New Mortgage Seizure Plan is the Nuttiest Idea Yet

Agenda-Setting Financial Insight.
July 5 2012 11:29 AM

New Mortgage Seizure Plan is the Nuttiest Idea Yet

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If a California county’s new plan to seize underwater mortgages from investors catches on, bondholders could face billions in losses.

Photo by Justin Sullivan/Getty Images

A California county’s new plan to seize underwater mortgages from investors may be the most dangerous housing market intervention yet. If it catches on, bondholders could face billions in losses – and taxpayers, too, if local authorities start targeting loans backed by the federal government. That would whack up mortgage costs and may leave Washington as the only lender.

The plan is simple enough. San Bernardino county wants to invoke existing eminent domain laws to seize mortgages that are bigger than the current value of the homes they’re lent against. That’s a radical departure from the way eminent domain is usually deployed – to commandeer land for public use, such as to build a road.

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The county would then sell the loans to a fund called Mortgage Resolution Partners. The deal is a no-brainer for all concerned: the investment group makes a profit on the safer new mortgages – to qualify, borrowers have to be current on their payments. The homeowners get a loan that’s now worth less than their home, so also end up with some equity. And the local politicians look smart and may win some extra votes.

But that doesn’t allow for the true cost of the program. Assume it’s implemented across the country and includes not just private-label mortgages, as is the case in San Bernardino, but the far larger market of those backed by the U.S. government. That opens up the scheme to a large chunk of the $1.2 trillion-worth Americans owe on their mortgages above the current value of their homes, according to Zillow’s first-quarter Negative Equity Report.

That would cause enormous losses for bondholders and taxpayers alike. At the extreme, private investors would probably abandon any intentions of financing a private mortgage market in the future, leaving the U.S. government as the only entity willing to shoulder the risk.

At the very least, the successful use of eminent domain laws to seize mortgages, even if limited to a few municipalities, would make bondholders charge far more for the risk, pushing up the price of home ownership – which could hit demand for loans and send house prices down again, perpetuating the cycle of bubbles and bailouts.

Of course, the threat of this program might light a fire under bondholders and servicers that have been sluggish to modify mortgages up to now. But the costs of this coercion would easily outweigh the benefits.

Read more at Reuters Breakingviews.

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