.

tommylotto on July 6, 2012 at 12:13 PM

Yes they are. The owner of the debt is holding a promise to repay $300,000. Period.

MNHawk on July 6, 2012 at 12:49 PM

The mortgage is a non-recourse loan, meaning the debtor is not really liable for the debt, only the property is. If the property has insufficient value to repay the loan, the lender can only get the property back. It cannot go after the debtor for any deficiency. So, if the property loses value, so does the mortgage. The home owner’s promise to pay the entire balance of the loan is illusory. If under water, the home owner only has to pay on the mortgage as long as he is too stupid to walk away from the property. He should walk away from the property. He has the right to do so. It makes economic sense for him to do so, and the lender knows that this was a risk when it extended the loan.

Also, it is not necessarily an unconstitutional interference with contracts. The state takes the property and pays everyone with an interest in the property just compensation for their interest. Since the loan was non-recourse, the bank cannot go after the former home owner. All they get is their just compensation for their interest in the property. The home owner gets nothing. Then the state could do anything with the property as they please, including selling it back to the original home owner for a lower cost. If this is all worked out ahead of time. It could be quite effective.

The original home owner (and new buyer of the property back from the state) would necessarily have to pay more than FMV for the property, because the new selling price would have to be enough to cover the just compensation paid to the lender as well as all transaction costs. However, for properties seriously underwater, it might be a way for the homeowner to get to stay in their home and avoid a foreclosure. That is a win win, as the lender will not have to lose income while they foreclose and will not have sell an empty foreclosure with a dead lawn and deferred maintenance. Meanwhile, the home owner reduces his principle and avoid trashing their credit. If the home owner is willing to pay a premium over the current value to stay in the home and save his credit, it can work.

I see the charm of the plan. If it just wasn’t government trying to execute it….

tommylotto on July 6, 2012 at 4:44 PM

What’s in a name? that which we call a rose
By any other name would smell as sweet;

TARP—QEII—BAILOUT!

Get these sons-a-bulches out of here!

auspatriotman on July 6, 2012 at 4:47 PM

Call this … Kelo meets Hugo Chavez:

I don’t even know this country anymore.

V7_Sport on July 6, 2012 at 4:54 PM

tommylotto on July 6, 2012 at 4:44 PM

Two slight problems with your premise:

- As long as the home”owner” agrees to live on the property, he or she is obligated to service the loan on mutually-agreed-to terms. The recourse in California if he or she doesn’t want to live up to the terms or renegotiate the terms to a mutual agreement is to abandon the property.

- The mortgage company already has a senior lien on the property should the home”owner” go into default on the mortgage – foreclosure. If the city then wants to step in and buy the property (a dumb idea IMHO), it should send a representative to the auction and try to outbid anybody else who shows up.

What the city cannot do is say, “Since this person wants to ‘refinance’, we’re going to seize the lien on this property from you.”

Steve Eggleston on July 6, 2012 at 5:15 PM

I’m pretty sure that this isn’t true in all states. Is it true in California?

blink on July 6, 2012 at 6:11 PM

Except for judicial foreclosures, mortgages in California are non-recourse loans.

Steve Eggleston on July 6, 2012 at 6:38 PM

Yes, there is protection in California for non judicial foreclosures regarding deficiency judgments against borrowers.

However, a taking of the collateral securing the property by eminent domain would not be afforded those non recourse protections. The note would still be “live” and any deficiency most likely treated along the same lines of an underinsured loss to the property. The balance of the note would be reduced by the amount paid, but the remainder of the balance would still be outstanding.

Take a look at the Fannie and Freddie Uniform Deed of Trust for California. Lenders have protection built into those instruments.

In addition, an eminent domain taking prior to foreclosure would likely fall into the category of an “event of default” allowing the lender to accelerate the remaining term of the loan and call the entire remaining balance due.

Chances are that lenders are not in a very charitable mood these days, and state actions such as those discussed would be viewed as a bet the ranch proposition. Of course, legal fees incurred by lenders to preserve their interests in the property are contractually expenses borne by borrowers under the California Deed of Trust pprescribed by Fannie and Freddie. Those expenses are just rolled into what they owe as additional debt.

Jim M. on July 6, 2012 at 7:04 PM

Steve Eggleston on July 6, 2012 at 4:36 PM

You are embarrassing yourself. Government is still taking property by force, and Ed still believes that eminent domain “should” be used, no matter if there is compensated “fair market price” or not. Compensation is absolutely irrelevant to the point. The following sentence that you quote is in reference to the specific blog topic, and not of eminent domain in general, and is also irrelevant.

