Using Eminent Domain for Underwater Mortgages

The New York Fed has an interesting white paper out by Robert Hockett, in which the author proposes the use of eminent domain to purchase large numbers of underwater mortgages — as in, the actual financial instruments. The idea targets mortgages whose debt holders are the holders of mortgage-backed securities– so called privately securitized mortgages. The strategy is based on the fact that PSM shareholders are such large and geographically dispersed classes that it is not reasonable to expect them to write-down the values of their claims in the same way that — say — a large bank could do. And, since there’s no cram-down power regarding home mortgages in bankruptcy court, the same write-downs couldn’t even be imposed through equity in cases where distressed homeowners wind up in bankruptcy. I thought the details of the proposal were fairly interesting to read through.

One aspect of the paper that’s really shocking is the following map, showing how many outstanding mortgages remain underwater, by county:

Underwater Mortgages as a Share of All Mortgages, by County, 4Q 2012. Source: CoreLogic Negative Equity Report, via Federal Reserve Bank of New York.

Underwater Mortgages as a Share of All Mortgages, by County, 4Q 2012. Source: CoreLogic Negative Equity Report, via Federal Reserve Bank of New York.

At the end of 2012, blue counties had the lowest rates of underwater mortgages, with increasing rates of negative equity correlating with increasing greenness, yellowness, and then redness. Note that (with the tiny geographic exceptions around wealthy New York City and San Francisco), the places with lowest levels of underwater mortgages are almost all rural areas that didn’t experience much of a run-up in residential property values in the decade before 2008. That’s a lot of pain.

It certainly makes theoretical sense that eminent domain can be used to take personal property — such as contract rights — and not just real estate. But it’s not something that you run across all that often. I liked this paragraph, summarizing the phenomenon:

Forms of intangible property that have been purchased in eminent domain include bond tax exemption covenants, insurance policies, corporate equities, other contract rights, businesses as going concerns, and even sports franchises (Hockett 2012a). Because the law draws no distinctions between kinds of property that can be purchased in eminent domain, it is unsurprising that loans and liens in particular, as one form of contractual obligation among many, are themselves regularly purchased. Among these are mortgage loans and liens, as the Supreme Court and state courts have long recognized.