Why the National Problem Is First a Local Problem
It was suggested earlier that state and local governments might be better situated than the federal government to take the lead in pursuing a plan like that sketched in this article—even if federal instrumentalities might play helpful supporting roles. Why is this the case? In what sense do localities face the worst of the mortgage debt overhang problem, and thus have incentive to act first?
The answer is that even though the problem is ultimately national in scope, its worst symptoms are locally concentrated. In some communities, more than 80 percent of PLS loans are underwater. The degree to which the loans are underwater, moreover, can be dramatic: some communities’ underwater PLS loans have average loan-to-value (LTV) ratios greater than 200 percent, and many more have ratios approaching that number. The map above affords a telling, if understated,15 picture of how localized the worst of the nation’s underwater mortgage problems actually are.16
Concerns Raised by the Eminent Domain Plan
While it is not possible here to anticipate and fully address all concerns that the eminent domain plan might invite, one can cover the most obvious ones in broad outline. These fall under two headings—concerns of the sort that debt write-downs seem always to raise, and concerns relating to the reliance on state rather than federal authority to implement the plan.
Debates over the justice and efficiency of debt forgiveness are long-standing. Critics say that contracts are binding commitments that must be upheld, while proponents of debt forgiveness say some debts are “odious.” Again, critics say that write-downs induce moral hazard and reduce credit availability, while proponents observe that you cannot squeeze blood from turnips. We are not going to settle such perennial questions here, any more than the Book of Leviticus or centuries of “law versus equity” have done. But three things bear noting.
First, owing to asset-price bubbles’ status as collective action problems, it is doubtful that many home buyers during the bubble years had much choice when it came to buying overvalued homes. That most homes were overvalued is what rendered the bubble a bubble. It therefore seems mistaken to blame homeowners as a class, or to characterize write-downs as per se unfair or morally hazardous. It is also easy to formulate loan-selection criteria in ways that do not encourage “strategic” defaults going forward—by reference to LTV/default correlations as suggested above (Hockett 2012a, 2013, 2010).
Second, for similar reasons, there seems little need to fear long-term contraction in liquidity or credit. Bubbles inflate only when credit is overabundant. We want, then, some credit-caution in future, just not too much. And we want to get to that middle ground as quickly as possible. The best way to do this is first to clear out the overhang under which 11 million homeowners still struggle, then to ensure that the pooling and servicing agreements for residential mortgage-backed securities going forward look more like the agreements for commercial mortgage-backed securities always have looked—providing in advance for value-salvaging modifications on a scale unanticipated before the most recent crisis, and thereby preempting the future need to resort to such methods as the one proposed here.17 New residential mortgage securitizations suggest that the latter change is already under way. To resolve what earlier securitizations have wrought, however, requires a plan like that outlined above.
Finally, it is important to recall that write-downs are done on non-mortgage debt all the time. We call it bankruptcy, and afford it to firms because it salvages value. The plan proposed here does the same. And as noted above, the value thus saved can be shared among all stakeholder classes.
Turning now to issues linked to the plan’s reliance on state, rather than federal, authority, we find some concerns stemming from possible differential application of the eminent domain plan across states and localities. Florida counties, for example, might construct variants of the plan that differ from those adopted by Louisiana parishes. California or Michigan plans might diverge from both. Would such differences raise fairness concerns?
The question is a complex one. We should certainly welcome some degree of national uniformity (this is one reason the present author [2009] first proposed federal, not state or local, action in 2008). But local conditions do var y from county to county, such that fairness itself dictates some variation. It is also the case that our federal system already involves quite significant state variation with respect to all manner of law—from property, tort, and even commercial law to electoral law. There will be nothing particularly unusual, then, in differing states’ crafting differing variants of the plan here proposed. It might even be welcome—for the usual “laboratories of democracy” reasons given for local experimentation.
All of that said, however, federal agencies could be helpful in confining local variation within reasonable bounds, as well as in promoting efficient and amicable loan workouts nationwide along lines like those here proposed. By bringing municipal or state, homeowner, bondholder, and bank representatives together under one “summit” structure, the Treasury, Federal Housing Finance Agency, Federal Reserve Board or regional banks like the Federal Reserve Bank of New York operating thereunder, the Department of Housing and Urban Development, or some combination thereof could facilitate consensus among all concerned parties on the basic contours that all local variants of the eminent domain plan should take. There is no reason this consensus could not include loan-selection and loan-valuation principles as well as more detailed practical elements.
Conclusion: It Takes a Village—but a Federal Government Helps
The guiding ideal in any such summit as that proposed here should be to convert the eminent domain tool into a mere formality enabling all interested parties to sidestep dysfunctional pooling and servicing agreements consensually and thereby recapture lost value. Getting past these contracts and the collective action problems they underwrite is, after all, precisely and solely what this plan is for. States and their sub-units are best situated at this point to act. But federal agencies could be helpful facilitators for all.
