From an Unlikely Source, a Serious Challenge to Wall Street
Something very interesting is happening.
There’s been so much corruption on Wall Street in recent years, and the federal government has appeared to be so deeply complicit in many of the problems, that many people have experienced something very like despair over the question of what to do about it all.
But there’s something brewing that looks like it might eventually turn into a blueprint to take on the financial services industry: a plan to allow local governments to take on the problem of neighborhoods blighted by toxic home loans and foreclosures through the use of eminent domain. I can't speak for how well this program will work, but it's certaily been effective in scaring the hell out of Wall Street.
Under the proposal, towns would essentially be seizing and condemning the man-made mess resulting from the housing bubble. Cooked up by a small group of businessmen and ex-venture capitalists, the audacious idea falls under the category of "That’s so crazy, it just might work!" One of the plan’s originators described it to me as a "four-bank pool shot."
Here’s how the New York Times described it in an article from earlier this week entitled, "California County Weighs Drastic Plan to Aid Homeowners":
Desperate for a way out of a housing collapse that has crippled the region, officials in San Bernardino County … are exploring a drastic option — using eminent domain to buy up mortgages for homes that are underwater.
Then, the idea goes, the county could cut the mortgages to the current value of the homes and resell the mortgages to a private investment firm, which would allow homeowners to lower their monthly payments and hang onto their property.
I’ve been following this story for months now – I was tipped off that this was coming earlier this past spring – and in the time since I’ve become more convinced the idea might actually work, thanks mainly to the lucky accident that the plan doesn’t require the permission of anyone up in the political Olympus.
Cities and towns won’t need to ask for an act of a bank-subsidized congress to do this, and they won’t need a federal judge to sign off on any settlement. They can just do it. In the Death Star of America’s financial oligarchy, the ability of local governments to use eminent domain to seize toxic debt might be the one structural flaw big enough for the rebel alliance to exploit.
The plan only makes sense in the context of America’s overall economic paralysis. Right now the economy is stuck in a standstill, largely because of the housing bubble. Five or six or ten years ago, when Wall Street was cranking out trillions of dollars of cheap home loans so that they could later be chopped up, pooled, and sold to unsuspecting investors in the form of high-grade securitized bonds, millions of ordinary people jumped on the housing comet, buying big houses for big money.
The problem is, if you bought a house for $300,000 then, it might be worth $200,000 now. When you’re $100,000 in debt, you’re not rushing out to buy washing machines, new cars, new DVD players. As Paul Krugman put it in his column today:
There’s no mystery about the reasons the economic recovery has been so weak. Housing is still depressed in the aftermath of a huge bubble, and consumer demand is being held back by the high levels of household debt that are the legacy of that bubble.
Then there’s the other problem. Even if you manage to keep making your payments on your house, your neighbor might not. Whoever used to live next door has left after a foreclosure: there are squatters building a meth lab in the basement now. Two more houses are being boarded up down the street. So now the value of your house is getting lower and lower every day. No matter how fast you make your payments, your debt situation is still going to be moving in the wrong direction.
Instead of letting everyone be slowly ground into dust under the weight of all of that debt, the idea behind the use of eminent domain is to pull the Band-Aid off all at once.
The plan is being put forward by a company called Mortgage Resolution Partners, run by a venture capitalist named Steven Gluckstern. MRP absolutely has a profit motive in the plan, and much is likely to be made of that in the press as this story develops. I've heard many arguments on both sides about this particular approach to the eminent domain concept. But either way, I doubt this ends up being entirely about money.
“What happened is, a bunch of us got together and asked ourselves what a fix of the housing/foreclosure problem would look like,” Gluckstern. “Then we asked, is there a way to fix it and make money, too. I mean, we're businessmen. Obviously, if there wasn’t a financial motive for anybody, it wouldn’t happen.”
Here’s how it works: MRP helps raise the capital a town or a county would need to essentially “buy” seized home loans from the banks and the bondholders (remember, to use eminent domain to seize property, governments must give the owners “reasonable compensation,” often interpreted as fair current market value).
