Fed Suggests Use of Eminent Domain Regarding Underwater Mortgages

08 Jul Fed Suggests Use of Eminent Domain Regarding Underwater Mortgages

Because of the mortgage debt overhang that is still overshadowing the real estate recovery, the Fed has suggested the use of eminent domain as a way to tackle underwater mortgages that remain. This is according to a new report titled “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt”  by the Federal Reserve Bank of New York that was penned by Robert Hockett.

The report shows that of the approximately 11 million mortgages in the U.S. that are currently underwater, about 3-4 million of those are in default, foreclosure, or have been foreclosed on and are awaiting liquidation. The report asserts that these past due mortgages are putting the U.S. economy at risk because they are impacting net worth, spending and employment growth, which is in turn, leading to more foreclosures.

In the report, Hockett said, “The most effective means of averting mortgage delinquency, default, and foreclosure-and the associated economic costs-is principal reduction.” The rate of write-downs held in bank portfolios continues to rise, it’s the securitized mortgage loans that are the real problem because of certain contract provisions.

Hockett says that these include the pooling and servicing agreements that make it impossible to modify a loan before the large majority of security holders can vote. He went on to say, “[T]hese bondholders, geographically dispersed and unknown to one another, cannot collectively bargain with borrowers or buyers on workouts or prices.”

And this is why the Fed has stepped forward with a potential solution–putting power into the hands of state and municipal governments who can use eminent domain to purchase and restructure underwater mortgages. Hockett went on to say, “These governments can step in to purchase underwater loans at fair value, deal directly with the trustees of the private-label securitization trusts, and sidestep the rigidities of the pooling and servicing agreements. They can then reduce the principal on these loans, lowering the ‘water’ and thereby reducing the risk of default.”