Do you think San Bernardino County’s loan cramdown-by-seizure plan for underwater homeowners will help the real estate market?
- No (72%, 118 Votes)
- Yes (28%, 46 Votes)
Total Voters: 164
A case for one county’s use of eminent domain to help underwater owners, despite anti-cramdown smokescreens launched by the opposition.
Repurposing an old sword
The San Bernardino County Board of Supervisors voted unanimously to approve a first-ever plan to seize underwater mortgages (yes, mortgages) through court ordered eminent domain. Congress could not instigate similar curative actions, and now San Bernardino County is stepping up to the plate in its own bold and unorthodox way. Cue the Homeownership Protection Program!
San Bernardino County Board of Supervisors: Joint Exercise of Powers Agreement: Homeownership Protection Program
The county is desperate to keep residents in their homes and increase homeowners’ disposable income. If implemented, this proposal to stimulate the local economy by reducing the debt burden carried by its underwater residents is threefold:
- “condemn” home loans on negative equity properties;
- take “possession” of these loans; and
- renegotiate the loans with homeowners to principal amounts at or below the home’s fair market value (FMV).
For a property to be eligible for loan seizure and restructuring, the following criteria must be met:
- the mortgage is currently held by private lenders;
- the amount of principal owed on the loan exceeds the FMV of the property; and
- the homeowner is current on their monthly mortgage payments.
Thus far, the proposed plan will apply to both purchase money loans and refinance loans. Underwater is underwater.
It is noteworthy that the seizure of the real estate securing these loans is not part of this eminent domain proposal.
The physical property itself will not be seized, allowing all participating homeowners to remain in their homes with their title intact. Only the lender’s security interest in the property, i.e., the mortgage, would be “taken” via eminent domain. In effect, the loans will be assigned (transferred) to the county.
As in all government takings, the FMV of the interest taken must be paid. A judicial determination based on appraisal evidence of the FMV is the lubricant that keeps the lender from receiving less, or the county paying more, than the current market value of the lender’s or investors’ security interest in the property.
The county proposes to use private investor funds to finance their seizure of the loans, though the plan is still in early stages of development.
For a source of mortgage funds, the players on Wall Street have proved they can be depended upon to bundle the resulting modified loans and sell them to bond market investors, packaged for the secondary money market as equivalent to newly-originated mortgages.
At current par rates of around 3.5% on 30 year amortization periods, the county’s economy will be greatly impacted by the project as each homeowner will have significantly greater disposable income and be suddenly become solvent – their balance sheets righted by a cramdown by a different name.
With the mortgages on their properties altered to match the current FMV of their homes, homeowners will be free to participate in the local economy – and sell their homes and move, thus greatly stimulating the housing market. With monthly mortgage payments eating-up less of their income, homeowners can finally contribute their liberated income to their local economy, a good thing for everyone.
The Homeownership Protection Program will not benefit individual homeowners exclusively; it will solve the core problem in San Bernardino’s economy (negative equity) and ripple out to financially strengthen every resident in the area. This is the “public good” meant by the eminent domain taking.
Don Quixote or Lancelot?
This plan may seem a little harebrained, but at least it communicates what inland Californians are thinking: Something must be done. Congress failed to take cramdown action on two occasions in 2009.
Underwater properties must be righted as soon as possible, as these home values will most likely only increase at the rate of inflation (approximately 2% annually) for well over a decade to come. This means prices will not rebound to be what they were during the boom, the time at which many of these homes were purchased. Time is not on the side of these homeowners, and San Bernardino is feeling the sting as a result.
San Bernardino’s exercise of their police power to take mortgages, rather than real estate, is a bold move many experts have lauded, including the renowned economist Robert Shiller. Their unorthodox plan to save Inland Empire homeowners from foreclosure will hopefully serve to inspire a California-wide initiative of cutting the principal on negative equity home loans – perhaps the only viable avenue for large-scale cramdowns in light of Congress’ continued inaction to again authorize federal bankruptcy judges to oversee these cramdowns.
However, those who doubt the efficacy of the program argue it is complicated by a bevy of problems:
- lawsuits by lenders in counterclaims to the eminent domain proceedings;
- more complications and inefficiencies in loan servicing;
- heightened risk for lenders and investors; and
- higher costs for future borrowers.
These are natural and reasonable questions to ask when faced with this kind of unprecedented proposition. However, most of these concerns are unsupported by evidence. Let us address each objection in turn and separate the wheat from the chaff.
