"Eminent Domain" Back On Table Following Fed's Latest Bailout Proposal

Tyler Durden's picture

We first discussed the possibility of state and local governments using eminent domain to 'save us' from further housing issues a year ago but now the NY Fed has gone one step further with an academic-based justification for why this process is not a "zero-sum-game" and will render all stakeholders better off. We can hear echoes of "trust us" in this commentary as the authors explain how multiple valuation methods will be used to ascertain "fair-value" - which has always worked so well in the past -  and that we have "little to fear" from the  resultant long-term contraction in liquidity or credit as bubbles can only inflate during times of easy credit availability (and that will never happen!)

 Paying for all this? Don't worry - resources to fund purchases of loans/liens can be raised from public, private sources or a combination of the two.

It seems to us that MBS holders will not be happy, consumers hurt as mortgage costs would rise (this 'risk' has to be priced in), and taxpayers unhappy as this is yet another transfer payment scheme to bailout underwater loans.

Oh and if that didn't worry you - remember back just a few short hours ago when we discussed the French socialist government's efforts at 'helping'!!



Some headlines from the report that caught our eye (via Bloomberg):

Underwater homeowners therefore are not to blame for current situation

 

Moral hazard can be prevented as it is “easy to formulate” criteria that doesn’t encourage strategic defaults

 

“Little need to fear” resultant long-term contraction in liquidity or credit as bubbles can only inflate during times of easy credit availability; we want “credit-caution” going forward

 

Eminent domain proceedings are not “zero sum game” and will render all stakeholders better off

 

Political authorities can use eminent domain to seize second-liens, too, “if need be”; can be used to “bring recalcitrant” creditors to the table

 

Via The NY Fed:

With more than 11 million homes still “underwater,” the mortgage debt overhang caused by the housing bubble remains an impediment to economic growth and a burden on communities across the country.  One possible solution to this problem is for state and municipal governments to use their eminent domain authority to purchase and restructure underwater mortgages.  This novel solution is proposed in a new report from the Federal Reserve Bank of New York.

 

Many analysts agree that principal reductions are the best way to assist underwater homeowners—those who owe more on their mortgages than their houses are worth.  Such write-downs can be difficult to achieve, however, when the underlying mortgages are securitized and held by private-label securitization trusts.  Specifically, such loans are subject to pooling and servicing agreements that require collective action by a large majority of security holders before a loan can be modified.  As a result, carrying out write-downs is challenging and sometimes impossible.

 

In “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt,” author Robert Hockett argues that one possible way to sidestep this problem is by having governments buy and restructure underwater mortgages.  By utilizing their eminent domain authority, state and municipal governments could bypass the coordination problems posed by the pooling and servicing agreements.  They could then reduce the principal on underwater loans, lowering the amount owed by borrowers and thereby reducing the risk of default.