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Can Eminent Domain Save the Housing Market?

The housing crisis has confounded experts for years, despite the best efforts of private parties and public governments. Now, though, a new proposal would use the government's power to take property with compensation in order to simplify restructuring mortgage loans. The proposal has drawn strong comments as proponents and opponents debate whether it can actually get the housing market moving forward.

A quick fix to the housing crisis?
In the past four years, investors and ordinary Americans alike have increasingly looked to the government for solutions to some of the biggest problems facing the nation. From the financial crisis to health care and housing, the government has been instrumental in exercising its power at critical times, and while those of different political ideologies would disagree about the results, few could argue that the government hasn't taken more dramatic steps recently than it has in the past. Yet the checks and balances on government power built into the fabric of the nation represent one of the biggest distinctions of the U.S. from its world peers.

The latest example of this balancing act of solving problems without overreaching government power comes in a recently proposed solution to the foreclosure crisis. Rather than letting overburdened courts go through the normal foreclosure process, the San Bernardino County government in California is considering using its power of eminent domain to force mortgage holders to sell their mortgages to the government. The government would then write down the value of the underwater mortgages, leaving homeowners in a better position to sell homes or refinance mortgages.

Predictably, though, the investors who own securities backed by these mortgages argue that the move wouldn't fairly compensate them for the value of the mortgages. Pointing out that many underwater mortgages that are still being paid on time are likely candidates for eminent domain, a Legg Mason (NYSE: LM  ) bond unit representative told Bloomberg that the entire mortgage-backed securities market could see reduced interest as a result, hurting it and other bond investors.

Eminent domain and you
The move wouldn't be the first controversial use of eminent domain. Historically, eminent domain required the government to pay fair value to private owners for property it took from them. More importantly, though, the Constitution requires a "public use" for the land. So there's no question that a government can appropriate land for use as a public park or some other clear example of public use.

Where problems arise, though, is where the cited public use also carries a private benefit. For instance, the Keystone XL pipeline would have required eminent domain for its construction, benefiting TransCanada (NYSE: TRP  ) as the operator of the pipeline. The arguable public need for energy, though, would have triggered the right to use eminent domain. Now that rival Enbridge (NYSE: ENB  ) is touting its  own pipeline proposals after opposition to Keystone, the status of eminent domain definitely plays a definite role in determining winners and losers in the industry.

Big-box retailers have also been criticized for taking advantage of local governments hungry for jobs and tax revenue by using eminent domain to take private land for development. Home Depot (NYSE: HD  ) , Target (NYSE: TGT  ) , and Wal-Mart are just some of the retailers that have benefited from eminent domain in the past.

Who wins with housing?
In the housing realm, the big fight over eminent domain would concern the valuation of the mortgages themselves. Local governments certainly don't have enough money to pay what mortgage securities holders would like for the mortgages, and they'll likely point to underwater mortgages as technically worthless in order to lowball investors. Courts haven't always made reliable assessments of fair value under eminent domain proceedings.

Moreover, just as current mortgage securities holders arguably benefit from the status quo, there would also be some private winners from the eminent domain proposal. For instance, San Francisco's Mortgage Resolution Partners, which is acting as a community advisory firm to help facilitate the proposal, says it will be paid a fee based on the volume of mortgage loans that governments acquire.

In the end, though, the only way we'll see whether eminent domain works better than the foreclosure process is for San Bernardino or some other government to try it. There are private winners and losers in every scenario, so perhaps the measure of success should focus not on the inevitable private gain, but on whether eminent domain actually thaws the frozen housing market.

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Read/Post Comments (28) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 16, 2012, at 10:01 AM, mdk0611 wrote:

    I thought the Kelo decision by the US Supreme Court a few years ago was terrible, but this would be worse.

    Who decides the fmv of the mortgage that will be seized under eminent domain? How do we defend against abuse and insiders using the process for personal gain?

    When would this process be used in the future? This is not the first time homeowners have been underwater. Under what circumstances would this be done again in the future?

    How do we prevent this policy from encouraging speculation in the future? Just as buyers in the mid 00's thought that their houses could never lose value, woiuld new purchaser's just assume that if they went underwater the state/municipality would bail them out?

  • Report this Comment On July 16, 2012, at 12:32 PM, pedorrero wrote:

    I side with the theory(ies) that the entire housing & mortgage mess was the result of government actions in the past (mainly: implied, actual federal subsidies and guarantees to mortgage and banking entities). A skeptic (me!) would think that further government action is likely to worsen or prolong the problem, not improve it. Look at who benefit(ted) from the guarantees (hint: bankers, mortgage writers, the real estate industry) and you will see most of those who make money off the small guy. In retrospect, perhaps a huge mortgage for a blue-collar, no-assets "homeowner" was not such a good idea after all.

  • Report this Comment On July 16, 2012, at 3:19 PM, TMFGalagan wrote:

    @mdk0611 - The court decides the fair market value, based undoubtedly on expert testimony from two experts who have wildly disparate theories for valuing mortgages.

    best,

    dan (TMF Galagan)

  • Report this Comment On July 16, 2012, at 5:29 PM, xetn wrote:

    It would be better just to foreclose all of these properties and sell them at market prices set by auctions or .... We need to get the government out of the equation and let the market handle the problem. Of course, it will never happen until the government defaults on it debt, which I think is unavoidable.

