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Why a drop in foreclosure completions is good for homebuilders (Part 4)

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The pernicious eminent domain solution

One proposal that has been floated has been the use of eminent domain to attack the foreclosure issue. Under this proposal, a municipality would declare eminent domain and seize underwater and current mortgages (not property) from investors and modify them. Needless to say, the constitutionality of such a move is dubious at best. Eminent domain was intended to prevent a small homeowner from standing in the way of the construction of a big public project like an airport or an expressway. This is the first time that it would be used to seize not real property, but a financial asset.

Foreclosure CompletionsEnlarge Graph

Here’s how the scheme would work. A municipality would declare that it’s in the best interest of the community to take a mortgage from a bank, or pension fund or other investor. The government would use eminent domain to seize the mortgage and would sell it to a hedge fund who would modify the loan, reduce the principal, and securitize the loan. The government and the hedge fund would split the profit on the deal.

In other words, say 145 Main Street is worth $100,000 but has a $200,000 mortgage on the property. Since the mortgage is current (meaning the borrower has been making the payments), the investor is probably valuing it close to $200,000. The local government would declare eminent domain, and force the investor to sell the mortgage to a hedge fund for $80,000. The hedge fund would then cut the principal down to $100,000, refinance the loan, and sell it into a securitization for $104,000. The fund and the city would split the $24,000 profit. The investor would be stuck with a $120,000 loss.

San Bernardino County was the first municipality to propose this, but ended up backing down after SIFMA (the Securities Industry and Financial Markets Association), which regulates the TBA market, declared that any government that did this would find all mortgages originated in that jurisdiction ineligible for TBA trading, which would effectively make them unsecuritizable. This would severely restrict credit in that locality.

FHFA chairman nominee Mel Watt has so far taken a pass on discussing the use of eminent domain. He has dodged the question by characterizing it as a local issue. For this reason (among others), Watt faces an uphill climb to be the next head of the FHFA.

Continue to Part 5

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