Once the town or county seizes the loan, it would then be owned by a legal entity set up by the local government – San Bernardino, for instance, has set up a JPA, or Joint Powers Authority, to manage the loans.
At that point, the JPA is simply the new owner of the loan. It would then approach the homeowner with a choice. If, for some crazy reason, the homeowner likes the current situation, he can simply keep making his same inflated payments to the JPA. Not that this is likely, but the idea here is that nobody would force homeowners to do anything.
On the other hand, the town can also offer to help the homeowner find new financing. In conjunction with companies like MRP (or the copycat firms like it that would inevitably spring up), the counties and towns would arrange for private lenders to enter the picture, and help homeowners essentially buy back his own house, only at a current market price. Just like that, the homeowner is no longer underwater and threatened with foreclosure.
In order to make MRP work, Gluckstern and his partners needed to find local officials with enough stones to try the plan. With so many regions in such desperate straits thanks to the housing mess, that turned out to be not as hard as perhaps might have been expected.
First in line was San Bernardino County in California, not coincidentally located at ground zero of a subprime bubble blown to gigantic proportions by Southern Californian mortgage giants like Countrywide and Long Beach. San Bernardino is more or less a poster child for the mortgage crisis; more than half of its homeowners are underwater on their homes, unemployment is past 12%, and the city of San Bernardino recently had to file for bankruptcy.
It’s not surprising, then, that local officials like Acquanetta Warren, mayor of the city of Fontana, were receptive to the eminent-domain plan.
“Sooner or later,” Warren told the New York Times, “all these people who are upside down on their homes are just going to leave the keys out on the door and say forget it. This was supposed to be the promised land, and now we have people waiting in some kind of hellish purgatory.”
San Bernardino County officials, along with two of its bigger cities (Fontana and Ontario), have set up the legal mechanisms needed to condemn and seize home loans, but the details of the plan haven’t been completely worked out yet. Still, officials say about 20,000 homeowners in San Bernardino would be eligible for the program; how many will get to use it is unknown.
In the meantime, other counties in other parts of the country are considering the plan. MRP has been courting local officials in Nevada, Florida, and in parts of the Northeast. In New York, officials in Suffolk County on Long Island, where 10% of homes are underwater, are seriously considering the plan.
The role of MRP and the presence of businessmen like Gluckstern in this whole gambit is going to tempt some reporters to pitch this story as a purely financial story, and certainly it does have interest as a business headline.
But MRP’s role aside, this is also a compelling political story with potentially revolutionary consequences. If this gambit actually goes forward, it will inevitably force a powerful response both from Wall Street and from its allies in federal government, setting up a cage-match showdown between lower Manhattan and, well, everywhere else in America. In fact, the first salvoes in that battle have already been fired.
For instance, the Wall Street trade association, SIFMA, this past week issued a denunciation of the eminent domain plan that includes a promise of a legal challenge. “We believe the MRP proposal is unlikely to survive a judicial challenge,” one of SIFMA’s lawyers wrote. Other trade groups are lining up to describe the tactic as illegal or "unconstitutional."
More insidiously, however, SIFMA pledged that its members will not allow future home loans originated in counties that use the eminent domain tactic to participate in something called the To-Be-Announced (TBA) markets for mortgage-backed securities. Explaining this would require a sharp detour into a muck of inside-baseball mortgage terminology, but the long and the short of it is that SIFMA is promising to make it difficult for any community that tries this tactic to obtain private mortgage financing in the future.
Essentially, SIFMA is promising a kind of collusive financial lockout of uncooperative communities. The threat would appear to be a high-handed form of redlining that raises serious antitrust questions, but in a way, that kind of response is to be expected.
Ultimately, the MRP tactic will be a fascinating test case to see exactly how much local self-determination will be allowed by the centralized financial oligarchy and its allies in the federal government.
If through boycotts, collusion, federal pressure and other forms of encirclement, local governments can be stripped of their right to condemn blighted property, we’ll know that the guts have been cut out of the very idea of regional self-rule. It will be fascinating to watch. At the very least, this story has the potential to be the first true open, pitched battle between Wall Street and the homeowners and communities who have been the primary victims of financial corruption.
