If delinquencies and strategic defaults were not risk enough for investors wading into the mortgage market to face, a new wrinkle is being considered in California—the concept of eminent domain introduced into the private marketplace.
Local officials in California's San Bernardino County are exploring the possibility of invoking eminent domain as a means of extending homeowners a helping hand.
In 2005, the U.S. Supreme Court decided Kelo v. City of New London by determining that eminent domain could be used as a means of transferring property between private owners.
Up until then, eminent domain had only ever been applied to the greater public good. The consideration currently underway in California would extend this narrowly defined extraordinary governmental authority to buying underwater mortgages from investors and marking them to market by reducing their outstanding principal. The reduced mortgages would then be sold to new investors.
Proponents of the plan praise the opportunity to provide some much needed relief to citizens who are struggling to stay afloatwhile acting responsibly and continuing to make their monthly mortgage payments.
They also insist the move is necessary to reignite the private label mortgage market, claiming that the persistent overhang of underwater loans is preventing private capital from returning to the market.
Putting aside the unconscionable idea of government seizing investments from free market participants, what is being overlooked here is the effect that such a bold move will have on loan origination and interest rates.
To start with, applying eminent domain in this fashion will depress housing values by providing banks with less incentive to originate mortgage loans.
Investors will likewise be unwilling to wade into the marketplace if they fear the potential for government seizure of their investment products on an unchecked whim—these jurisdictions have authority that allows them to act without approval by city councils or boards of supervisors unless they require public funding.