The author thanks Kaushik Basu, Michael Campbell, Thomas Deutsch, Laurie Goodman, Howell Jackson, Darius Kingsley, Christopher Mayer, Brad Miller, Lawrence Rufrano, Robert Shiller, Joseph Tracy, Lauren Willis, and other colleagues at the Federal Reserve Bank of New York, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Federal Home Finance Agency, the International Monetary Fund, the Treasury Department, and the World Bank, as well as in the academy, for helpful comments. The views expressed are nevertheless his own and not attributable to others absent express confirmation. Some of those named here oppose the proposal.
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About the Author
Robert Hockett is a professor of financial law subjects at Cornell Law School, a former visiting scholar at the Federal Reserve Bank of New York, and, while on sabbatical during the 2012-13 academic year, consulting counsel at the International Monetary Fund. He serves frequently as an unpaid consultant on finance-regulatory and mortgage-related matters to consumer and financial reform groups as well as to legislators, regulators, and other officials at all levels of government. In 2012, he received a fee from the firm Mortgage Resolution Partners to provide legal analysis of questions raised by his eminent domain proposal in the state of California. All of his current work on the foreclosure crisis and eminent domain plan, for public and private entities alike, is done gratis.
Current Issues in Economics and Finance is published by the Research and Statistics Group of the Federal Reserve Bank of New York. Linda Goldberg and Thomas Klitgaard are the editors of the series.
The views expressed in this article are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.
Footnotes
1 Data are from CoreLogic, available at http://www.corelogic.com/, and from OCC Mortgage Metrics, available at http://www.occ.treas.gov/publications/publications-by-type/other-publications-reports/ index-mortgage-metrics.html.
2 See Olick 2012, Goodman et al. 2012, Ritholtz 2012, and Goodman 2012, as well as the latest data from CoreLogic and OCC Mortgage Metrics, cited in note 1 above.
3 See, for example, Fannie Mae 2012 Form 10-Q data, p. 111, available at http://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/ 2012/q22012.pdf. See also Olick 2012; Goodman et al. 2012; Ritholtz 2012; Goodman 2012.
4 Of course not all mortgage troubles are attributable to declining home values. Some homeowners face difficulty keeping current on payments for reasons of temporary unemployment in a slack economy. For this class of mortgagor, several colleagues at the Federal Reserve Bank of New York and I have designed a Home Mortgage Bridge Loan Assistance Program, informed by a successful Pennsylvania program developed during the early 1980s steel slump (Orr et al. 2011). A draft bill to institute the program, which two of us coauthored, is under consideration in New York (Campbell and Hockett 2012a, 2012c). But even assuming success here and in other states, the nation’s larger mortgage debt overhang problem will remain unaddressed (Campbell and Hockett 2012a, 2012b).
5 In some cases, for example, pooling and servicing agreements allow no more than 5 percent of the loans in the pool to be modified. This percentage, which shows how little the marketwide crash was expected, has long since been reached in the case of most loan pools.
6 Lee, Mayer, and Tracy (2012) offer a contrary view, finding that by the time a borrower goes delinquent on the first lien, there is little credit available on the home equity line.
7 For more on the 2009 and 2010 efforts to pass mortgage “cramdown” legislation, see Hockett (2012b).
8 See the latest CoreLogic data and OCC Mortgage Metrics, cited in note 1.
9 See Fannie Mae’s second-quarter 2012 Form 10-Q, p. 111, available at http://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2012/ q22012.pdf, and its 2011 Form 10-K data, available at http://www.fanniemae.com/ resources/file/ir/pdf/quarterly-annual-results/2011/10k_2011.pdf.
10 Note, however, that Fannie Mae and Freddie Mac themselves hold significant numbers of underwater loans in their portfolios.
11 Freeing the loans from their PLS trusts, it bears noting, renders them amenable to the Federal Housing Administration Short Refinance, Hardest Hit Funds, and HAMP Principal Reduction Alternative programs.
12 Phillips v. Washington Legal Foundation, 524 U.S. 156 (1998) (accrued interest on account funds); Armstrong v. United States, 364 U.S. 40 (1960) (materialman’s lien); and the iconic Legal Tender Cases, 79 U.S. (12 Wall) 457 (1870). See, generally, Hockett (2012a).
13 Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 602; W. Fertilizer & Cordage Co. v. City of Alliance, 504 N.W.2d 808, 816 (Neb. 1993). Again, see Hockett (2012a).
14 Kelo v. City of New London, 545 U.S. 469 (2005).
15 The chart covers all underwater loans, and does not distinguish high-LTV loans from lower-LTV loans.
16 CoreLogic Negative Equity Report, Fourth-Quarter 2012, available at http://www.corelogic.com/. Source: CoreLogic Negative Equity Report.
17 For more on the differences between RMBS and CMBS pooling and servicing agreements, see Hockett (2012b).