The New Proposal in a Fed Report That Involves Eminent Domain and the Government Seizing Mortgages

A scholar at the New York Federal Reserve in a recent report proposed the idea of using eminent domain to seize mortgages of underwater homeowners as a means of “easing” their debt.

Eminent domain, as some of you may know, is when the federal or state and state governments seize on some vacant property or other land for public use. The thinking behind Cornell University’s Robert Hockett’s June 9 New York Fed report is that eminent domain can reduce the number of foreclosures by "helping" homeowners who owe more than their property is worth.

Banks attempting to writedown privately securitized mortgages “are almost impossible to carry out, since loan modifications on the scale necessitated by the housing market crash would require collective action by a multitude of geographically dispersed security holders,” Hockett states in his paper, titled “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt.”

Hockett has been championing this idea since at least 2008.

NY Fed.

Although the idea was pretty much abandoned in 2012, Jaret Seiberg, an analyst at Guggenheim Securities LLC., tells Bloomberg the Fed paper may revive the debate.

“Housing industry efforts to date have kept the eminent domain advocates in check,” Seiberg said in a statement. “Our worry is that the latest paper from the Federal Reserve Bank of New York will change that equation even though the paper only reflects the views of the author and not of the New York Fed.”

The idea of using eminent domain to confiscate mortgages and “save” underwater homeowners was first proposed in California and has since been given a serious look in both Chicago and New York.

NY Fed.

“It’s been opposed by Pacific Investment Management Co., AllianceBernstein LP and the Securities Industry and Financial Markets Association, who have argued it would make lending more costly in hard-hit areas by raising the risks of investor losses,” the Bloomberg adds.

Here are some key passages from the New York Fed press release [emphases added]:

With more than 11 million homes still “underwater,” the mortgage debt overhang caused by the housing bubble remains an impediment to economic growth and a burden on communities across the country.  One possible solution to this problem is for state and municipal governments to use their eminent domain authority to purchase and restructure underwater mortgages.  This novel solution is proposed in a new report from the Federal Reserve Bank of New York.

Many analysts agree that principal reductions are the best way to assist underwater homeowners—those who owe more on their mortgages than their houses are worth.

[...]

By utilizing their eminent domain authority, state and municipal governments could bypass the coordination problems posed by the pooling and servicing agreements.  They could then reduce the principal on underwater loans, lowering the amount owed by borrowers and thereby reducing the risk of default.

And here’s a copy of Hockett’s report:

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(H/T: ZH). Featured image AP photos.