The one glimmer of hope in a otherwise disappointing recovery is the recent bottoming out of the housing market. While no one expects home prices to start skyrocketing again anytime soon, it appears that the steady descent they saw over the past six years has finally ended.
But that doesn’t change the fact that because of the housing bubble bust, nearly one quarter of all U.S. homes are underwater. And even if home prices have ceased falling, it will take a very long time for owners of these homes to rebuild equity. And this epidemic of negative equity remains a drag on the economy. That is why there has been widespread calls for the federal government –in its role of conservator of Fannie Mae and Freddie Mac — and other holders of underwater mortgages to forgive principal owed. The thinking is that such a measure would keep borrowers in their homes and current on their mortgages, while stimulating the economy by stabilizing the most distressed areas of the housing market.
Unfortunately for proponents of principal reduction, efforts to get this policy implemented on a large scale have failed. This has led to increasing support in the media and among academics and public officials for a proposal first originated by Mortgage Resolution Partners for municipalities to use the age-old power of eminent domain to purchase mortgages at market value and to offer homeowners new mortgages that reflect the actual market value of the property.
As Yale Econmics Professor Robert Shiller argues, the fact that the private sector isn’t already doing this is an example of a “collective action problem.” Shiller says that principal write-downs are in everyone’s interest, that coming to an honest assessment of what a mortgage is worth would obviously help homeowners, but also mortgage lenders who would benefit from fewer homeowners defaulting on their loans. Writes Shiller:
“In a nutshell, mortgage lenders need to write down the amounts owed by individual homeowners . . . but the different stakeholders have been unable to reach an agreement, even if it is in their common interest.”
This plan has also been recently endorsed by New York Times columnist Joe Nocera and Cornell University Law School Professor Robert C. Hockett, who has served as an advisor for Mortgage Resolution Partners. And yesterday, in an editorial in American Banker, U.S. Representative Brad Miller came out in favor of the plan.
Of course, there was a lot of pushback from investor and other Wall Street trade groups. In a letter to municipal officials in San Bernardino County — one of the municipalities purported to be considering this plan — 18 trade groups from the mortgage, securitization and investing community protested the plan, arguing that it was unconstitutional and would limit future access to credit. According to the letter, “the impact would be borne by the very homeowners and communities that the proponents of the plan claim they are trying to help.”
As Felix Salmon at Reuters points out, the argument that implementing this plan will curtail future financing of mortgages is flimsy, because there is very little private financing of mortgages going on now anyway. Salmon writes:
“But really the point of the letter isn’t to make an argument: it’s to make a point . . . there’s the word “unconstitutional”, which appears very high up. That’s code for “we’re going to appeal this thing all the way to the Supreme Court, so you’d better be willing and able to spend an enormous amount on legal fees.”
It would be pointless to implement a plan that the industry would fight tooth an nail. If each individual seizure were fought bitterly by investors, then the process would proceed too slowly and expensively to be prudent.
But there is another, more troubling, aspect to this story: the possibility that Mortgage Resolution Partners is using this crisis, and many people’s firm belief in principal write-down, to gain popularity for a program that would enrich the firm but do little to solve the housing mess while putting municipal governments at risk.
Yves Smith, proprietor of the blog Naked Capitalism, goes furthest in alleging less-than-noble motives, writing, “Beware of financiers bearing gifts.” She makes several points against the Mortgage Resolution Partners plan including:
- The firm will charge unnecessarily high fees to bear no risk and act as a middle man.
- The plan only calls for the seizing of performing mortgages. And while the homes underlying the mortgages are worth much less than than the mortgage, the lien itself is very valuable because the homeowner is still making payments on an overvalued home. Smith writes, “This premise is fundamental to the entire scheme working; it’s how the municipalities can afford to pay the considerable operational costs as well as MRP’s fees. And it amounts to theft.”
- There doesn’t seem to be any sufficiently transparent competition process for other firms besides Mortgage Resolution Partners to bid for the role of middleman. Writes Smith, “This program looks to have been awarded to MRP without sufficient competition . . . the process smacks of special dealing.”
It is still unclear whether San Bernardino County or any other municipalities are seriously considering this initiative. If one does go forward and attempts to implement this plan as it has so far been outlined, it is not likely to get very far. Without the cooperation of mortgage investors, the probability that this gets tied up in time-consuming and costly legal battles is too great. But even if you are a proponent of widespread writing down of mortgages, it appears that there are better ways to go about it than this.