Tuesday, July 30, 2013

Floating Eminent Domain for Underwater Domains

You only thought the mortgage meltdown was behind us.

Turns out, now some municipal bureaucrats have cooked up another way to cook the mortgage books.  And they're winning converts to their scheme thanks to pervasive, persistent, and populist anger towards banks.  Banks and other financial players that helped perpetrate the greed that turned up the heat on flimsy mortgages to begin with.

This time, banks are the ones balking at the new mortgage math, as cities try to salvage entire neighborhoods where residents are underwater, and hanging out to dry.  Basically, some mayors want to use the highly controversial tactic of eminent domain to seize homes that have drastically dropped in value, and re-sell them to the same home buyer, but at a price reflective of the city's new economic reality.  It's hoped that erasing the debt between what was paid for the house and what it's now worth will help encourage home buyers to stay and work on paying off their (new) loan.

In other words, home buyers who can't afford their current mortgage, and whose home's value has dropped below what they still owe on it, may be able to have their city sever their mortgage contract through eminent domain and basically write up a new deed of sale.  Along the way, what's considered an inflated dollar value for the house magically disappears!  Cities in California, Washington, New Jersey, and Nevada are considering such an unprecedented use of eminent domain with the hope that wiping out a lot of "bad" debt can help stabilize neighborhoods where foreclosures and abandoned homes are a blight on the community.

The only problem with this scheme is that, in a mortgage, money just doesn't disappear, does it?  Robert Hockett, a law professor at Cornell University, has written an article for the Federal Reserve Bank of New York on the use of eminent domain to invalidate mortgages, and its title is "Paying Paul and Robbing No One."  But that's not true, is it?  If somebody loaned X amount to a home buyer, that amount can't get renegotiated to a lower amount without somebody losing money.  And since many people, particularly in areas of the country that have been hit particularly hard by the mortgage meltdown, believe financial institutions bear the responsibility for selling home buyers houses they couldn't afford, it's the financial institutions that should bear the loss.  Having it all sound like a community improvement plan helps make it less irresponsible an idea than it is.  For his part, Hockett, who champions the idea mercilessly, is convinced that it's all perfectly legal, that the ends justify the means, and that banks should even be glad somebody wants to take sub-prime loans with a high probability of default off of their hands.

Of course, pulling the rug out from underneath banks and mortgage servicers by such an unconventional use of such a powerful tool as eminent domain is doing nothing to reassure the financial services industry of these cities' respect for basic contracts.  If a municipality is willing to treat something like a mortgage so cavalierly, why should any bank write mortgages for anybody in that town?  Or indeed, even as banks have been jolted by Detroit's bankruptcy filing, might a city's future ability to borrow be compromised if commitments can be voided so blithely?

Eminent domain, of course, is bad enough when used to condemn private land for a stadium, or a roadway, or an airport.  But usually, some shared benefit for the public at large can be found in what otherwise would be considered a brazen land grab.  Plus, with eminent domain, fair market value is paid to the holdout landowner, and that value pushes the upper reaches of what's reasonable to expect for the property.

And that's the catch with this new trick.  With property values tanking after 2008 and the commencement of our Great Recession, it's the fair market value that's complicating this issue, both for whatever company holds a property's mortgage, and the people who are supposed to be paying it off.  Unfortunately for many home buyers in places like California and Nevada, they paid inflated prices for negligible domiciles through sketchy mortgage contracts infused with extra fees, variable rates, and balloon payments.  Now those inflated prices have deflated, leaving home buyers "underwater" in their mortgages.

Advocates for distressed homeowners say that many of them were sold mortgages they didn't understand.  Or they were bedazzled by brokers banking on the borrower's gullibility, and are now holding the bag for - in many cases - hundreds of thousands of dollars in value that has evaporated from their purchase.

Why blame home buyers for paying too much for these homes?  Why blame them for the housing bubble?  Why let entire neighborhoods suffer for the financial shenanigans of shifty bankers?

America's mortgage meltdown had several causes, some of which are better understood than others, but all of which point to unreal expectations by home buyers, sellers, and their agents.  People abandoned common sense and bought more home than they could afford.  Speculators greedily snapped up properties only to hold them until they could be re-sold at a profit, thereby shrinking the market of homes for genuine buyers of limited means, and artificially inflating home values.  Unconfirmed reports of the federal government trying to move residents out of rapidly-deteriorating public housing complexes led to suspicions that Washington pressured banks to loosen lending restrictions to working-class minorities so they'd be able to move out and up from their starter homes - to make way for the folks from public housing (who'd be resettled with Section 8 vouchers).  Banks discovered that they could bundle sub-prime mortgages and sell them off to greedy investors who wouldn't even bother to read the fine print.  Home buyers would eventually learn that they had no idea who held their mortgage anymore, since it had been bundled and sold off so many times.

What some municipalities want to do now is go in and restore some sanity that was missing during the build-up to the housing bubble's pop.  And yes, on one level, it's easy to feel sorry for people who overbought, overpromised, overdreamed, and are now facing crippling financial problems.  It's easy to understand how municipalities want to preserve neighborhoods, and keep home buyers from struggling in the face of massive debts, or simply walking away, and leaving houses to languish.

But between what a distressed home buyer paid for their house, no matter how unfair or unrealistic a price it was, and what it's worth today, there lies money some lending institution somewhere paid out.  And that's a debt that somebody needs to pay.  Can it simply be written off, or walked away from?  Let's assume that banks and their lending practices were entirely predatory, racist, and even criminal.  Why hasn't anybody been arrested, tried, and convicted of any of those crimes?  Banks have been fined, yes, but isn't it uncanny how those fines have been political stage dressing instead of raw trials in a court of law?

Our mortgage meltdown should be serving as a warning for future home buyers that the financial services industry is not on their side.  They're going to tell you what you want to hear, not what you need to know.  And, guess what?  It also reminds us that a lot of inequity flourishes in this life.  And, too, that some cities are simply more expensive than others, for a whole host of reasons that have little to do with mortgage brokers and big bad banks.  Maybe moving on up in the American dream of homeownership is going to be much more difficult in some cities than others.

Of course, it's all too little to late for many home buyers, according to advocates of using eminent domain to fight inflated mortgages.  But isn't the growing trend of ignoring contracts and belittling one's financial obligations becoming a bit worrisome?  If you're one of those people lamenting the loss of those days when a humble handshake could seal a deal, imagine what today's global banks are worrying about with their databases of mortgages coming up for possible deletion!  It's kind of like trickle-down economics in the era of government bailouts; a politically-savvy way to try and find the biggest entity that can absorb the fiscal mistakes a smaller entity can't.  It worked for the automakers and big banks; now it's the individual homeowner's turn.  And this time, individual homeowners can have their revenge on those big bad banks.

No matter where you live, the fair market value of your home in 2007 likely wasn't what its fair market value is in 2013.  Sometimes values increase, and in rare instances, they sometimes decrease.  For people whose homes shot up in value leading up to the mortgage meltdown, did their lenders come knocking on their door, demanding a cut of their home's appreciation?  What's different, now that appreciations have turned into massive depreciations, other than the fact that for home buyers, financial accountability has also turned from a profit to a liability?

One thing that hasn't changed is this:  two wrongs never make a right.  Even when you want your house to stay your home.

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