Underwater Mortgage Loans and Eminent Domain—Odd Bedfellows But a Coupling Whose Time Perhaps Has Come

Leave it to the venture capitalists to create a way to make money and solve a real societal need.

This is an idea that from this perspective even staunch GOP capitalists can support—said with tongue firmly planted in cheek:

Use the power of eminent domain

1. To seize overvalued (that is, underwater) real estate backed loans
2. To pay the current owners (investors) of these loans the fair market value of the loans as is constitutionally required by the law of eminent domain,
3. Then the new owners of the loans write down the principal of the loans to a reasonable value that approximates what was just paid to the original owners of the loans, and
4. Presto the homeowners stay in their homes and their homes have some minimal positive equity—motivating them not to default and avoid foreclosure, and possibly even to spend, all to the good of the economic recovery.

Who pays the price of this process?

The current owners of the loans are compelled to “recognize” the loss in value of their investments in these loans.

One harsh example:  The owner of a second loan on a property where the first loan is underwater would be paid close to $0.00 for that second loan as economically the value of that loan is next to $0.00.

The owners of these loans, to the extent the owners are identifiable and even capable of action such as writing down the principal of their loans, are presumably reluctant to “take the loss”.  Just like most investors whose investment has declined in value.

See:  “Eminent domain for underwater mortgages could have biggest impact on banks”, by Matthew Goldstein, June 19, 2012

Is it legal to force these owners to recognize these losses?

At least one academic who apparently is representing one set of venture capitalists says it most certainly is constitutional.

See: “A solution for underwater mortgages: Eminent domain”, By Robert Hockett, June 19, 2012

Professor Hockett’s article is well worth reading—here are the sound bites that

appealed to this writer:

“To solve a collective action problem, we need a collective agent. That’s what governments are. But which government?”

“How redemptive it would be … to see cities employing the eminent domain authority to keep residents in their homes this time around – and maximizing the values of more realistically valued loans in so doing.”

See:  Robert J. Shiller’s Op-Ed in the June 23, 2012 New York Times, “Reviving Real Estate Requires Collective Action.

More to come.

The Frog Knows, aka Chuck Farrar