The Eminent Domain Solution for Underwater Mortgage Debt

This week, the Federal Reserve Bank of New York published a paper about the use of eminent domain as a solution for mass underwater mortgage debt in an effort for municipalities to take direct action in order to ameliorate housing blight.

From the website: “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.”

The paper’s author, Professor Robert Hockett, is a Professor of Financial and Monetary Law at Cornell Law School.  He is also the original architect behind the original eminent domain solution that has been debated hotly for more than a year.  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.”

Hockett suggests that many analysts have called “for the write-down of principal on mortgage debt as the most effective solution o the problem of underwater mortgages,” the toll of which he positions as directly against the economic welfare of communities and the nation as a whole.

“The difficulty lies in carrying out the write-downs. While principal reduction on mortgages held in bank portfolios occurs at significant and still growing rates, loans held in private-label securitization (PLS) trusts have certain structural features that make such reductions very rare. Specifically, these loans are subject to pooling and servicing agreements that would require collective action by a large majority of security holders before the loans could be modified or sold out of trusts. Conducting such a collective action across most holders of the securitized loans would be nearly impossible.”

This eminent domain plan “puts forward a strategy for carrying out the write-downs. Essentially, it recommends that state and municipal governments use their eminent domain powers to address the collective action problems that now prevent the write-down of privately securitized loans. Under eminent domain, these governments can step in to purchase underwater loans at fair value, deal directly with the trustees of the private-label securitization trusts, and sidestep the rigidities of the pooling and servicing agreements. They can then reduce the principal on these loans, lowering the “water” and thereby reducing the risk of default.”

The most well-known attempt to utilize eminent domain as a solution for housing blight failed in San Bernardino, CA, a county desperate for a solution to a rampant housing crisis. Housingwire reports that “Richmond, Calif. and North Las Vegas, NV. are now said to be seriously considering eminent domain as a potential solution to current housing woes.”

Opposition to such plans has been particularly vocal across the country from Massachusetts to Southern California. The legality of such a use of the law has been under serious scrutiny and skepticism and opponents argue that complex and expensive legal conflicts may do more harm to any recovery than help.

What’s your take on this innovative solution? Do you think that it can serve a vital function in terms of recovery, or is it a sleeping giant waiting to consume recovery efforts in a black hole high-stakes of legal red tape? Leave us a comment below.

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