Bottom line: Ed supports eminent domain, which is the government forcibly seizing private property. THAT is the antithesis of liberty.

Dante on July 6, 2012 at 8:26 PM

The time will come when they will seize things like this, not to help people, but to enrich their friends. Seize a home or mortgage, throw out the occupants and turn the property over to political friends. It’s already been done in other 3rd world countries. We’re headed there. It’s the natural evolution.

JellyToast on July 6, 2012 at 8:31 PM

While Kelo may allow use of eminent domain for the purpose described, the issue will turn on what is “just compensation”. Kelo did not say that New London could pay less than “just compensation”, whatever that amount turned out to be, for the houses it took, it just said that it could use eminent domain power to take the houses.

The scheme these partners propose is to “argue” that the mortgage’s value is less than the value of the property but the mortgage holder’s interest is the full value of the mortgage of which the property value may be less than the face value of the mortgage. That the partner’s scheme requires that they make their money by getting more for the property than they argued that it was worth in order to resell (in effect) it to the mortagees would seem like the kind of use of eminent domain that may be too blatant even for Souter.

There is already a remedy for ‘underwater’ property. It is called a short sale where the sale price is less than the outstanding principal and the bank chooses to write off the balance.

Russ808 on July 6, 2012 at 8:48 PM

Where to start on this nonsense, given to us courtesy of David Souter?

Souter the gift that keeps on giving

To think he was pushed by Grover Norquist

My my my

If property can be Souterized, then presidents can be Norquisted

Now that my health care has been Roberted it comes full circle. I have been Bush whacked, and now Obam-bammed to the point naked photos of my umbilicus could be kept at the WH for emergencies, while their panels decide if I shall receive an operation, or an ibuprofen.

If a judge agreed, the program’s private financiers would fund the city’s seizure of the loan, paying the current loan investors that reduced amount

Who needs private property when public property is such a deal

This will pretty much end the US as a desirable investment location. China is a better deal if this spreads

Our only hope for California is a major earthquake to keep them from trying to think

entagor on July 7, 2012 at 12:49 AM

I just bought a new car for $50,000 last week; but now it’s only worth $30,000. Take that loan and resell it to me for $30,000 government officials.

gekkobear on July 6, 2012 at 4:12 PM

That’s kind’a how we got into this mess in the first place. 60 minutes did a ‘touchy feely’ story about a “homeless” family living in a California “slab city shanty town”, named for all the houseless slabs that were the yet to be built suburb, out in the middle of nowhere. It was all about “The Children” and the challenges of getting ready for school each day homeless. They were squatters living in their Fifth-wheel RV. They still had their car and their truck and the boat and the jet-skis and the 4wheeler ATV’s. You see all that was FREE and clear, BOUGHT AND PAID FOR with the 110% mortgage they walked away from. Thank you Barney Frank!

Pole-Cat on July 7, 2012 at 10:53 AM

California smoke meet SCOTUS mirrors.

Eminently demented.

profitsbeard on July 7, 2012 at 12:47 PM

It’s nonsense. A State cannot interfere with the obligations of a Contract, which is what a Mortgage is. It cannot be seized. It also is not “property”.

DOUBLE EPIC FAIL

John Kettlewell on July 7, 2012 at 3:39 PM

Dante on July 6, 2012 at 8:26 PM

I get it – you don’t want to live in the United States in any form that it has ever existed. So tell me, what else did the Founding Fathers get wrong? Were they wrong to allow any form of taxation? Were they wrong to allow a court to issue a search warrant? Were they wrong to allow the government to call out the militia to quell rebellions? Were they wrong to allow government to make any laws at all?

Tell me, what would life be like in Danteville?

Steve Eggleston on July 7, 2012 at 4:24 PM

A community would have to demonstrate that seizing your car loan from the lender for fair market value would be in the best interest of the community. Good luck with that.

blink on July 6, 2012 at 4:14 PM

So cutting car payments on a loan I’m currently making payments on doesn’t benefit “the public”.

But cutting home payments on a loan you’re currently making payments on does benefit “the public”?

How does that work exactly? This program isn’t for people behind on payments or facing foreclosure after all; it’s people making their payments now… but my payments are different from your payments?

Why is that? Why is cutting your payments “public good” while cutting my payments isn’t? We’re robbing the same people and cheating the same banks and corrupting the same type of loan agreements on underwater loans.

Why is it only good for you to do this?

gekkobear on July 7, 2012 at 4:49 PM

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