Although the rate of underwater mortgages has decreased significantly in the past year due to rising property values, politicians, research analysts, investment professionals and others are nonetheless still looking at ways to solve the negative equity problem. Among them is the controversial idea of using eminent domain on the local level to bail out underwater homeowners. Several communities, including Richmond, Calif., and Newark, N.J., are currently considering the idea – which involves buying the underwater mortgage, refinancing it, using taxpayer money to offset the difference and then reselling it to investors in an effort to prevent the homeowner from going into default. Still, others, including North Las Vegas, Nev., have rejected the idea after much consternation.
According to the Zillow Negative Equity Report, the national negative equity rate fell at its fastest pace ever in the third quarter of this year, dropping to 21% of all homeowners with a mortgage. In the second quarter, the negative equity, or underwater, rate was 23.8%. Zillow noted that although roughly 10.8 million American homeowners remain underwater, owing more on their home than it is worth, the rate is down more than 4.9 million from the peak in the first quarter of 2012.
Officials in Richmond announced earlier this year that they were working with San Francisco-based firm Mortgage Resolution Partners on a plan in which the city would contact holders of more than 620 underwater mortgages, offer to buy them at a discount and repackage them with a lower principal. While borrowers might welcome the opportunity to lower their monthly payments, servicers would likely not want to sell their mortgages, so the city said if banks decline, it would take these mortgages through eminent domain.
There has been backlash – and the plan has not yet been implemented. Banks filed lawsuits in August, but a federal judge dismissed the suits, saying it was too early to evaluate the legal merits of the plan.
Also in August, the Federal Housing Finance Agency (FHFA) issued a statement noting that a year after it had filed a notice in the Federal Register in August 2012, it had concluded its review of the use of eminent domain to restructure performing loans. The agency ‘determined such use presents a clear threat to the safe and sound operations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks’ and added that the FHFA may initiate legal challenges.
In response, in December, the American Civil Liberties Union (ACLU) and the Centers for Popular Democracy filed a lawsuit under the Freedom of Information Act, seeking information about the FHFA's relationship with financial institutions and why the agency would prevent municipalities from implementing a program to address the foreclosure crisis. The suit was filed in the U.S. District Court for the District of Northern California.
In its complaint, the ACLU noted that there has been widespread interest in the continued foreclosure crisis and debate over principal reduction. In fact, the agency said, ‘Principal reduction was a central topic of the recent Senate Banking Committee hearing considering the nomination of Congressman Melvin Watt to lead the FHFA.’ Watt, D-N.C., reportedly will likely reverse FHFA acting director Edward J. DeMarco's prohibition against principal reduction.
Other entities have weighed in on the eminent domain issue on their websites. The Credit Union National Association says it ‘supports a broad range of programs to assist struggling homeowners and their communities’ but believes that using eminent domain would harm housing markets and communities. The Center for American Progress says ‘the FHFA should adopt a well-designed principal-reduction program to prevent foreclosures’ and notes that principal forgiveness rather than forbearance can save homes and save money for government-sponsored enterprises Fannie Mae and Freddie Mac.
The Urban Institute, in its research paper, ‘Eminent Domain, The Debate Distracts from Pressing Problems,’ notes that it is unclear whether seizing mortgages could prevent foreclosures. The October 2012 paper examined several municipalities that have announced plans to try eminent domain, including El Monte, Fontana, Ontario, Pomona, Salinas, San Bernardino County and Stockton, Calif.; North Las Vegas, Nev.; Chicago; Wayne County, Mich.; Brockton, Mass.; Suffolk County, N.Y.; and Irvington and Newark, N.J. Author Pamela Lee notes that housing prices have not recovered in these markets as much as in the U.S. overall.
‘The cities and counties that have considered eminent domain are, in essence, pockets of distress left behind as the tide of the recession gradually pulls back,’ Lee wrote. Also, existing efforts, such as the Home Affordable Modification Program, have fallen short of goals.
Four U.S. senators reiterated that last point in a November letter to Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development (HUD), and Jacob Lew, secretary of the U.S. Department of the Treasury. In the two-page letter, the senators said they are concerned that the illegitimate use of eminent domain to buy underwater mortgages at a discount would, among other actions, ‘scare off private capital.’ The letter also indicated that the ‘wait and see’ approach is flawed and asked HUD to prohibit the Federal Housing Administration from insuring mortgages on any affected properties.
The four senators are Pat Toomey, R-Pa.; John Boozman, R-Ark.; Mark Begich, D-Alaska; and Heidi Heitkamp, D-N.D. ‘We're drawing attention to the issue because eminent domain, in the context of seizing mortgages, has national consequences,’ Sen. Boozman said later by email. ‘We believe that HUD's existing authority can help provide certainty to the housing market and protect taxpayers against the threat of eminent domain mortgage seizures.’
Much of the attention has been on how eminent domain would affect taxpayers, but investors are speaking out, too. Private capital is an important part of the discussion because eminent domain would take the mortgages out of securitized pools, according to the Securities Industry and Financial Markets Association (SIFMA).
‘The issue is not whether they're taking from banks,’ says Tim Cameron, managing director and head of SIFMA's asset management group. ‘The reality is the scheme looks to take money from private investors, which provide substantial capital to our markets. Private capital is essentially the gasoline that allows the engine of the economy to run effectively.’
He also notes that none of the communities have moved forward with their announced plans to use eminent domain to seize underwater mortgages. ‘The question is, 'Are you helping individuals in that jurisdiction?'’ Cameron says. ‘We would put forward the answer is 'no.' If you take money from private investors, that capital retreats from that marketplace.’
One plan that is supposed to help homeowners is underwater mortgage protection, a new product from AmTrust Insurance Co. of Kansas Inc., a subsidiary of AmTrust Financial Inc. Underwater protection is for homeowners who worry they might someday owe more on their mortgage than their home is worth. The insurance is available to homeowners in Georgia, North Carolina and Oklahoma who currently have positive equity in their homes.
Nora Caley is a Denver-based freelance writer.