For the last six years homeowners have felt the pain of one of the most widespread and sustained downturns in the housing market in our history. Hundreds of thousands have lost their homes to foreclosure, and the federal government has implemented numerous programs to help families make their mortgage payments.
While progress has been slower than anyone would like, and the frustration of those who desire faster progress is understandable, home prices have stabilized and in many areas begun to rise. Indeed, millions of homeowners have received loan modifications or been able to refinance.
Slow progress is not an excuse to impose bad policy that will result in immediate and lasting damage to Main Street investors and current and future homeowners. Yet that is exactly what is being proposed by certain speculators as a “tonic” to local government officials eager to aid their constituencies.
When someone proposes a supposedly risk-free scheme to help homeowners, one must ask if it is too good to be true. In this instance, a group of speculators have proposed that they would fund a local government’s exercise of its power of eminent domain to seize mortgage loans from investors at below market value, write down the principal owed on those loans, and re-securitize them with government guarantees. There would be no cost or risk to the municipality, only benefits, according to these speculators.
Did we mention that the speculators, in return for their generosity, would walk away with a 20% to 30% profit and leave municipalities with the risk if something goes wrong?
As the old saying goes, if something sounds too good to be true, it probably is.
LONG-TERM IMPACTS
It is wholly unacceptable to line the pockets of speculators at the expense of main street investors and the local governments and taxpayers who will likely be on the hook should this scheme fail in any phase of its execution. Worse yet, undermining the sanctity of a mortgage contract will have a significant deleterious and long-term impact on all homeowners and prospective homebuyers in the very community the speculators are purporting to rescue. The costs of this scheme clearly exceed any benefits.
Let’s be clear, the idea of using eminent domain has three fundamental flaws.
First, it has the potential to severely damage mortgage markets and mortgage investors. The use of eminent domain in this manner will confront lenders and investors with an unquantifiable new risk — the unpredictable use of eminent domain condemnation to seize their loans at a significant loss. As a result, these proposals would reduce the sources of funding for mortgage originators, and cause originators to underwrite in a defensive manner, therefore increasing prices and reducing credit availability. Future credit borrowers would be harmed as it would most certainly result in increased costs for credit and reduced credit availability.
Second, we have grave concerns regarding the valuation and the profit motivation that underlies the proposed schemes. The proposals would impose severe losses on mortgage investors, including the retirement and savings accounts of thousands of individual investors (think teachers, police officers, firefighters) in order to extract profits that would be delivered to a small group of opportunistic speculators, with the added value of guarantees given by Ginnie Mae.
How can the plan be fair to holders of seized loans when the scheme’s backers stand to extract vast profits from them? This plan is a veiled short-term, deceptive and opportunistic scheme that utilizes taxpayer backed guarantees to fleece holders of mortgage loans.
Lastly, we seriously question the legality of the eminent domain proposals under the U.S. Constitution, state constitutions and other federal and state laws. The U.S. Constitution permits government seizures of private property only if such takings are made for a public purpose in exchange for just compensation. State constitutions and laws governing eminent domain are often equally or even more demanding. As discussed above, the likelihood of any material public benefit coming from these proposals is very low, and the fact that the proposals would transfer profits from one private party to another renders the exercise of eminent domain in this instance constitutionally defective. Furthermore, the “takings” by design will not satisfy the requirement of just compensation, both by underpaying for the seized mortgages in order to provide new investors with substantial profits, failing to account for the secondary effect on the value of the mortgage trusts and securities affected, and other factors.
Local government officials are correct to be trying to help their constituents in need, but they should look carefully under the hood of these too-good-to-be-true schemes.
Tim Cameron is a managing director and the principal staff adviser to SIFMA’s asset management group. He is responsible for developing and managing a wide array of policy perspectives on issues that directly affect AMG members.
