CA Cities Intend to Steal Debt Instruments

CA Cities Intend to Steal Debt Instruments

A group of West coast financiers have proposed helping several California Cities (legally) steal debt instruments from their owners.  Through a novel and dubious use of eminent domain these cities intend to force mortgage companies to sell performing loans at discounted ‘market value’ rates.

Eminent domain is a governmental power that allows the government to seize private property for public purposes.  Although eminent domain has traditionally been used to clear land for major infrastructure projects like highways or reservoirs it has been abused in recent years to seize private land for transfer to developers who built shopping centers, subdivisions or amusement parks.

In this case, they would condemn troubled mortgages so they could seize them. Then the borrowers would be helped into mortgages with significantly lower monthly payments.

…The plan targets homeowners who are current on their mortgage payments but “under water,” meaning they owe more on the mortgage than the home is worth. Here’s how it would work for a hypothetical city:— The city goes to court and argues that the public purpose is served by having the county own, and ultimately refinance, the mortgage.

— The city pays fair market value to the owner of the mortgage…

— The city, the new owner of the mortgage, encourages and helps the homeowner to find refinancing. Now the principal is lower, and interest rates are at historic lows, so the homeowner winds up with easier monthly payments.

via Calif. cities eye plan to seize mortgages – Yahoo! News.

No matter how you feel about banks and mortgage companies this is a bad idea on multiple levels.

  1. The use of eminent domain is extremely coercive.  If the cities really intend on paying ‘market value’ for the mortgages then make the mortgagors an offer and conduct the transaction without the use of force.  That term ‘market value’ is misleading it really means sell at a discount, perhaps 50% or more.
  2. This plan, as proposed cherry-picks only the performing mortgages in a loan portfolio which will further weaken an already troubled industry.
  3. One of the reasons for the real estate bubble in the first place was due to government intervention encouraging private lenders to make riskier loans than they would have made without Fannie Mae and Freddie Mac.
  4. Bankers and investors are smart…seizing performing financial instruments at discounted rates would have a chilling effect on the availability of credit for future home buyers.  Would you loan someone money to invest if you knew that you could be forced to cover your borrowers losses in their investment doesn’t appreciate?

Having an investment lose money (like becoming upside down in your home) is a pain, but investments don’t always pay off and that borrower signed a promissary note knowing full well that housing prices fluctuate.  Losing a house is a tragedy…but further eroding property rights and destroying the system that helps people purchase houses in the first place would be adding insult to injury.

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