Thursday, July 19, 2012

This Will Fail Horribly

In the foreclosure-battered inland stretches of California, local government officials desperate for change are weighing a controversial but inventive way to fix troubled mortgages: Condemn them.

Officials from San Bernardino County and two of its cities have formed a local agency to consider the plan. The securities industry has been quick to register its displeasure and say it will only make loans harder to get.

Discussion of the idea is taking place in one of the epicenters of the housing crisis, a working-class region east of Los Angeles where housing prices have plummeted. Last week brought another sharp reminder of the crisis when the 210,000-strong city of San Bernardino, struggling after shrunken home prices walloped local tax revenues, announced it would seek bankruptcy protection.

Now — and amid skepticism on many fronts — officials from the surrounding county of San Bernardino and cities of Fontana and Ontario have created a joint powers authority to consider what role local governments could take to stem the crisis. The goal is to keep homeowners saddled by large mortgage payments from losing their homes — which are now valued at a fraction of what they were once worth.
Hmmm. How will that work?

Typically, eminent domain has been used to clear property for infrastructure projects like highways, schools and sewage plants. In this case, supporters say, the public purpose is served because communities battered by foreclosures have seen tax rolls decimated and services gutted and have suffered economic blight.

The plan targets homeowners who are current on their mortgage payments but "under water," meaning they owe more on the mortgage than the home is worth. Here's how it would work for a hypothetical city:

— The city goes to court and argues that the public purpose is served by having the county own, and ultimately refinance, the mortgage.

— The city pays fair market value to the owner of the mortgage. That is usually a securitization trust, an otherwise passive financial entity used to bundle mortgages and sell pieces to investors that became a bigger part of the mortgage market during the 2000s housing boom.

— The city, the new owner of the mortgage, encourages and helps the homeowner to find refinancing. Now the principal is lower, and interest rates are at historic lows, so the homeowner winds up with easier monthly payments.

— Mortgage Resolution Partners collects a flat fee, $4,500 per loan, for helping the city find homeowners who can be helped and for handling the other mechanics of the process.

The company says everyone should wind up happy: The homeowners get lower payments, cities help clean up the mortgage crisis and shore up their tax base, and the mortgage-owning trusts unload a risky asset.
In other words, falling home prices have adversely affected tax revenues (never mind that the homes were grossly overpriced in the first place). So, a local government seizes the mortgage, as it were, paying "fair market value," which, if the courts go along with this, will be the current market value less the principal already paid--meaning the mortgage companies take a huge loss. (Since my 401k, and yours too, probably invests in some of these companies, it isn't just a situation of some fat cat somewhere getting his just deserts). Now, this is where things get really tricky. Some company that is cozy with the local government now gets paid a big fat commission for helping the city find out who to target. But don't worry, as the story notes, it is not about the money.

Just a few problems here. First, what happens to the credit rating of the person whose mortgage is seized? The story doesn't say, but I'm not so sure that it might not just show up as a default.

Second, at what price will the homes be refinanced at? Story doesn't say. It could be the current fair market value, or something higher. For instance, say the city finds a person with a home with an $800,000 mortgage (probably not uncommon), but only a current value of $200,000. The city gets the mortgage for $200,000. But the mortgage itself still has a face value of $800,000. However, in order to flip the mortgage (i.e., get someone to agree to refinance the house), they are going to have to find someone willing to extend the credit. That bank or mortgage company isn't going to pay more than the current value of the home. In fact, because they might be the next in line for some "eminent domain" action, they will probably discount the amount they are willing to pay for mortgage, charge a really high interest rate (to reflect the risk), or both. 

Third, how is the city or individual going to afford this? As the story notes, the "finder" gets a fat commission. Normally, fees like those get tacked onto a mortgage. But we also have the possibility of the city having to sell the mortgage at a discount. So who pays the discount and/or the fee? Who knows.

Finally, there is a more basic issue here, which is the government extending eminent domain to the seizure of intangible property (a note). Dangerous precedent.


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