As is the case in too many cities in the United States, even after more than 4 years since the beginning of the foreclosure crisis, Chicago’s homeowners have been hard hit. In March of 2012, nearly 667,000 Chicago area homes were underwater, and 13% of those homeowners were also delinquent on their mortgage payments for three months or more. Add to these troubling statistics Chicago’s above-average unemployment rate which, as of May 2012, was 9.8%, and the city’s condition appears even more dire.
Chicago has been willing to take aggressive (though problematic) actions to solve problems brought on by the financial crisis. One such move was the passage of the vacant building ordinance which landed a leading role here at Crunched Credit on two separate occasions (click here and here).
And, once again, Chicago has managed to catch our attention with its recent decision to consider a plan to “use the power of eminent domain to purchase underwater mortgages out of securitized packages of loans at a steep discount, write them down to fair market value and then create a new mortgage with a much reduced principal and monthly payment.” Sound familiar? It should. San Bernardino County recently entered into an agreement with two of its cities, Fontana and Ontario, to create the Homeownership Protection Program Joint Powers Authority (“JPA”) “to assist in preserving homeownership and occupancy of homeowners with negative equity within the Parties’ jurisdictions, avoid the negative impacts of underwater loans and further foreclosures, and enhance the economic vitality and the health of their communities” which “may include the Authority’s acquisition of underwater residential mortgage loans by voluntary purchase or eminent domain and the restructuring of these loans to allow homeowners to continue to own and occupy their homes.” Click here for more information about JPA, eminent domain, and a discussion of just a few legal challenges to the proposal. For an interesting read, see the fact sheet of Mortgage Resolution Partners (“MRP”) (the venture firm that proposed the eminent domain plan).
Chicago’s plan “recognizes that the best way to keep troubled homeowners in their homes is by reducing the principal on their mortgages, thus lowering their debt burdens and more closely aligning their mortgages with the true value of their homes.” Forgive me if the following observation seems obtuse, but doesn’t this recognition assume that the solution to the problem is keeping struggling homeowners in their homes? This assumption may be useful for sound bites and re-election campaigns but is it really the best thing for the housing market? What about the effects of unemployment (both Cook County (9.8%) and San Bernardino County (12.6%) have high unemployment rates)? Aren’t they the real driving forces behind people’s refusal to buy new homes or refi (assuming if a homeowner has no job (and no job prospects), he or she may consider alternatives to staying in the home or refinancing to lower his/her monthly mortgage payment (e.g., moving, selling or walking away)) despite historically low rates? As we all have experienced for a number of years now, high unemployment means a decrease in consumer confidence, less discretionary spending and more strain on government resources (as more people are eligible for social safety nets) which leads to higher taxes (sometimes) the debt ceiling crisis and so on, all of which begets higher unemployment. And the cycle continues.
In addition to concerns that the eminent domain proposal may not work either to help keep homeowners in their homes or to prop up the value of home prices, consider the very real possibility that the proposal may end up doing more harm than good: The implementation of the eminent domain proposal could increase the cost of lending, investors in mortgage securities could demand higher interest rates or abandon the market altogether and homeowners may still end up defaulting, all of which may cause housing prices to fall even further. Moreover, according to a new Moody’s Investors Service analysis, should such proposals be adopted nationwide (which seems highly unlikely), mortgage bond investors could see defaults rise by more than 30%, leading to losses for investors. Reportedly, the San Bernardino eminent domain proposal would affect less than 1.5% of private-label security loans in the area, as the mortgages are bought out of pools, which amount could increase as the idea gains traction in other areas. But is this amount really enough to change the trajectory of the housing market? Further, only homeowners who are current on their mortgage loans would be eligible, and the plan would not apply to mortgages backed by Freddie or Fannie. Add to the scenario the facts that apparently private mortgage securities now fund less than 1% of all new loans and the U.S. government currently backs about 90% of all home loans, and it’s difficult to envision how this proposal would end up helping those homeowners most in need.
On the other hand, assuming that the proposal survives the plethora of legal challenges it is likely to face, private investors expect returns as high as 30% from their investment in MRP. MRP expects to receive a fee of $4,500 per transaction. This proposal could, in fact, lead to the stabilization of home prices and the minimization of future defaults. It might cause, in certain areas, an increase in consumer confidence and discretionary spending (especially if homeowners feel their personal net worth increase as a result of a spike in the value of their homes). At the very least, it could open the door (and already has) for candid discourse about the housing crisis and what plans, solutions and government programs have not worked and are not working.
From this vantage point, it is clear that the failure of the housing market to recover, slow (glacially slow) economic growth and stagnant job growth are causing people to think outside the box. Maybe a little ingenuity (spurred by the private sector) is exactly what we need.