By Tim Ryan
The legally questionable plan being considered in San Bernardino County, Ontario, and Fontana to seize mortgages and force loan restructurings will inflict considerably more harm than good on residents of those communities. The municipalities may have the best of intentions as they contemplate ways to help homeowners, but the consequences of using eminent domain to tear up the contract between a mortgage borrower and creditor would have far greater and lasting negative effects than any benefits this plan purports to bring.
The plan, proposed by venture capital firm Mortgage Resolution Partners, would have these local governments seize control of mortgages where the loan amount exceeds the value of the home that secures it. The loans would be taken from the private investors in mortgage-backed securities (MBS) that fund them and forcibly refinanced. This should not be confused with a traditional refinancing. Rather this would have the government step in, seize the mortgage and force investors to accept as compensation an arbitrarily defined amount that is significantly less than what is owed to them, and even significantly less than the value of the property that secures the loan. These loans would then be refinanced and sold for a significant profit to Mortgage Resolution Partners. This is not a public good – this is a local government being used by a profit-motivated private company to help it extract profits from other investors. The governments would be deciding which investors should win and which investors should lose.
Above all, it’s important to recognize just who are the investors hit by this proposal. They are often the teachers, firefighters, policeman, and other everyday savers who are the ultimate beneficiaries of the pension plans, mutual funds, and other entities that invest on their behalf in mortgage-backed securities. These are the regular people who will bear the loss incurred by this purported “public good” while other investors, such as Mortgage Resolution Partners, profit.
Never before has eminent domain been used in such a fashion. If this plan is implemented, approximately $7 billion worth of mortgages would be called into question in San Bernardino, according to research from Fitch. MBS investors and mortgage lenders would lose confidence in the sanctity of their contractual agreements. They would lend less money and require higher premiums when they do. In short, future mortgage credit would be less available and more expensive in San Bernardino and other areas that take – or even consider -- similar action.
So who really benefits from this proposal? It won’t help homeowners who are delinquent on their payments or in foreclosure. In fact, only homeowners who are in good standing and in a position to continue making their payments, and whose loans have been securitized to private investors, would be eligible. On the other hand it will harm all potential borrowers who want to obtain credit, and those whose savings are invested in MBS. In other words, benefits would be realized by a subset of borrowers (and a private firm), but the costs would be borne by all residents of the San Bernardino area and millions of individual investors from around the country.
This proposed plan runs counter to the widely accepted notion that we must prioritize the return of private capital to mortgage markets; indeed it would be destructive to the revitalization of the broader U.S. mortgage markets. The recovery of the private securitization market is vital to restoring a healthy balance of mortgage funding in this country. Currently, 95% of mortgages are backed by government entities such as Fannie Mae and Freddie Mac. There is nearly universal agreement that this level of government support is not sustainable – we need private investors to come back to the table. Once this precedent is set, why would private investors put their faith (and money) into a contract that could be broken at the whim of a local governments (and private firms looking to profit)? They simply will not, and housing markets will suffer as mortgage credit retreats from this unpredictable risk.
Not only does this use of eminent domain have far-reaching negative implications, it also appears to be illegal. A recent legal memo prepared by the law firm O’Melveny and Meyers for SIFMA concluded that this plan “suffers from multiple legal and procedural defects, including defects arising under the U.S. Constitution and the California Constitution.” Among other issues, the plan is likely an impermissible “Taking” of private property under the U.S. Constitution and California Constitution on at least two grounds: First, the mortgage loans are not being taken for a legitimate “Public Use.” Second, investors will not be receiving “Just Compensation” for the taking of their mortgages.
Regardless of whether or not this use of eminent domain is legal, and we don’t think it is, the bottom line is that it’s just a bad idea. Credit in areas that employ this use of eminent domain would become more expensive and less available. Private investors would be deterred from returning to the U.S. mortgage markets. Teachers, policeman, and other everyday investors would suffer losses. The negative consequences are far- reaching. A rush to implement this plan will fail local residents as bad public policy based on a widely-questioned right to use eminent domain.
T. Timothy Ryan, Jr.
President & CEO