Fighting Foreclosures with Eminent Domain
Industry Update: On July 2, The Wall Street Journal published an article titled Fighting Foreclosures With Eminent Domain.
Fighting Foreclosures With Eminent Domain
A way for cities to rescue underwater mortgages from the banks.
The fight over using eminent domain to prevent foreclosures is on again. Wall Street banks crushed an effort earlier this year by California's San Bernardino County supervisors in a community devastated by foreclosures and collapsing home values with threats of ruinously expensive litigation and a lending boycott.
Despite the bullying, the anti-foreclosure idea has been explored by a number of cities, including North Las Vegas and El Monte, a suburb of Los Angeles. The tactic is simple: Municipalities buy mortgages that are likely to end up in foreclosure and negotiate new mortgages that homeowners can afford.
Critics try hard to make this familiar government power sound frighteningly strange and extreme. It is not. Cities invoke the right of eminent domain or compulsory purchase every day in every corner of the country.
A bank owned sign hangs outside a home for sale in Las Vegas, Nev.
When cities need to buy property, they usually negotiate a price with the owner like any other buyer. Sometimes the property owner is unwilling to sell. Eminent domain allows cities to take property for a public purpose while paying fair market value so a single owner cannot block an important project or gouge taxpayers by holding out for more money.
Eminent domain is how we build relatively straight roads, extend water and sewer lines to new homes, and locate schools near neighborhoods in which children live. The property involved is usually land, but courts have allowed authorities to invoke the right of eminent domain for all kinds of property, including contract rights, trade secrets, insurance policies, stock and yes, mortgages.
Eminent domain can address the housing crisis. Sensible reductions of homeowner debt can provide relief from a community's foreclosure crisis, but it can make great economic sense for creditors too. Foreclosures are hideously expensive. Creditors usually come out ahead when they reduce a homeowner's debt to an amount the homeowner can pay. When creditors act on their own behalf, they often do just that.
The problem with mortgages is that during the housing bubble banks bundled mortgages and sold securities backed by the loans. The banks do not own those "securitized" mortgages, but manage, or "service," the mortgages for investors in mortgage-backed securities. With no "skin the game," banks skimp on the unglamorous back-office operation required to service securitized mortgages.
Banks bristle at the suggestion that they are inept, but other explanations are more damning. It takes more work to negotiate a sensible modification of a distressed mortgage than to foreclose, but banks can make more money by foreclosing than by modifying, as a 2011 Washington Law Review article by Diane E. Thompson noted.
Banks deny that this "perverse incentive" affects how they service mortgages. On June 7, however, six former Bank of America BAC -0.54% employees filed sworn statements in a class-action lawsuit by homeowners who claim the bank mishandled their mortgages.
The employees allege that the bank denied mortgage modifications to qualified homeowners, falsely claimed not to have received necessary paperwork, falsified electronic records, ignored properly completed applications, denied applications en masse because the paperwork was no longer current, and gave employees bonuses for pushing homeowners who qualified for modifications into foreclosure instead. They claim that the bank pushed for foreclosure instead of modification because foreclosures were more profitable.
Bank of America denies the charges. Yet if the allegations are true, the bank did unconscionable harm to homeowners, their neighbors, and investors in mortgage-backed securities for the sake of a modest additional profit.
The Home Affordable Modification Program has depended on banks to help deal with the housing crisis. But this program, like others, has yielded disappointing results. Recovery from the foreclosure crisis remains painfully slow. Eminent domain, however, can assure that troubled mortgages get the "high touch" servicing needed to avoid foreclosure.
Opponents, such as the American Securitization Forum, argue that the proposed formula for deciding how much cities would pay for mortgages would cheat investors. Yet if investors and cities do not agree on a price, investors could contest the price in court and present evidence of their own formula for valuing mortgages.
Critics also argue that the real motive for the idea is not to help struggling homeowners and communities, but to let slick businessmen make a profit. If a city takes the houses through eminent domain, they say the city will probably hire a company to run the program and make a profit doing so.
This is not much of a criticism. Paving contractors profit when cities use eminent domain to build roads, but cities still build roads. There is no good reason not to try using eminent domain to help homeowners in distress to save neighborhoods from the blight of vacant, foreclosed homes and to break the cycle of foreclosures and declining home values.
Mr. Miller is a former member of Congress, a senior fellow at the Center for American Progress, and of counsel to the law firm of Grais & Ellsworth LLP.
A version of this article appeared July 3, 2013, on page A13 in the U.S. edition of The Wall Street Journal, with the headline: Fighting Foreclosures With Eminent Domain.
To view the online article, please click here.
Safeguard Properties is the largest mortgage field services company in the U.S. Founded in 1990 by Robert Klein and based in Valley View, Ohio, the company inspects and maintains defaulted and foreclosed properties for mortgage servicers, lenders, and other financial institutions. Safeguard employs approximately 1,700 people, in addition to a network of thousands of contractors nationally. Website: www.safeguardproperties.com.