  • Report this Comment On July 16, 2012, at 5:42 PM, rhealth wrote:

    This was obviously NOT the purpose of the eminent domain legislation. When you start perverting the purpose of something that was clearly not meant to solve mortgage problems, what end will there be to it? It's pretty clever I have to admit, I would never have thought of it, but even if it turns out to be legal, it's a bad idea.

    Incidentally I have some old motorola cell phones I would like the govt to "eminent domain"...or I could just sell them on Craigslist.

  • Report this Comment On July 16, 2012, at 6:36 PM, Borbality wrote:

    Maybe I can sell my loser stocks to the government and they can give me my money back.

  • Report this Comment On July 17, 2012, at 9:00 AM, LegalizeMe wrote:

    Government intervention in a free market has been, and always will be, a bad thing.

  • Report this Comment On July 17, 2012, at 9:26 AM, StopPrintinMoney wrote:

    Author - WTH are you even talking about ? Are you on crack?

  • Report this Comment On July 17, 2012, at 9:31 AM, mdk0611 wrote:

    Dan - Would it go directly to the courts, or would the first step be an administrative process/hearing where there would be an incentive for the state to assert a value that would be below FMV? You would then proceed to court, where your point about wildly varying expert testimony reflects both an amusing degree of cynicism and accurate assessment of the process.

    And what will the legal representation cost the mortgage owner who has done nothing wrong other than to be a debt holder in recessionary economy? And do we do this when the property is only 5-10% under water? I wonder whether there will be an uptick in seizures in the 6 months running up to an election.

    This whole concept reeks with possibilities for abuse

  • Report this Comment On July 17, 2012, at 11:05 AM, Lucaskasan wrote:

    Housing is not in crisis, and we need to lose that meme. It was in crisis during the bubble. In some communities, especially coastal communities, it is still in crisis because prices have not yet corrected to align with local wage demographics. When the housing market is healthy, the local median wage can purchase a local median turn-key house.

  • Report this Comment On July 17, 2012, at 11:10 AM, fool3090 wrote:

    The worst part of this idea is the notion that government, any government, can invalidate a private contract (between lender and borrower). I find this especially chilling. If contracts are suddenly viewed as "optional" or a "suggestion" to be repaid, we have some serious problem. And I'm liberal! This scares the heck out of me. I can't even begin to list the unintended consequences. We gotta let the market take care of this one, as ugly as is. Folks are going to hurt and are hurting now, but this is nuts.

  • Report this Comment On July 17, 2012, at 1:22 PM, BMFPitt wrote:

    That a proposal like this can be made without being immediately met with laughter and scorn is a sad commentary on where we are as a country.

  • Report this Comment On July 17, 2012, at 2:29 PM, TMFJebbo wrote:

    Why use eminent domain for this process? Why not just use the commerce clause. It seems to be a handy excuse for all other government overreaches.

  • Report this Comment On July 17, 2012, at 4:45 PM, TMFGalagan wrote:

    @mdk0611 - I'm sure the value-determining procedure differs from state to state. Here's a useful primer I found from an Ohio lawyer: https://www.ohiobar.org/ForPublic/Resources/LawYouCanUse/Pag...

    best,

    dan (TMF Galagan)

  • Report this Comment On July 17, 2012, at 5:23 PM, whereaminow wrote:

    --->In the past four years, investors and ordinary Americans alike increasingly looked to the government for solutions to some of the biggest problems facing the nation<-----

    No, they have not. They have overwhelmingly opposed government intervention (re: opposition to bailouts, tea party movement), though not always with a clear idea of what exactly constitutes gov intervention.

    The State has used these crises (which it created) to increase its involvement in our lives. Big difference.

    David in Liberty

  • Report this Comment On July 17, 2012, at 5:23 PM, awallejr wrote:

    Well I am not sure the proposal by San Bernardino would pass Constitutional muster because you aren't really talking about taking real property for public use but, rather, commercial paper (mortgages).

    San Bernardino would first have to obtain title to the properties which would mean kicking the people out. And since these properties are "under water" that means these people basically get nothing. Now assuming they go that far they would then have to come up with the money to pay off the fair value of all the mortgages.

    Now assuming they do that, and have the money to even come up with, they would then have to do something with all these houses. They can't just give it back to the individuals they took it from since there are statutory procedures municipalities must follow.

    The properties would have to go on public auction. And in light of the fact that the municipality just told the lenders their security is not safe I doubt you would find buyers except for the wealthy investors who can pay cash.

    What then did the municipality accomplish? It made a bunch of people homeless, even those who could afford their mortgages while the property was currently "under water" and it probably chased away all the lenders.

  • Report this Comment On July 17, 2012, at 5:53 PM, knighttof3 wrote:

    Ermmm - old news if you read the METaR board :-)

    I posted this on Sat July 14 - http://boards.fool.com/clever-lawyers-30148639.aspx.

