Enter Mortgage Resolution Partners, who have apparently been shopping a new idea on how to dig out from under this problem. A story from Reuters says this mortgage firm is proposing that governments use their eminent domain power to condemn, not the homes, but the mortgages.
A big part of the problem with the real estate market is that many borrowers are “upside-down,” or “underwater.” That is, the home owners have negative equity–they owe more on their mortgage than their home is worth in today’s market. A recent report estimates that nearly one in three home buyers owe more than their home is worth, and altogether, the difference between the real value of the homes and the mortgages is $1.2 trillion.
Negative equity restricts mobility (no one wants to move when they are going to lose money on the sale of their home, even in California where lenders cannot pursue the borrower for a deficiency judgement). In a time of widespread unemployment, the inability of skilled workers to move to where a job is available slows economic recovery. If the buyer can afford to continue paying the current mortgage, despite the lower home value, they will generally make the payments in the hopes that the value will rebound. In fact, the same study that showed the depth of the problem also reported that “90 percent of underwater home owners are current on their mortgage and continue to make payments.”
Of course, for those home buyers who cannot keep up their payments, owing more than the home is worth means that a default and foreclosure will leave them with no equity to use in moving to other housing, whether that is buying a less expensive home or renting a home.
The unwillingness of home owners to sell at a loss also artificially reduces the number of homes for sale. A recent article in the L.A. Times reported that the market has shifted so that now there are more qualified buyers than there are homes to sell them (see “Shortage of homes for sale creates fierce competition“).
In time, the marketplace would correct this imbalance between the demand from home buyers and the supply of housing for sale by increasing the price until either the prospective buyers could no longer afford the homes for sale, and/or owners would be able to sell their homes for more than they owe on their mortgage. But it seems that some experts and real estate brokers either don’t believe the market mechanism sometimes called “supply and demand” works, or they are just impatient and unwilling to wait.
Enter the government, intervening in the market, to speed up the adjustment between home prices and mortgage levels using eminent domain.
Mortgage Resolution Partners is proposing a new government intervention in the mortgage market. Unlike historical interventions, which usually involve reducing risk for investors and reducing costs for consumers through programs like mortgage insurance, this would be a explicit effort to force the real estate mortgage industry to “mark to market” the value of outstanding loans through use of eminent domain.
Usually eminent domain is used to acquire property that a government agency needs to provide some public good or service, for instance, to build a park or school, or widen a road or install a water main. Most often, eminent domain is used to acquire the full fee title to the property, but sometimes only an easement or some other interest that is less than full ownership is acquired.
In this proposal, the property being acquired would be the deed of trust and mortgage note–much less than the full ownership, but nonetheless a property interest.
How would this make things better? Well, when a government acquires property using eminent domain, they only pay the actual current fair market value, as determined either through negotiation or by an independent appraisal. And the process is mediated by the courts to make sure that everyone involved is adequately represented and fairly treated.
The current fair market value of a mortgage should only be what it would be worth in the case of a sale of the underlying asset. So, for a $300,000 mortgage secured by a home worth only $250,000, the government should only pay the current $250,000 value in an eminent domain acquisition. In essence, the mortgage should “sell” for the same price that the home would sell for in a short sale situation.
The government could then renegotiate the mortgage with the borrower for the current market value of the home. This new, smaller mortgage should result in more affordable monthly payments, and the possibility of some gain in equity value for the home buyer.
One of the unresolved issues in this kind of write-down is that the borrower would have received a reduction of debt, which is treated as income for most tax purposes. At the same time, the mortgage owner would have a tax loss of that could be deducted from their other income.
The proposal by Mortgage Resolution Partners would use private capital from institutional investors to fund the purchases, and would sell the restructured mortgages to repay that investment, with some profit, one assumes. The restructured loans should be attractive to investors because they would be more affordable to the borrowers and thus less likely to result in future defaults and foreclosures, unless home prices continue to decline.
Where this idea will go is anyone’s guess. Use of eminent domain has been very controversial, but in 2005 the United States Supreme Court declared that state and local governments were not precluded by the U.S. Constitution from using eminent domain to acquire private property from one private owner and sell that property to another private owner for economic development purposes. Whether state and local laws would permit this use of the power of eminent domain is uncertain. What do you think about this approach to resolving the one of the remaining problems left over from the popping of the Housing Bubble?