Slaying imaginary dragons
Worry #1: lenders have threatened lawsuits over the FMV purchase price for underwater mortgages.
The legality of paying no more than FMV for seized mortgages will be established in court the same way it is decided in standard eminent domain cases relating to the seizure of real estate.
There will be no shady grasping at mortgages for “unfair” prices by the county and its partnering private investors. This portion of the plan does not require a foray into uncharted territory – the court is well-versed in the art of awarding compensation in eminent domain cases. They do it all the time.
Worry #2: lenders and mortgage investors will be scared away from what may now be seen as a high-risk investment.
No new risk is created by this use of eminent domain, and the current risk of originating a mortgage at any location in the U.S. is so low that lenders are managing to cover inflation and the risk of default in today’s 3.5% mortgage rates. Additionally, the federal government guarantees nearly all mortgage originations under one or another program, and they are not about to “red line” San Bernardino County.
If the courts allow the county to follow through on their plan, it is because the county has always possessed the power to do so. No new law needs to be crafted and none will be created.
The only reason this has not been done in the past is because the unique situation of economic inertia and pervasive negative equity has not previously existed to make such a taking in the interest of the local economy necessary. Nor is it likely to happen again in the near to distant future. Desperate times call for desperate measures, conducted within legal parameters.
Worry #3: more complications in loan servicing.
This proposed use of eminent domain is only viable or desirable in the context of today’s market. The impetus behind the plan is the overwhelming number of homeowners who purchased their homes during the unsustainable frenzy of the Millennium Boom, fed exclusively by funds from the bond market, and who are now unanimously underwater.
This market is exceptional, and the Inland Empire is ground zero (though similar actions are being considered by the municipalities of other highly affected sand states, such as Nevada and Florida).
Thus, lenders have little cause to plan for another mass mortgage seizure when originating news mortgages going forward. Making loans involves a forward-looking analysis, and no risk of a future mass negative equity financial crisis is presently being factored into the mortgage rates. Anomalies rarely occur twice – especially in such close proximity. No further hoops will be added to the loan origination process for new homebuyers to jump through, in San Bernardino or elsewhere.
Worry #4: future borrowers will have higher loan costs.
See rebuttals for worries #2 and #3. No increase in risk means no increase in complications for lending, which means no increase in loan costs for homebuyers seeking purchase mortgages or refinances.
Lending is structured with an eye on the future, calculating risks such as inflation and default to set the interest rate. Further, it is Fannie Mae and Freddie Mac (collectively Frannie) and the Wall Street bond market that support and set lending rates, not the geographical location of a borrower. The Federal Housing Administration (FHA) does not set rates, but merely insures, and the same is true for private mortgage insurers. The physical location of the borrower has never been a determining factor, nor will it ever be.
Worry #5: The properties involved will not produce a broker fee, and the program will actually interfere with such earnings by enabling homeowners to keep their homes by a reduction of the loan-to-value ratio (LTV) to 100% or below.
Short sales will be lost and no need will remain for them to be arranged by agents and their brokers. Further, speculators will not have an opportunity to benefit by the profit from a property flip. A second set of fees for all other transaction providers will also be lost.
Worse, rents will not be driven up as the homeowner of a short sale or foreclosure will not be entering the rental market.
How will real estate practices sustain the sudden loss of profit?
Take a step back and look at the bird’s eye view. The county’s Homeownership Protection Program will ultimately benefit the real estate industry.
With home loans crammed down to their FMVs, these homes can now be listed and sold through conventional sales arrangements – a more long-term and stable arrangement in any market than the horrid short sale conditions we’re now experiencing. This of course will pave the way for trade-up buyers to make future purchases, the ultimate elixir of a stalled market with its two commissionable transactions undertaken for the client: a sale and a purchase.
Thus, the homes will no longer be the financial prison in which a couple of million California homeowners currently find themselves trapped, despite the detriment to their standard of living.
Hail, San Bernardino!
We must give the county credit for experimenting with an antidote to the negative-equity plague, by voting unanimously to move toward a solution. In times of acute desperation, all ideas must be considered, no matter how unusual or controversial. After all, necessity is the mother of invention.
California is again demonstrating its interest in relieving the financial burden of underwater homeowners for the good of the individual and the general economy. In one bold stroke, the county board of supervisors has succeeded in circumventing the congressional refusal to permit federal judges to again conduct cramdowns.