  • Report this Comment On July 17, 2012, at 7:03 PM, bijay64 wrote:

    1) Big winners = trial lawyers

    2) Unintended consequences: I can just see the headlines a few yrs from now: XYZ city goes bankrupt due to derivatives bought to 'protect' value of housing purchases via eminent domain

    3) A poorly conceived solution to a problem just creates more problems down the line, especially given the precedent set by this 'solution'.

    4) Housing prices have by in large corrected (some even say over-corrected) in USA. Yours is also one of the only countries to have massively deleveraged in the past 5 yrs thanks to the above This is no longer a housing crisis but the lingering impact of a debt crisis for individuals who over-reached and find themselves underwater, so to speak.

    That said, I'm sorry but I don't agree with Legalize Me that Govt intervention in a market is ALWAYS bad. Markets are not sacred, perfect, always provide the 'right' solution etc. Even Adam Smith saw the need for regulation and his advocacy of the invisible hand was based on a system akin to 'perfect competition' which hardly exists today. Rather we have imperfect markets, oligopolies or monopolies whose power needs to be blunted The common person doesn't have the power or resources to do that, so what's the solution. Plus, free markets often cause externalities and examples of market failures bound. Who should resolve these? Simplicity is a virtue, but one system does not solve all the world's issues. Politics exists because we all have different views on which system to use in different situations.

  • Report this Comment On July 18, 2012, at 1:33 AM, TerryHogan wrote:

    I don't see it happening personally. But if it does, bijay64 hit the nail on the head - it's the lawyers who will reap the most benefits. Since they are consistently huge donors to the Democrats, I guess maybe it will happen.

    Ahh well, at least China has a decent growth rate... if you can't beat 'em, join em. Crank up the Government intervention some more!

  • Report this Comment On July 18, 2012, at 2:37 AM, anuvaka wrote:

    Dan

    Houses for eminent domain are usually appraised at current vale, so it would of course be less than the homeowner paid for it. And the ED offer is usually about 90% of that..

    So the homowner would lose, the bond holder would lose, the mortgage company might break even and the City is stuck with a house. IF it sells, they can collect taxes from it.

    Tell me why you think this is a good idea?

    jC

  • Report this Comment On July 18, 2012, at 7:22 AM, TMFGalagan wrote:

    @anuvaka - Keep in mind that the government isn't using eminent domain to take the house, but rather the mortgage covering the house. My understanding of the proposal is that the government has no intention of exercising any mortgage rights to foreclose on property after obtaining the mortgage. In fact, that seems to be exactly the opposite of what would happen.

    To be clear, I have no idea whether it will work better or worse than the foreclosure process has in trying to unstick the housing market. The only way we'll know is if somebody tries it. Perhaps even just the threat of eminent domain will unfreeze the situation.

    best,

    dan (TMF Galagan)

  • Report this Comment On July 18, 2012, at 9:00 AM, outoffocus wrote:

    NO!

  • Report this Comment On July 18, 2012, at 11:27 PM, awallejr wrote:

    TMFGalagan, that is why the process is unconstitutional. The municipality can't take "commercial paper" under eminent domain. They HAVE to take the property. And then that goes according to my comment above. It is a ridiculous proposal being sought after by a company trying to make money.

  • Report this Comment On July 19, 2012, at 12:27 AM, NOTvuffett wrote:

    don't try this in tx, we have guns.

  • Report this Comment On July 19, 2012, at 1:44 AM, DJDynamicNC wrote:

    >>>Of course, it will never happen until the government defaults on it debt, which I think is unavoidable.<<<

    It is unconstitutional for the government to do this.

    "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. "

    Any debts authorized by law - which is pretty much all of them, though there are some murky ones that we would all probably better off without anyway - is valid and Constitutionally MUST be valid, meaning the government MUST pay them, meaning the Treasury MUST print the money to do so, or find some other means of doing so.

    I mean honestly, you could just as easily ask the Federal Reserve to extend "overdraft protection" to the Treasury if it came down to it, if I can have overdraft protection for 4$ a month I'm sure the United States of America could arrange the same.

  • Report this Comment On July 20, 2012, at 11:18 AM, DavidAkre wrote:

    This is so wrong on a constitutional basis it is beyond disturbing. When did we elect Putin??

  • Report this Comment On July 20, 2012, at 12:06 PM, diggerdan28 wrote:

    Like almost every other government program it will fail miserably and then they will create another program to fix it and eventually the government will have the house and the money, and the people will pay the government (with their government provided job) to live in the government house and...Wait a minute! Didn't they try this in the Soviet Union?

  • Report this Comment On July 21, 2012, at 2:40 PM, sfearnot wrote:

    It is good to see such intelligent, thoughtful comments. Some of them suggest a truth that too many ignore or have yet to learn. The question of whether the intended end justifies the means typically overlooks the reality that the means will become its own real end. The issue of underwater mortgages will pass, whether or not the use of eminent domain facilitates its passing. What will be left, if eminent domain is used in this manner, is the ability of government functionaries to manipulate the lives and property of others by means of an expanded and expandable power of eminent domain.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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