The debate around San Bernardino County’s proposed program to use eminent domain rights to seize ownership of underwater mortgages has continued to heat up since we first wrote about it here last week [4]. As Barclays notes, the county (along with two other cities in the area) has formed a joint powers authority, which would not need permission from the respective city councils unless they need public money. There are conflicting reports of the path that such an authority would take and the role of private investors. However, the most likely path seems to be that the authority is funded by private investors and it uses this money to buy current loans that are underwater at a "fair price" and then refi the borrower into a new private or more likely into an FHA mortgage. So, this program, if implemented, is likely to be a transfer of wealth from existing investors in these loans to the city governments and the newer investors led by venture-capital firms. Barclays does note though that there are many challenges to such a program including the legal issue of whether eminent domain can be used to seize financial assets in this fashion, especially if the primary beneficiaries are private investors at the expense of existing investors, which include, among others, pension funds and mutual funds and the fact that new mortgage origination is likely to suffer with new mortgagees
bearing the costs of such a program in the form of higher mortgage
rates/less credit availability.
Barclays: Eminent domain debate heats up
The debate around San Bernardino County’s proposed program to use eminent domain rights to seize ownership of underwater mortgages has continued to heat up since we first wrote about it. The county (along with two other cities in the area) has formed a joint powers authority, which would not need permission from the respective city councils unless they need public money.
Possible mechanics
There are conflicting reports of the path that such an authority would take and the role of private investors. However, the most likely path seems to be that the authority is funded by private investors and it uses this money to buy current loans that are underwater at a "fair price". The next step would be to refinance the borrower into a new private or more likely into an FHA mortgage (at, for example, 97% LTV of the currently appraised value). For the investors funding this program to make money, this implies that the "fair price" must be at a discount from the property’s worth (assuming that the new mortgage is at most a 97% LTV FHA loan). With this discount, the price paid for the loan is likely to be much lower than the value of the lifetime cash flows expected to be paid on such a current loan. So, this program, if implemented, is likely to be a transfer of wealth from existing investors in these loans to the city governments and the newer investors led by venture-capital firms, such as Mortgage Resolution Partners. Based on our limited understanding, it appears to us that the effect will be very similar to doing a FHA short refi with current investors taking a slightly higher loss (than a short refi) and the difference going to the city governments and the new investors.
A host of challenges likely
There are many challenges to such a program. First, there is the legal issue of whether eminent domain can be used to seize financial assets in this fashion, especially if the primary beneficiaries are private investors at the expense of existing investors, which include, among others, pension funds and mutual funds. Next, the plan appears to be exclusively targeted at mortgages in MBS that are not backed by the GSEs/GNMA. These mortgages form less than 10% of all mortgages in the country. The use of eminent domain requires the counties to show that the property seizure is for public use. If the program targets less than 10% of all mortgages, it would be hard to justify this as being for public use. Finally, new mortgage origination is likely to suffer with new mortgagees bearing the costs of such a program in the form of higher mortgage rates/less credit availability. Given this new uncertainty, which effectively subordinates a first-lien mortgage to the local governments, private lenders are likely to demand compensation for this in the form of higher interest rates and higher down payment requirements. This is likely to increase the burden on the taxpayer as more and more mortgages will have to be backed by the GSEs/FHA. In an environment where Congress is calling for efforts to revive private lending and to wean the mortgage market off of taxpayer assistance, such a move would be highly short-sighted and counter-productive, in our view.