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Fed Report Proposes Use of Eminent Domain for Underwater Mortgages

There's a mortgage debt ""overhang"" that threatens the health of the national economy, and one possible solution to the problem comes in the form of eminent domain, according to a ""Federal Reserve Bank of New York"":http://www.newyorkfed.org/research/current_issues/ci19-5.html report authored by ""Robert Hockett"":http://www.lawschool.cornell.edu/faculty/bio_robert_hockett.cfm.


Of the roughly 11 million underwater mortgages, about 3 or 4 million are in default, foreclosure, or foreclosed on and awaiting liquidation, the report, ""_Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt_"":http://www.newyorkfed.org/research/current_issues/ci19-5.pdf, found.

These past due mortgages put the economy at risk due to their impact on net worth and spending. As spending lowers, so does employment growth, leading to more foreclosures, the report explained.

So what should be done to address these problem loans?

""The most effective means of averting mortgage delinquency, default, and foreclosure-and the associated economic costs-is principal reduction,"" Hockett wrote.

However, while write-downs held in bank portfolios ""occur at significant and still growing rates,"" securitized mortgage loans are more of a problem due to certain contract provisions, the report explained.


For example, many of the pooling and servicing agreements governing such loans require the large majority of security holders to vote before a loan can be modified.

""[T]hese bondholders, geographically dispersed and unknown to one another, cannot collectively bargain with borrowers or buyers on workouts or prices,"" the report stated.

Thus, this collective action problem requires a collective agent in the form of state and municipal governments who can use their power of eminent domain to purchase and restructure underwater mortgages.

Hockett further explained ""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.""

To finance the purchases, Hockett suggested using monies lent by federal agencies and/or from private investors.

""Mortgage Resolution Partners"":http://mortgageresolutionpartners.com (MRP) is one firm that has been actively approaching local governments, proposing the controversial use of eminent domain to purchase underwater mortgages, which would then be refinanced. As part of MRP's proposal, the firm would provide funding for the purchases.

The _Las Vegas Sun_ ""reported"":http://www.lasvegassun.com/news/2013/jun/11/nlv-council-weigh-controversial-mortgage-assistanc/ the city council in North Las Vegas is scheduled to meet Tuesday to discuss whether or not to partner with MRP. According to the article, if the proposal is approved, North Las Vegas would become the sixth and largest city to partner with MRP.

San Bernardino County and two of its cities, along with other areas, have ""rejected"":http://dsnews.comarticles/san-bernardino-county-rejects-eminent-domain-proposal-2013-01-28 the idea due to a lack of support.

About Author: Esther Cho


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