Property values have fallen so sharply in San Bernardino County that nearly half of the homeowners with mortgages owe more than their houses are worth. Hoping to aid at least some of those "underwater" borrowers, the county is considering a novel plan to use venture-capital dollars to buy and refinance their mortgages. The plan's authors say that homeowners would end up with less debt and the county and its financial backers would make a profit — all without the taxpayers spending a penny. The losers? Supporters say there would be none. We're not so sure.
The collapse of the housing bubble has led to wave after wave of foreclosures, driving housing values ever lower. Plummeting values, in turn, increase the risk that more borrowers will default because they can't sell their homes for what they owe.
Hoping to interrupt the vicious cycle, San Bernardino County, Riverside and Fontana have joined forces to review a proposal by San Francisco-based Mortgage Resolution Partners the governments would pay investors what the loans are estimated to be worth now, which would be significantly less than the amount actually owed. The borrowers would then be offered new, government-backed mortgages for less than the current value of their houses.
To avoid encouraging people to default, the relief would be available only to borrowers who'd remained current on their payments. It also would be offered only for homes worth at least 15% less than the amount owed, which are the ones most likely to go into foreclosure in the future. Notably, the new loans would be larger than the "fair market value" paid for the old ones, enabling Mortgage Resolution Partners and governments to profit from each seizure.
Although governments have used it in the past to seize all kinds of property in the name of the public good, eminent domain remains a drastic step that, when asserted in a novel way, can send shock waves through a market. That's one reason the local officials who've talked to Mortgage Resolution Partners haven't yet signed onto its plan. On the other hand, they have been waiting years for the banking industry and Wall Street to respond more effectively to the foreclosure crisis, and their patience is understandably wearing thin.
Lenders who still own the mortgages they issued are starting to offer meaningful help to troubled and underwater borrowers, but investors who purchased packages of loans on Wall Street are hindered by securities contracts that make it extremely difficult for them to write down individual loans, according to Cornell University law professor Robert C. Hockett, a supporter of the eminent-domain plan. Seizing underwater loans from those complex securities would let local governments do what investors haven't been able to do for themselves, which is minimize the foreclosures that are reducing the value of their securities.
The trade groups that represent investors and lenders aren't buying that argument. They contend that seizing securitized mortgages would spook investors, drying up the supply of money for new mortgages.
Their warnings may very well be exaggerated, but it would be pointless to implement the Mortgage Resolution Partners plan if every use of eminent domain drew a lawsuit. That means county officials will have to mollify the objectors before moving forward. They also have to make the case that reducing the risk of foreclosures justifies seizing loans regardless of whether the borrowers are capable of paying them off — an approach that raises tough questions about fairness. Finally, they need to show that it's appropriate to use eminent domain to generate profits for one group of investors (and local governments) at the apparent expense of another group of investors.
Ideally, the county's deliberations will prod investors to do much, much more than they've been doing to avert costly, needless foreclosures and eliminate the overhang of uncollectable debt that's holding back the economy. If they don't, however, they shouldn't be surprised if hard-hit counties such as San Bernardino take the matter out of their hands.