Tune in for more on this front soon.
Editor's note: Readers interested in learning more about this would do well to read North Carolina congressman Brad Miller's piece on this in American Banker. Miller is not necessarily a proponent of the exact mechanism proposed by MRP, but he is intrigued by the general idea of using eminent domain to address the blighted-loan problem, and seems particularly interested in the strategic possibilities of addressing the problem at the local level. He writes:
The biggest banks have used their political power in Washington to defeat any effort that would effectively reduce foreclosures, such as allowing judicial modification of mortgages in bankruptcy, allowing a federal agency to use eminent domain to buy mortgages, or providing teeth for the chronically ineffective Home Affordable Modification Program, because those efforts would also require the immediate recognition of losses on mortgages.
But Wall Street's power in Washington may be as useless in defeating a proposal in San Bernardino County as strategic nuclear weapons are in fighting an insurgency. No wonder Wall Street is panicked.
Also, here's a piece Miller wrote a couple of years ago in The New Republic suggesting the use of eminent domain through the use of a public vehicle similar to FDR's Home Owners' Loan Corporation, or HOLC.
Editors' Note II: There've been some readers who are concerned with the question of MRP's profit margin, and who will end up having to pay for it. I've heard these complaints from different voices, including some belonging to government officials who support the eminent domain idea generally, but would prefer to see it done by a government-run program a la FDR's HOLC.
In an ideal world, I'd probably like to see this done via something like HOLC, but the problem is that our president is not FDR but Barack Obama, who hasn't shown a willingness to go very far to fix this problem. The advantage to the MRP model, as I see it, is that it has a chance of happening. The important question is the more general issue of whether or not communities will be permitted to use eminent domain to condemn blighted home loans. The details of how exactly it will be executed to me are negotiable. But more than anything, I'm interested to see if it can happen.
Here's how rep. Miller put it: "A program by a government agency not motivated by the pursuit of profit would be greatly preferable, but this proposal by the for-profit mortgage company obviously serves a public purpose."
It's important for people to remember that the bondholders are not, necessarily, the bad guys in this story. The lenders like Countrywide who created the loans, the big banks who securitized and repackaged them, and (in some cases) the trustees of the loan pools who failed to properly maintain and service the loans, they all have culpability, but in many cases, they are not the ones who are going to take the loss. The loss will be taken by anyone who holds mortgage-backed securities, and in addition to the big banks that could also include unions, pension funds, hedge funds, and so on. So it's important that this be done as equitably as possible, if it's going to be done.
So if this ends up happening, I trust that a way will be found for people on all sides to find the right price. As it stands, the condemnation process will allow both sides an opportunity to make an argument about loan value before a judge. Remember also that it would cost bondholders money to foreclose upon any properties headed in that direction.
So there has to be a sweet spot somewhere in terms of loan value that all sides would accept. If the MRP model doesn't get us there, we'll find that out, but I haven't seen anything yet that tells me it absolutely can't work under any circumstances.
Again, these are all details and all negotiable. What matters to me here are the broad strokes. This money, it's already lost. What is paralyzing the country is our failure to recognize that loss. This is an idea that allows us to dynamite those losses at the bottom of a mine, and start over.
The use of eminent domain is obviously an extreme reaction. But the moral argument for its use is clear here. Virtually every community in America was the victim of a broad fraud scheme perpetrated by banks, lenders, ratings agencies (and, yes, even the GSEs like Fannie and Freddie) to artificially inflate the real estate market. The people who bought houses at the peak of the market and are now underwater, they are victims of a crime, the crime being a conspiracy by banks, lenders and ratings agencies to misrepresent the value of home loans (particularly subprime loans) to the bondholders who bought them. The damage from that criminal scheme is not just ruining and bankrupting the homeowners who bought these artificially-inflated properties, it's also destroying neighborhoods and paralyzing the whole economy.
So it's absolutely appropriate for local governments to use the powers available to them to try to undo the damage, aid the victims, and help restore neighborhoods. How exactly they get there is negotiable, but it's definitely intriguing to see them trying.
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